Michael Burry Trashes Index Funds – Are We Screwed?

As a general rule, Mr. Money Mustache avoids reading the daily news and ignores the fluctuations of the stock market. And he advises you to do the same thing.

The negative factors of wasting your time, diluting your precious brainpower, and creating undue stress by worrying about things outside of your circle of control far outweigh any slight advantages you might get from the tiny slice of news stories that are actually useful and relevant to your daily life.

But on very rare occasions, something will squeeze its way through the News Sphincter that is worth addressing, and last week I learned of one of them. The basic idea was this:

Image source: Bloomberg
If you’re not a finance nerd, the phrase “Like Subprime CDOs”, just means “really bad”.

Michael Burry, who in my opinion is a relatively brilliant and well-known financial figure, voiced his concerns that we may be inflating a big bubble by concentrating too much of our money in passively managed index funds.

And because I have been telling you since the beginning that index funds are the best way to invest, my email inbox and Twitter feeds started filling with concerned questions and links to his interview on Bloomberg, asking if we should be taking this seriously.

So is it a big deal? Should we be worried?

The quick answer is No. And we’ll get into the full explanation below, but first let’s do a quick review of Index Funds in general.

Why Index Funds are Great

Index fund investing is both the simplest and the highest performing way to invest your money. It’s as simple as getting any brokerage account and buying the Vanguard Exchange traded fund called VTI, or getting a Betterment account and setting your allocation to at least 90% stocks.

It’s the ultimate win/win because you just set it and forget it. Both the math behind it, and the historical performance for the past 40 years (since the invention of index funds) has proven this out.

Yes, a small percentage of actively managed funds have beaten the market, and a larger percentage have trailed the market. But this over and underperformance itself tends to be random, and today’s winners often become tomorrow’s losers.

A bowl of actively managed funds. Can you pick the winner?

And here’s the real problem: you can’t predict in advance which of these horses you are betting on. So your best bet is to ride directly in the middle of the pack, while minimizing the fees you pay for the privilege.

But suddenly, Michael Burry says we are reaching the point where this model may soon stop working. So who is right? Mr. Money Mustache or Michael Burry? Have I been naively misleading you?

And what about the reassuring words of Jim Collins in his book The Simple Path to Wealth or rather amusing Guided Stock Market Meditation he put up on YouTube? Is Jim full of it too, in light of these new comments from a financial expert?

Now, we are already treading onto thin ice here, because similar stuff is in the news every day, and most of it is junk. Financial ‘experts’ are a dime a dozen, and just because somebody got something right once (in this case predicting the 2008 financial meltdown), doesn’t mean they will be right in the future.

Because the financial news industry is powered by profits which come from clicks and traffic, their job is to shock and worry and distract you as much as possible so you will click your way through more of their bait. Within the context of that single Burry interview, for example, I saw the following bits of “Breaking News”:

Big gain! (never mind that aside from meaningless fluctuations, the market has gone exactly nowhere in the past nineteen months since January 2018)
Down Six Percent! (Oops it was back up to those highs by the time I checked)
Triple digits! (oh, wait, that is less than a third of one percent because the index is about 27,000)
Volatility! Impact! (oh wait, that is all just the random fluctuation it always does and it means absolutely NOTHING to you as an investor)

NONE of these things are the least bit newsworthy, and they shouldn’t even be mentioned in a footnote, let alone labeled “Breaking News.”

So, stock market reporting is silly, and predictions of doom should be viewed even more skeptically. Because the nature of our economic system assures that virtually 100% of predictions of financial doom will always be wrong, because we are not really all doomed – the future is very bright.

However, I’ve read a lot of Mr. Burry’s writing and have more respect for his analysis than that of permanent fearmongers like Peter Schiff or Dmitri Orlov. So I pay attention to his opinions, even when they differ from my favorite permanent realist-optimists Warren Buffett and Bill Gates.

So the summary of his argument is this:

  1. Passive investing tends to distort the prices of individual stocks, because we buy everything in a fixed ratio without considering the value of each company.
  2. The “exit door” is small – there is a lot of money invested in fairly small companies whose shares are not frequently traded. So if we all tried to sell at once, we’d have way too many sellers and very few buyers. This would cause a massive price crash in the stock prices of these small companies.
  3. There are some complex bits under the hood of index funds – things like options and derivatives that can break under stress and cause money losses or more volatility.

Now at this point, the stock traders and active fund managers are probably cheering and jeering at us:

“YAY! Told you all along – come back to us where you belong.

We are well worth our much higher fees because we are gonna beat the market! Just look at this cherry-picked data from the current ten year bull market!”

But instead of picking a fight, let’s just address these points one by one:

  1. Yeah, but active traders have been making this argument against passive investing forever. The theory is correct, but in practice it would only be a problem if too many of us became passive and there were no active traders left. Thus the real question is: Are we close to this tipping point? And the easy answer is “Not even close”. Index funds own about 18 percent of global shares, and 45 percent here in the US. And active trading still outweighs index fund trades by 22-to-1.
  2. A small exit door only matters if everyone is running for the exits at once. And even then, as index fund investors (as opposed to active stock traders), we don’t do that. And even in the event of liquidity problems in a big sell-off, the only downside would be some bigger temporary price swings. We don’t care about those either.
  3. To better answer this question, I interviewed some of the people deep inside the machine – Betterment’s investing team and their director Dan Egan. A summary of their thoughts – This is actually more of a problem for “Synthetic” or leveraged index funds, not the true funds we invest in. For the most part, in the index funds you and I use, our money simply purchases real shares of businesses.

