Jay Smith @jaynemesis: "𝐓𝐡𝐞 𝐅𝐞𝐞𝐝𝐛𝐚𝐜𝐤 𝐋𝐨𝐨𝐩 𝐚𝐭 𝐭𝐡𝐞..."

United Kingdom

𝐓𝐡𝐞 𝐅𝐞𝐞𝐝𝐛𝐚𝐜𝐤 𝐋𝐨𝐨𝐩 𝐚𝐭 𝐭𝐡𝐞 𝐂𝐞𝐧𝐭𝐞𝐫 𝐨𝐟 𝐌𝐚𝐫𝐤𝐞𝐭𝐬 //𝑃𝑎𝑟𝑡 𝟷 𝑜𝑓 𝟸 - 𝑆𝑒𝑒 𝑐𝑜𝑚𝑚𝑒𝑛𝑡𝑠 𝑓𝑜𝑟 𝑃𝑎𝑟𝑡 𝟸 𝙏𝙝𝙚 𝙈𝙚𝙘𝙝𝙖𝙣𝙞𝙨𝙢 I want to talk about something that affects everyone reading this, whether you copy me, hold an S&P500 ETF in a 401k or ISA, pay into a pension fund without much thought, or pick your own stocks. The market has a mechanism that warps performance, benchmarking, and influences valuations across the market. Index funds, and the growth in index investing. Before I dive in, I want to be clear that this isn’t a doom post, it's not me telling you to sell your index funds or change strategies. They remain an important, accessible tool for all types of investors to help build wealth. But I think there’s a feedback loop building under the surface that a lot of investors are not fully aware of, or do not consider. As someone who measures myself against the S&P500 and Nasdaq100 every day, this is something I think about often. 𝙏𝙝𝙚 𝙈𝙚𝙘𝙝𝙖𝙣𝙞𝙨𝙢 The largest indices - the $SPX500 and the $NSDQ100 - are weighted by market cap. The bigger the company is, the larger its slice of the index is. That sounds sensible, and for decades it worked well. But it means that when money flows into index funds, it isn’t spread evenly, it is allocated based on size. The biggest companies get the biggest share of every dollar invested. The problem is that Index tracking ETFs have become extremely popular, both for retail investors, and institutional investors. Plenty of investors here on eToro use these funds as part of their portfolio, or maybe even all of it. In the US peoples 401(k)s, in Europe their workplace pensions, and in the UK their stocks and shares ISAs are often set to automatically buy more every month or quarter. Even the funds people deposit in banks or hold on crypto exchanges often ends up to some extent buying into the S&P500 or Nasdaq100. Regardless of how the top companies are performing, or their valuation there is a steady stream of buyers. 𝙏𝙝𝙚 𝙁𝙚𝙚𝙙𝙗𝙖𝙘𝙠 𝙇𝙤𝙤𝙥 You can probably already sense where I’m going with this. The larger a company's weighting grows, the more passive buying it attracts. The more buying it attracts, the more its price rises. The more the price rises, the larger its weighting becomes. Of course, that doesn’t tell the whole story. nVidia wasn’t always among the top 10 weightings of these benchmarks, they got there on merit - through growth of the business. But passive flows make these companies sticky and harder to unseat. Fundamentally, even though you buying shares doesn’t directly give the business any cash. It does help them secure more favourable financing. This in turn means that even if the company isn’t innovating, they can more easily buy their way into new markets using mergers and acquisitions, often largely paid for with stock, not just cash. Plenty of investors have been aware of this problem for a long time. It’s very common to see a company share price rally even at the mention that they could soon be included in a major index like the S&P500. $QQQ (Invesco QQQ) $VOO (Vanguard S&P 500 ETF) //𝐸𝑛𝑑 𝑜𝑓 𝑃𝑎𝑟𝑡 𝟷 𝑜𝑓 𝟸 - 𝑆𝑒𝑒 𝑐𝑜𝑚𝑚𝑒𝑛𝑡𝑠 𝑓𝑜𝑟 𝑃𝑎𝑟𝑡 𝟸

Not investment advice. The author may have financial interests in the mentioned instruments.