“No one pretends that democracy is perfect or all-wise,” Winston Churchill famously said in a 1947 speech. “Indeed, it has been said that democracy is the worst form of government except all those other forms that have been tried.”
I recalled this bit of wisdom recently when two readers sent me links to articles that question the safety of index funds. Both identify genuine flaws in traditional cap-weighted index funds. But the problem—as always—is that the alternatives turn out to be worse. In this post, I’ll look at some of the arguments levelled at equity index funds. Next time, we’ll turn the focus to bond indexes.
Earlier this month, the venerable New York Times ran an article called The Ease of Index Funds Comes With Risk. The piece acknowledges the many benefits of index ETFs but then warns that “their simplicity harbors some simmering problems, which have grown more troubling in the course of the bull market in stocks.” It goes to say that “cracks in the edifice of passive investing are beginning to show.”
Experts in the article are concerned that the mere inclusion of a stock in a major index—particularly the S&P 500 of large-cap stocks and the Russell 2000,