Point #1 above deserves a bit more of an answer. Because the real question here is “how many active investors does it take to balance out a market?” And like everything in life, this is not a black-and-white question. Instead we can look at this as being on spectrum. For reference, this is where we are now:

The great increase in Index fund investment after MMM and Jim Collins started advocating for it :-)
Image source – Morningstar / CNBC

A Purely Active Market

If everybody was an active investor or speculator, you would just have a sea of squabbling bullshit. Even today, people are trading back and forth for no reason just based on what they think the price will be later this afternoon. Even worse, you have “technical” traders, who place bets on the immediate future of a stock based not on fundamentals, but on obscure (and proven to be useless) mathematical patterns of what the stock price has done in the recent past. I may be unfairly lumping thoughtful value-based investors in here with day traders, but stock price prediction is a slippery slope and most of the trading volume on today’s exchanges is very slippery. And don’t even get me started on the nonsense of “high frequency trading” and the “flash crash” of 2010. No shortage of overly active trading.

If Everybody Was Passive

At the other extreme of this would be an “All Index Fund” world, where giant zombie-like index funds would just buy all the companies in proportion to their current market value, even when those companies have stopped making money or are on the verge of bankruptcy.

Nobody would be even looking at the earnings, so stock prices would never drop, even when the underlying companies go extinct. And on the flip side of that, companies who became vastly more profitable would never be rewarded with higher share prices.

In this case, a gigantic market opportunity would open up. Apple shares would still be at their 1980 IPO price of 39 cents per share (after accounting for splits), and each share would pay an annual dividend of $3.08, which is like getting a 792% annual interest rate on your investment. Individual investors (even me!) would come back to the market and they would flood in and buy Apple shares, until the share price rose up to a level where supply and demand balanced out. And today, that price happens to be about $216 per share.

There are plenty of people out there, finding and exploiting these little opportunities. People like outspoken tech investor and futurist Catherine Wood speak authoritatively about them – but only time will tell if her $2.3 billion ARK capital fund proves to outperform the market over the long run.

And that is the real answer to question #1: If Actively managed funds start consistently outperforming index funds on average across the entire industry, then we have reached the point of “Peak Indexing”, and you should switch to a good low-fee active fund.

This is far from happening, but I’ll let you know if it ever does.

And for every successful niche-finder, there are a hundred wannabe players, spouting buzzwords and predictions, getting ever-louder when they are right but going mysteriously off the radar when proven wrong. This survivorship bias ensures that if we read the news, we get the mistaken impression that most stock predictors know what they are talking about. They don’t.

So really, that’s all there really should be to stock investing. A small group of dedicated experts seek out the best values, and in a big enough market a larger amount of index fund money can tag along.

Never Forget What Stock Investing Really IS

The value of one share of a company is equal to the “net present value” of all of its future lifetime dividends payable to you the shareholder. Higher expected profits mean higher eventual dividends and thus higher stock prices. Lower profits mean lower prices. And a company that never makes a profit over its lifetime should not even be listed on the stock exchange.

Lower expected interest rates also mean those future dividend payments are worth more of in today’s dollars, which means today’s stocks are worth more. Which is why drops in the interest rate often trigger simultaneous boosts in all share prices.

Some companies don’t currently pay dividends, but that is only because we the shareholders have given the management permission to temporarily reinvest profits into growth – in hopes of larger future dividends.

If we knew (theoretically) in advance that a company would never pay any of its future earnings to shareholders, those shares should be worth zero. A company which never produces and returns value to shareholders is worthless from a financial perspective – unless you could get someone to buy your proven-worthless slips of paper purely on pure speculation, in hopes of selling it to someone at a higher price in the future – like gold and bitcoin. Speculation of this type is a less-than-zero-sum game, a tax on overall human prosperity, which is why you shouldn’t waste your time on it.

So the stock market really is built upon the fundamentals of earnings and dividends. Not on news snippets and soundbites and rapid trading. And since publicly traded companies are big, slow entities with hundreds of employees and thousands of customers, their fates simply don’t change very quickly. “Analysts” who try to predict these future earnings with any certainty rarely outperform a coin toss.

So We Can All Just Stay the Course and Relax

Just as with other bits of news in the financial media, you do not need to take any action. Keep investing and stay the course. If you are so inclined, study up on profitable real estate investments as a side hustle, and if you want a bit of a safety margin in exchange for slightly lower returns in the long run, consider paying off your mortgage as you approach early retirement.

Once you arrive, you will probably find that money and investments are the last thing on your mind. After all, that’s what Financial Independence is all about – becoming free from the need to worry about money.

It’s a nice place to be, and I’ll see you when you get here!

  • John Jones September 16, 2019, 9:11 am

    Hi MMM
    Love your blog, I’ve been investing for about 12 months now based on your suggestions. My concern is about Automation. I read the book, “The War on Normal People”, by Andrew Yang, and if he’s correct millions of jobs will be automated by AI and robotics, so much so, there will be fewer and fewer jobs, leading to mass unemployment, which would lead to less consumers with money, leading to an epic crash, The system needs people spending, so unless something is done to address the Automation of jobs away, how can the system keep going? I know it seems alarmist, but I’m seeing the signs of automation everywhere everyday, and the rise of the gig jobs that don’t offer benefits, or any real living earning power. What is your opinion?

    • Mr. Money Mustache September 17, 2019, 7:11 am

      Yeah, that would be a fun subject to write about sometime. The first step will be figuring out if and when it ever actually happens. Gig economy aside, we currently have the lowest unemployment ever in the US, and the inflation-adjusted wages for the non-rich have been slowly trending up for 25 years as well (https://en.wikipedia.org/wiki/Real_wages#/media/File:United_States_real_wages_(red,_in_constant_2017_dollars).png)

      And the concern about machines taking our jobs has been around since at least the 1800s when the industrial revolution really started weaving. So far, each wave of advancement has displaced people, but still ended up with a net increase in standard of living. Artificial intelligence could be different (and I know it could even be catastrophic), or it could be incredibly good.

      It is true that MOST of the increased wealth since the 1990a has gone to the richest people, including engineers like me who happened be in higher demand. But was that due to automation or something else like tax policy?

      There is lots to learn about in this field, and I know very little so far. But I do like Andrew Yang’s approach, and I also agree that a universal basic income could be a good approach at some point, to help make working for the basic needs of life a less desperate and more optional thing.

