We are enormously indebted to those academics [Eugene Fama & Co.]: what could be more advantageous in an intellectual contest – whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy? –Warren Buffett, 1985 Berkshire Hathaway Letter to Shareholders
I’m a huge fan of low-cost, index-based investing. Hell, it’s the focus of my book, “FIRE Wall Street.” And I believe that robo-advisors like WealthFront will and should take over the majority of investable assets around the world.
BUT… there’s one major issue I’m beginning to worry about: as this form of investing becomes more and more popular, the risk of mispricings (and even bubbles) in the markets grows with it because it completely abandons the basic process of analyzing value and risk. When you have a growing stream of buyers who are agnostic when it comes to value – meaning they will continue to buy regardless of price – it’s hard not to see problems arising.
Imagine it this way: You and your family like to eat bacon for breakfast. However, if the price of bacon tripled overnight on your next shopping trip you would probably decide to substitute breakfast cereal or fruit or anything cheaper until the price of bacon came back down. BUT, if everyone decided to buy bacon every week no matter the cost, bacon prices could conceivable go up 10-fold before somebody decided that their bacon addiction wasn’t worth paying through the nose for. Then a few other folks might follow suit and soon you have a bacon crash.
This could conceivably happen in stocks or bonds or any other asset class for that matter simply due to the fact that we now have a growing chorus of investors who have decided to employ an investment process that abandons fundamental investment analysis. This is all well and good for investors looking to take advantage of mispricings like Mr. Buffett and me. We may well see greater and more frequent opportunities as a result. However, for mom & pop this could work out rather poorly.