  • Cameron September 16, 2019, 8:05 pm

    Can’t believe no one praised the impressive visuals created by the phrase “news sphincter”. Search the entire internet and I seriously doubt you’ll ever find a better analogy than that!

  • Joe September 17, 2019, 11:33 am

    Is it possible that everyone here thinks MB’s comments and the entire discussion has to do only with equity index ETFs(SP/DJIA/Nasdaq)? I wish to remind you there are 100’s of other niche ETFs in the equity universe and MORE IMPORTANTLY a huge credit (bonds) ETF universe that includes an even higher population of uninformed investors who are not going to manage a market dislocation well. The credit markets have still greater liquidity issues under the surface. I think the entire post here is massively over-simplified and certainly suffers from not considering anything beyond large index ETFs. It is beyond debate that dislocations in markets do not stay contained and intact there is a reflexive mechanism once things start rolling. The current index equity ETF situation does share some characteristics with the ’87 portfolio insurance environment. No I have not sold my SP500 ETFs but I hold them knowing they can come under attack from other assets class issues. Yes it will be an opportunity but it is a zero-sum game and returns earned from that opportunity will accrue to fewer folks and be extracted from more and less prepared folks. …. my .02

  • Ron Cameron September 17, 2019, 4:53 pm

    “A small exit door only matters if everyone is running for the exits at once. And even then, as index fund investors (as opposed to active stock traders), we don’t do that”

    MMM, it sounds like you’ll be surprised when it -does- happen. It always does. Like clockwork. While a few of us may have stomachs of steel when it comes to severe market fluctuations, most people (including Mustachians and your typical indexer) don’t. They’ll crack. Maybe when they see their account down 20%. Maybe 30%. Maybe 50%. Most will crack. At the worst time. And remember, many of these “I’ve found the light!” indexers are generally young and haven’t see their portfolio dwindle down in real-time while the media is screaming “RUN!RUN! THE WHOLE WORLD IS BURNING DOWN!”

    I mean, even more than it already does.

    It is super easy…and common…to say “I can handle the next downturn!” It’s another to actually do it. When it does happen…let the show begin! (and if you haven’t seen this already, although it’s a bit outdated: https://www.qidllc.com/wp-content/uploads/2016/02/2016-Dalbar-QAIB-Report.pdf)

    • Ron Cameron September 17, 2019, 5:51 pm

      I should have stated: The link above is a report that shows how horrible investors are at…well, investing.Sorry I couldn’t find a more recent one.

  • Tim Azzopardi September 18, 2019, 2:28 am

    Almost everyone is saying Michael Burry is (mostly) wrong. Michael Burry is a very smart guy. Probably much smarter than 99.999% of us. So HOW could he be right. Think the unthinkable don’t reinforce your assumptions. Aren’t we contrarians here? e.g. MMM readers.

    My first thoughts: The market is only 50% passive by market cap, 22 to 1 by number of trades. Therefore everything is fine. Or is it? That passive 50% is predictably always going in a known direction: playing catchup with where the market is now compared to where the index fund is. The other active 50% is (somewhat*) random, some sells, some buys. The 50% passive flows must affect the market prices in a known and PREDICABLE direction. This MUST accelerate relative price differences. (And possibly encourage active “front running” further accelerating the relative price movements. *) It was OK when passive flows were relatively small, but now the passive cash flows are massive and predicable? How is this NOT bad? How will it end? Who knows?
    I’m buying gold, whisky and shotgun cartridges :)

  • Ecodad September 19, 2019, 8:24 pm


    I have been an avid follower of your blog for several years. You are preaching to the choir, other than in regards to our outlook for the future. I do not see it being bright at all, and I consider myself anything but a pessimist.

    Are you familiar with The Limits to Growth? William Catton’s books… Overshoot and Bottleneck? David J.C. McKay’s Sustainable Energy..without the hot air? Tom Murphy’s Dothemath blog? There is no avoiding the fact that we live on a finite planet with finite resources, that our entire way of life is based upon the use of fossil fuels, and this “gift” is what has allowed us to overshoot our carrying capacity.

    There are no solutions to our predicament. With that said, being as self sufficient and energy efficient as we can be, as you generally advocate for, is likely to be the best preparation for the future. Pretty fun and rewarding way to live in the present as well. I would think an index fund of truly green and sustainable businesses, if they could be independently found, would be a good place to park extra cash, after paying off all debt.

    Jeremy Grantham is a well known conservative value investor and is also well worth reading

  • BicycleB September 20, 2019, 8:35 am

    One of the things that usually helps me stay the course on indexing is pleasant yet educational interactions with the fantastic crew of early retirees and Mustachian investors who populate the forum section. I use the forum interactions to quell any need to trade actively in my portfolio. But I”ve been unable to access the forum recently because it keeps timing out. Any access suggestions, fellow Mustachians?

  • HeadedWest September 22, 2019, 10:45 am

    I’m more concerned about a bubble in bonds than any problem with index funds. The 4% rule generally relies on the assumption that in a recession, bond prices rise to protect an investor against falling stock prices. But right now bond prices are kind of ridiculously high already. What happens if the next recession is triggered by a bond bubble bursting?

  • Michal Palczewski September 22, 2019, 2:47 pm

    Past performance does not guarantee future returns.

    So what if in the last 40 years index funds outperformed.

    If you started in 98, you would have been better off buying gold and if you invested in 1929 you wouldn’t have gotten your money back until the 40’s.

    Investing in passive funds right now, smells like a Ponzi scheme.

    They changed the weighting from market cap weighted to float weighted. That means that businesses with a strong owner/operator get penalized. These are the types of businesses that tend to over perform.

    Furthermore, the mantra is buy this thing that’s never gone down. “We’ve never had a decline in house prices on a nationwide basis,” Mr. Bernanke 2005. So what if stocks have outperformed since forever. I just don’t buy these types of arguments. Passive investing will continue to be a great idea, right up until the day that it isn’t.

    This is common. The smartest people used to say invest in stocks. Then we had the great depression. Then they said to buy the nifty fifty. Then the 70’s happened. Then junk bonds, tech bubble and housing bubble all happened and all had good reasons and smart people telling you to use these failed strategies. What’s really all that different this time?

    The question you must ask yourself is, at what point would you no longer think it is a good idea to buy this opaque investment product from an industry known for it’s shadiness. It might be correct that buying passive funds is a good idea right now, in fact it has been hard to beat, and even more so recently, but if you don’t have an answer to the question of what conditions would make you think this is no longer a great investment, all you are buying is a hope and dream.

    • Mike September 23, 2019, 12:06 am

      You talk about index funds as though they’re some shady product and different from the stock market in general. While there may well be shady ETFs based on derivatives or weird indicies, they are not what is being advocated here.

      MMM has several articles on why buying equities has done and will do provide the best returns over the long term. He has also never said that said market will never “go down:.

  • Mark Kirby September 22, 2019, 3:53 pm

    Michael Burry is a hedge fund manager who looks for market imbalances to exploit. I’m not a mind reader, of course, but I think I know what he’s doing behind the scenes. He is right that indexing artificially bids up weak companies, simply because they get pulled up by this sort of bulk purchasing. At the same time, that would under price the strongest companies. They should be getting a larger share that is essentially diverted to the weak ones.

    Quantitative hedge funds like Burry’s use complex math and data analysis to find above average returns (or so they hope). So they would be looking to buy the underpriced stocks and sell shot the over priced ones. That is why he’s worried about crashes. Because lots of hedge funds may be doing this, with leverage, and they may someday try to hit the exits at once.

    But for all the reasons MM explained, we longer term investors don’t need to worry about that. We can dollar cost average to buy in, and rebalance as values rise.

    • Joe September 27, 2019, 9:35 am

      Scion is not a quant fund. AN example of a quant fund (and a very successful one) would be Renaissance Technologies run by mathematics impresario Jim Simons. Scion is a deep dive into ‘fundaments’.

  • Dustin Stout September 22, 2019, 9:55 pm

    “the market has gone exactly nowhere in the past nineteen months since January 2018”. It’s up ~ 7% since 1/2018 at the time of this article, I wouldn’t say it has gone nowhere. Sure, it isn’t cranking like it did in 2017.

  • TommyC September 23, 2019, 6:00 am

    No one seems to have read Burry’s actual comments on this, I think he has a real point that everyone in the FIRE world is collectively dumping on because of ‘MUH ETFS THO’

    When you buy a coventional index fund you are purchasing shares from hundreds of companies. The percentage of shares in the index is governed by the rules of the index, if it was a value index, then 3% of the indexes shares would be from a company worth 3% of total value of that index. Buying and selling all those shares all the time in response to tiny changes in the market would be prohibitively expensive, so indexes only adjust their % alloments once a day. You own the shares, and you are paying someone a tiny % to occasional manicure your investment.

    An ETF started off as a wrapper for index investments. The keyword in ETF is FUND. You don’t own anything in the ETF at all, the fund does. This makes buying and selling the thing easier, and cost less in taxes, because you are just selling your stake in the fund.

    But already you are one step away from actually owning the shares. Who does the person managing the ETF owe allegiance to, you, or the people that actually own the fund?

    Vanguard ETFs make the whole thing a loop, every vanguard ETF will give you Vanguard shares, so you are both customer and company owner.

    The first ETFs were simple and honest. An ETF would wrap up the shares of the top 100 companies, tracking the index, and would pay out the same amount the index pays out, minus some extra fees for the costs associated with running the ETF.

    This proved incredibly popular (although not at first) and now more and more of the stocks owned are owned passively (45% of the stock market), ie almost never bought and sold. This is one of Burrys arguements. Our giant 3% company could change CEO and go in a new exciting direction, and this change would be ignored vs a 100% active market, because indexes don’t do discovery, don’t know who the CEO is etc. The hysteresis of a stock price is very wide when passively investing. Say the inverse happens, the company loses 30% of its value (factory expodes, no insurance, government fines etc) The company is now massively overvalued by 45% of the stock market, and less people take notice, because of less discovery happening.

    Stock buy backs add nothing to the value (maybe even reduce it) of the company except inflate share price, which the index loves as it see the increase in stock price. Active discovery would pick up on this and be more cautious, indexes will blindly buy more of the more expensive stock.

    So now we have a system of an overpriced stock market, and thousands of investors hungry for that ETF and index action. What’s a small ETF to do? the buy in is too expensive. Enter the Synthetic ETF.

    An ETF doesn’t have to own the same stocks as an index, just replicate the returns of an idex its mimicking. So I start a synthetic ETF100* that I say is going to replicate ETF100 from Vanguard. I fill it with unsecured bonds and then pick shares from companies that I think will be great.

    The first year goes amazingly well, thanks to a fantastic stock market. ETF100 gave 7% returns, but my ETF100* made 11%!!! I give my investors the 7%, pay everyone in the company the extra 2-3% in bonuses, and if I’m smart, maybe save the extra 1% for a rainy day.

    The second year isn’t so hot, ETF100 made 3%, I only managed 2% but my junk bonds defaulted, so I sell shares to make up the 1% loss and pray for a better time next year.

    So herein lies the problem. To the average fire investor, ETF100 and ETF100* look exactly the same, but are full of totally different things. 100 will be fine, 100* could collapse in a year. But unless you really dig, ETF100* looks to be the better buy, as it has lower costs to incite people to buy the fund.

    All of this mirrors things which brought about the 2008 crisis, although I don’t see the fallout being as big as and when the market corrects, or the synthethic ETFs collapse.

    • Mr. Money Mustache September 23, 2019, 12:08 pm

      Right, but I think I addressed both of these points in the article already:
      – there is still way more than enough active trading for “price discovery”
      – Synthetic ETFs can indeed be a problem, but there is only one ETF you need, and it’s run by Vanguard itself: VTI.

      • Reade September 24, 2019, 6:42 am

        Hey MMM, would you still recommend VTI for Canadians? I would suspect yes, but you leave yourself open to currency fluctuations.

        • FromFrugalToFire.com September 24, 2019, 2:23 pm

          Convert your money to USD, then buy VTI. I have been increasing my position in VTI.

      • Mike November 20, 2019, 12:26 am

        First of all, I read the original article, and his actual words are very brief and he hardly mentions index funds. But what he does say does not fully explain his position, but it does point you in the right direction to do your own research, which is what I’ve been looking into.

        I think there’s a few valid points to bring up:
        1 – Liquidity is not the same thing as trading volume
        2 – When you need liquidity (like in a market crash), that’s exactly when it tends to dry up
        3 – Banks cannot provide that liquidity like they had in the past because of financial regulations (aka. this time might be different)
        4 – When you have large withdrawals from index funds, that lack of liquidity will not hit all companies equally. While overall the market has less liquidity and price discovery due to index funds taking a larger share, this might be much more of a problem for small stocks than big ones. Simply put, a small company does not have proportionally less eyes (and money) looking at it than a big company – it has much much less.

        When you combine this with the inherent flaw of market weighted indexes, this could be a very big problem. For example, let’s say there is a market panic, and there is a ton of selling from unsophisticated investors holding index funds. These withdrawals (even from ‘good’ index funds) will cause large net selling action. This may absolutely tank the share price of small companies while larger companies may be less affected. Then, let’s say there’s another wave of selling. Because the small stocks got his harder, they now have a smaller market cap, which means they actually will get sold way harder as the index tries to rebalance. It’s a feedback loop.

        There’s a book called the history of the United States in 5 crashes, and this very much rhymes with the 1980’s crash as algorithmic trading becomes the main stock market volume and the rest of the market cannot absorb it. John Bogle says the price discovery mechanism still works until index funds become 80% of the market. But what about in a crash? There are numerous studies that show that index fund impact on price discovery is limited. But this has been in a 10 year bull market where index funds went from a bit player to a dominant market force. There is literally no crash to draw data on.

        The simple truth is that nobody knows exactly what will happen when index funds start to dominate the selling action. Is it a problem at 50%? Is it a problem at 80%? Burry says himself that he’s not sure when, but that it will eventually be a problem and it will be worse the longer this trend goes on.

        And for those that think that they’ll just wait it out, if you hold your funds in an index fund, and everyone else in that fund starts selling their shares which causes prices to tank (selling low), and then later on, they come back in which causes prices to rise (buying high), your money is lumped in with theirs and your performance will no longer track the market. Remember, index funds only work when their trading does not move the market.

        Summary: Burry did not say ‘Index funds are bad’, his argument is much more nuanced. Nobody knows what will happen (if anything) when a large selling action occurs – including Burry.

  • ashzach September 23, 2019, 8:27 am

    For a new investor, that knows bits of this and that about index funds how would I invest 100k CAD of hard earned savings in todays market. thanks!

  • Jim September 23, 2019, 8:48 pm

    Hi Pete, great blog-love the way you have tried to change people’s ridiculous behaviors and encourage people to live a more healthy, happy life that is not so damaging to the planet with out forcing it down their thoughts! I read with interest a peice about how banks and insurance could be used to reduce fossil fuel use/exploration


    and wondered if you have any views on it? Is there a smart way we could use the money we invest to help the planet while still getting a good return? Many thanks Jim

  • Jordan Burnett September 25, 2019, 11:26 am

    My guess is that there would be a fairly easy fix to filter these out. P/E ratios would still exist for the respective underlying equities, regardless of market cap.

    That would, of course, imply a certain amount of active management (or committee review)–but, my other guess is that Vanguard as an organization would come up with a way to filter out these shell companies from staying in the index in perpetuity.

    As stated, there are always going to be individual investors for equities. Just like there will always be people chasing flashy cars and clothes instead of FI.

    “Better yet,” we may find these computer-automated algorithm traders doing us a much needed service by punishing companies with poor earnings (which is what we already see today). Eventually, that would affect their market cap, and would take them out of our passive index funds. A La “Self Cleansing” which is the nature of an Index Fund stated by JL Collins.

  • Nuke September 25, 2019, 5:15 pm

    Why do stock buybacks increase share price?

    Very simple example: A company is worth $100K and has 1,000 shares of stock, meaning each share is worth $100. Company has $1,000 cash sitting around. If it chooses to pay $1 to each shareholder, then the company is now worth $99K. And each shareholder has stock worth $99 and $1 cash; nobody is richer or poorer (ignore taxes). Everyone with me so far?

    Suppose that company instead buys back 10 shares of stock. Company is worth $99K, and each of the remaining shares is still worth $100. The cashed-out shareholders have $100 cash in their pocket. Again, nobody is richer or poorer. More specifically, each remaining share of stock has the exact same value as before the buyback.

    Why do share buybacks increase share price? There is an answer. I’d just like to hear what people think about the question

    • Mike R November 21, 2019, 8:23 pm

      Let’s say that $100k company is valued at 10x earnings of $5k per year and it has a $50k cash pile.

      The price is $100 per share, but really you could look at it as $50 for an income producing asset and $50 for a cash pile that isn’t generating any value.

      You’re right that if they bought back 500 shares, the shares outstanding would still be the same $100 value. But here’s the thing, what if you want to buy the company’s shares except you don’t want to be forced to hold cash?

      For easy math, assume you could generate 10% return with any cash you hold on hand, but this company is generating 0% interest on that cash.

      The market might punish your company because everyone else has the same idea. So maybe the market discounts that cash pile as worth 10% less than it is. So the company will be worth $95k, not 100k. Then the company could swoop in and get an instant 10% return on their money.

      That’s just a very simplistic example which probably isn’t super common. But anytime the company thinks the future is much brighter than investors think (because they have access to tons of insider information), and they have too much cash needed to run and expand their business, they might go ahead and use the excess cash to “Invest” in their own business by buying back shares. A lot of the time, the company needs to only announce that they will be willing to buy back shares under $X/share and the market will respond by buying the stock up to that level. Sometimes buyback plans don’t even end up buying back that much stock, and the price runs up before the company uses all the capital they were intending to.

      The reverse of this is also true incidentally. If a company thinks the stock is overvalued, it can do a share dilution by issuing new shares and using the cash for investing in itself. A recent example was Beyond Meat raised more money in a second round after their IPO because their stock was (in their view) overvalued – although they would never say that publicly. They issued at I believe $140 and today the stock is under $80, so I would say they made a great decision.

  • Ab September 26, 2019, 1:02 am

    My problem is that i don’t want to invest in all available companies. I just don’t want to be part of businesses that have a big environmental impact. I’m now investing in a semi green fund. I know i could get much lower costs. I also noticed that the companies in it are sometimes not really environmental friendly(my own company was in there :-)). Is there perhaps a low cost index fund that would be reasonable environmental friendly?

  • Jared September 26, 2019, 12:32 pm

    In corporate finance math (firm is efficiently priced, etc), a share buyback would not increase share price nor change the firm’s value (Market Cap + Net Debt). It would just lower market cap and increase net debt as the repurchase would need to be funded by either using cash or raising debt. So in your 2nd scenario, firm still worth $100k but now market cap is $99k and there is $1k of net debt. As there are 990 shares outstanding, share price is still $100.

    Share buybacks just send a strong message to the stock market that management believes the stock is under priced and thus repurchasing shares at the current price is a good return on capital to shareholders because now each of their shares represent a larger piece of the total under priced equity of the firm. Negative to buybacks could be it could suggests the firm doesn’t have enough high IRR projects left to pursue so thus needs to spend capital in other alternatives (same reason dividend stocks are usually less return, but also less risky than early stage companies)

  • Rob from Canada September 26, 2019, 2:28 pm

    Thanks so much for taking the time to write this post Pete! It really gave you something to bite into I’m sure. I planned to stay the MMM course but it’s great to see that you agree and don’t get caught up in any of the headlines.

    Small note, I fired in May this year, a huge part because of you bro!! Thanks for all your help!

  • Curtis Chapin September 26, 2019, 7:10 pm

    Hey everyone,

    Pretty devoted follower of MMM and JL Collins here. Zero debt, high savings rate, index funds only (401k + taxable). I haven’t deviated from the index fund piece at all since I found these heroes. However, lately I’ve been researching real estate investing and I have a huge itch to get started in this space (duplex, triplex, ect.) to create a bit more diversification and income.

    Can someone please talk me out of this? I know MMM owns a rental property (I think he still has it), but obviously most of his wealth sits outside real estate. What am I missing here that is causing me to be so excited about it?

    • Mr. Money Mustache September 26, 2019, 8:24 pm

      Hi Curtis, thanks for reading!

      Although I don’t own any rentals these days (unless you count the commercial building that houses the MMM HQ), I still think your plan is perfectly sound, in theory. It all depends on the numbers, which are driven by the price-to-rent ratio in your area and the level of property taxes. What’s an example of a typical deal you might consider on a multiplex?

      The reason real estate often works out better than stock investments is that you are adding your own skill and management labor to the equation. Plus you get cheap mortgage money to leverage your investments. If you’re good at it, you can effectively get paid thousands of dollars per hour for buying and managing properties. (Or, lose thousands of dollars per hour if you do it wrong :-))

      • Jordan Burnett October 2, 2019, 9:38 am

        Pete, I think you highlight a great point here that many people miss. Unless you’re investing in REITs or a syndication, almost no real estate investing where you own the property outright is completely “passive.” Even with syndications, you SHOULD be doing some legwork to make sure the deal you’re getting into is something you want to get involved in.

        With single family or triplex/duplex you put sweat equity into the deal by finding the property, paying closing costs, property taxes, paying to have your deductions/depreciation/taxes done.

        That all assumes that you’re also paying someone to manage the property for you. If not, you have your own labor costs to factor in.

        Compared to the truly passive index investing world, I would consider all these aspects “fees” and they matter just as much as fees on an index fund matter.

        True, you can oftentimes get higher returns with real estate by using leverage (you could also get higher returns with index funds by using leverage or margin…but it’s not a smart long-term strategy).

  • Dave October 6, 2019, 8:21 pm

    I do agree that trying to time or beat market is a complete waste of time

  • Stacy Mizrahi October 7, 2019, 8:20 am

    As I read Burry’s concerns, the thing that stuck in my mind is risk management in a portfolio. Let’s just assume his fears are 100% correct. Who would lose the most? The person who would lose the most would be the person who has 100% of their portfolio in the stock market – specifically index funds. And the closer you are to retirement (or death), the more risk you have of not recouping your losses.

    However, a person with a blended portfolio has the risk spread across various investment types Maybe they kept it simple and did a 60%/40% stock/bond split. Or maybe they diversified more into REITS and treasuries. Risk is still there, but spread across different asset classes. I have no idea if Burry is right, but if you keep your portfolio blended and have a short retirement timeline , it seems to be that you would sleep easier knowing that you had your portfolio diversified.

    • Mr. Money Mustache October 7, 2019, 10:30 am

      This is true Stacy – portfolios with bonds are less volatile – but when you look at the retirement simulations (using FireCalc or cFireSim), the portfolios who have 100% (or at least almost 100%) stocks still seem to have the highest success rates.

      This is all because when the stock market goes down, you don’t actually LOSE money unless you happen to sell during that down time. In retirement you are selling 2% or less of your portfolio per year, and bear markets are usually less than two years.

      Still, it’s great to understand all the options and remain flexible. These two things are even more important tools to a happy retirement than any investment could ever be.

      • Matt V October 7, 2019, 1:33 pm

        Less than 2% per year? You typically recommend the 4% rule – sure, if that bear market comes after years of great market performance, your portfolio will be larger and what started at 4% might be 2%, but it also could come just a couple of years after you retire.

        In that case, if you’re withdrawing around 4% of your portfolio, and let’s say stocks fall by 30% (a fairly typical bear market). Now that’s closer to withdrawing 6% of your portfolio, and if you have to withdraw for a number of years, that could do some significant damage.

        Now, I’ll certainly agree with you that 100% stocks has a higher chance of success, because you have more growth on average. But it also has a higher variance – if you are unlucky, that bad luck will be more painful if you don’t have any bonds to help absorb the hit.

        • Joe Hurst October 8, 2019, 12:42 am

          Typically stocks pay about 2% in dividends. If you live on 4% of your portfolio’s value every year, you’ll only end up selling 2% of your stocks every year because the other 2% will come from dividends. I believe that is where MMM gets the 2% number from.

          Those dividends also help protect you when the stock market tanks because when stocks drop during a bear market, their dividends don’t drop by nearly the same magnitude. For example, during the ’08 recession, SPY dropped 55% peak to trough but the dividends only dropped by about 20%. If you had started withdrawing 4% exactly at the peak, you would be withdrawing 9% of your portfolio during the worst period. About 3.5% of that would be covered by dividends so you’d end up selling 5.5% of your stock. The down periods tend to be followed by quicker-than-average upswings so you wouldn’t have been selling 5.5% of your portfolio for long. In the subsequent bull market you would have made back all of your losses plus some.

        • Jack Sarles October 8, 2019, 12:45 am

          Hi Matt,
          You seem worried about dragging on your portfolio by withdrawing too high of a percentage with a heavy stock portfolio during a downturn.

          In most scenarios this is only a problem immediately after someone retires. For a bad-ass early retiree this shouldn’t be a problem. They should have fresh career skills , networks of colleagues , tons of relative energy , and frugality muscles to weather the storm. If this previously highly productive person is able to operate at half efficiency doing free-lancing part time or using their newly found free-time to be more frugal or find a better situation through geo-arbitrage , they should be able to pull only 2% of their portfolio or less.

          Your emphasis on “Having” to withdraw is what is very likely to happen to older retirees, but younger retirees tend to actually have a lot less to worry about. The scenarios of health problems, being disabled from working, no marketable skills tend to unfortunately inflict older folks than younger folks.

          Even though it’s easy to talk about averages and probabilities here, everyone’s situation is different and bad luck can and will strike. The best way to be prepared for bad luck is retain your frugality muscles, find something mildly productive you enjoy, and keep enough insurance, cash, and bonds to satisfy your brains need for safety. If you’re someone that is prone to worry that’s okay.

        • Kristian Schofield October 8, 2019, 5:10 am

          Seems to me that all the evidence points towards having a heavily weighted (to stocks) portfolio during the growth/accumulation phase. Here you’re primary goal is growth and you are able to tolerate, possibly even welcome some fluctuation. However as you move towards F.I. and certainly as you begin to drawdown you’re primary goal is then preservation of your stash. Growth is no longer the goal. I’d think that at that point a different strategy is possibly more optimal?

        • Paul T October 8, 2019, 10:51 am

          You’re forgetting you also earn around 2% dividends – withdrawing only 2% from principal per year.

        • James October 8, 2019, 12:36 pm

          It’s 2% since the dividend yield for a whole market index like VTI is roughly 2%, so to have a 4% withdrawal rate you only have to sell 2% of your holdings each year. Plus often when stocks go down the dividends don’t change, so the dividend yield actually goes up.

  • Mystic October 22, 2019, 11:42 am

    I think to create a portfolio of ETF’s to manage risk is likely much better than investing solely in stocks. Reading multiple sources, and picking ideas from Ray dalio’s All weather fund and Brown’s Permanment portfolio. Here is one example- ratios can be changed based on your age/ risk.

    VYM( high dividend US stoicks)/ Vangaurd target date retirement funds ( for more bonds): 50%
    VYMI: Intl high dividend: 15%
    VWO: emerging markets stocks etf: 15%
    GDX- precious metals for insurance:5%
    VDE/USO energy/oil- 3%
    GLD/SLV- 3%
    VNQ- real estate 7%
    CFD- commodities 2%

    This provides you massive diversification along with passive investing. for more astute investors they can change percentages slightly depending on market cycles.

  • Brad October 29, 2019, 9:57 am

    I like finding good companies. I’m a CPA and like reading 10-Qs. That’s just me. Having said that, any time someone asks me for advice, I point them towards the index.

  • Lou Jane November 3, 2019, 7:51 pm

    Just chatted with a friend on this post, and he brought up a good point: that we should be more concerned with overall equity market valuations, rather than active vs. passive investing. Thoughts? Maybe this should be the next MMM blogpost!

  • john November 4, 2019, 6:48 am

    The company I work for recently made the S&P 500. This was celebrated and our company leadership even spoke about how this is a good thing since many funds/investors that are tied to the S&P 500 will automatically buy our stock. And it certainly did seem to give our stock a boost.
    This type of phenomena does seem to me to be a distortion in the market that someone with the means and know how could exploit.
    That’s not me and I’ll continue investing almost 100% in index funds and real estate.

    It did occur to me that the arguments you’ve made could also be used to argue that there shouldn’t be bubbles. Yet we do have group think in the markets and we do see bubbles despite a myriad of opportunistic active investors who in theory should see the distortions in the markets and be able to exploit them and in so doing eliminate them.

    In the terms of my finance professor you’r really making an argument that the markets are efficient. I mostly agree. Or I would say they are mostly efficient or just inefficient enough for there to be incentive for active investors to find and exploit the inefficiencies and thereby making the markets more efficient. The darn problem is we still have bubbles. Michael Burry was apparently one of the rare investors who saw through the last bubble. Is he onto something now and if so are there enough other people on board to counteract and self correct this effect before it manifests itself and blows up in a bigger way?

    I”m probably 99% with you and most others visiting your site on investment strategy, but I think we need to be careful not to become so dogmatic about our investment strategy and philosophy that we don’t see other possible realities.

  • Tom November 24, 2019, 2:25 pm

    “But this over and underperformance itself tends to be random”

    This isn’t true. There is a thicker-than-predicted area under the curve of market outperformers, and those that outperform the market tend to outperform the market year after year, exceeding the expectation for consistency if their outperformance were random. Is it due to cheating? Maybe. People are always getting caught breaking insider trading laws. But it’s a real and persistent fact.

    Also, index funds are slightly worse than market average (they’re the market, but with transaction fees). People would be better off buying similar baskets of stocks themselves, with varied holdings and slightly different portfolios from person to person. No need to pay someone transaction fees to track Russel or S&P or Dow’s particular composition. Make your own! Or buy approximately the VTI or SPY, but buy it at low or no fee on Robinhood or other brokers, and then buy and hold for longer than VTI or SPY do.

    The OG of FI/RE, Jacob, surmised that if we take the virtues of index investing to their logical conclusion, major companies should just fire their leadership and copy the decisions of “the market”, i.e. their competitors. If everyone does that, eventually there’s just a mindless herd. This is the case with passive investing, and it’s just starting to cause problems. The mindless herd doesn’t vote on companies’ decisions or take any active role in steering investment towards a better future state. It’s stupid to think that S&P or Vanguard are smart in the way they construct and maintain an index. Do it yourself instead of paying them to do it for you. Think for yourself.

  • Tom November 24, 2019, 2:45 pm

    “All Index Fund World” is a farcical strawman. Prices would NOT be locked to IPO values. The real nature of “All Index Fund World” is that prices are set by the overall demand for index funds and the arcane wizards (or arcane algorithms) that define the various index funds!

    Please do justice to the argument against index fund investing.

  • Myriam January 14, 2020, 3:21 am

    Hey Mr MM,
    I was wondering about your opinion concerning the latest news of Vanguard’s pretty terrible reccord concerning climate-related shareholder motions. It seems pretty at odds with your engagements & philosophy, so I’m very interested about your view on this!

  • Mika M January 23, 2020, 1:36 pm

    Super late on this one… But I know ERE is skeptical of relying on indexing and advocates for managing your own DIY mutual fund (in his case, at least as far as one of his older posts I remember reading goes, buying/selling based on the Dogs of the DOW list). I’m far too lazy for that so I am a proud Boglehead. If some people stick with his advice and others with yours, I think we’ll all be okay.

  • TC March 9, 2020, 11:28 pm

    Hi MMM,

    Have you come across a book called Aftermath? James Rickards, the author, makes a similar argument for the index bubble. Suggests buying small allocation of wealth into gold to help offset certain incomes and potentially benefit in the event of adoption of the gold standard again. Personally, I’ve always had the view of investing in index funds so some of the content was eye opening, but it’s hard at times to recognize the truth from the noise. Any thoughts you might have would be great.


  • TJ April 2, 2020, 2:39 pm

    I need your help.

    In the article you stated “So the stock market really is built upon the fundamentals of earnings and dividends.” This has me confused.

    As of 4/2/2020 Stock market prices are based on earning and dividends, which are both currently going down with the stay at home recommendations currently in place yet prices continue to go up. GDP is down, unemployment is up, return rates are down, dividends are, or are being recommended to be, zero, trading volume is way down most days.

    How is the market still going up? Things are starting to smell wrong to me. Please help me continue to have faith in the process I have followed for the past 10 plus years.

  • Alberta Nomad April 6, 2020, 2:52 pm

    Care to write a follow-up article on this? It would appear an ETF bottleneck at the exits was a problem with the COVID-19 crash. In the long run I do not think it is a problem, but I do think it amplified the crash.

  • Marcus November 30, 2020, 7:04 pm

    I am completely sold into Index fund that tracks the market, but there is one that might not work right ? If we have bought into an index fund that tracks the Japan market, it would have stagflated these decades? I could be wrong to say this, please do share with me your thoughts.

  • Married to a Swabian December 2, 2020, 8:04 am

    Hello again MMM community! Haven’t been here in a while. I was reading Barron’s this weekend, specifically:


    Wow! Based on advice all over the internet, including MMM, I’ve been plunking $ into Vanguard and other S&P 500 index funds. All the while, thinking smugly to myself how smart, cheap, low risk and diversified my investments are!
    With 25% of the S&P 500 currently concentrated in Apple, Amazon, Google, Microsoft and Facebook, so much for diversification.

    My concern is that the scenario we currently have: a Fed pumping unlimited funds into the markets, trillions in assets in just Vanguard (6.2) and Blackrock (7) index funds, with algorithms doing much of the trading is untenable.
    To me, it sounds like a financial Black Hole, with these largest corporations getting exponentially bigger until something blows up.

    Am I the only one ignorant to the fact that the S & P is market cap weighted?

    Didn’t see it mentioned here in Michael Burry’s post.

    What think ye, MMM community??

  • Mark Schreiner March 13, 2021, 3:09 pm

    MMM, you suggest: “If you are so inclined, study up on profitable real estate investments as a side hustle.” As an economist, I would be interested in your take on why market forces have not reduced profits in real estate to be similar to those of other investments. Because they are local? Illiquid? It is not fashionable to get dirty or to be a landlord in an older or poor part of town? What is it that makes real estate investments good options (why are their risk-adjusted returns higher)?

  • Arshid Mahmood February 5, 2022, 2:48 am


    I am on my journey to be a lifetime index investor. But I have one concern and I would be grateful MMM for yours or anyone else’s comments on this issue. I wasn’t able to find you being asked this question before.

    Based on my research, there is a clear correlation between quantitative easing and stock prices. If there is more paper money in circulation, then that means there is more money to invest in stocks, hence the “always going up theory”. But if inflation rises and the public get extremely frustrated and the government consequently abandon quantitative easing forever: then that will mean that there is FOREVER less paper money in circulation. This could mean that now is the all-time high in stock market?

    I look forward to hearing from you.

    Kind regards


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