Groupthink: The Seeds of Indexing’s Flaws

Our little intellectual exercise in the rapidly growing fund, I hope, makes it easy to see why Bogle’s creation has done so well. Launched as the market was recovering from the depths of a vicious downturn, the Vanguard 500 fund family has become the standard by which other indexers are measured. But one can reasonably ask whether the success of even this kind of investing carries the seeds of its own, if not destruction, then at least rather severe limitations.

Why?

As I mentioned earlier, indexing is all about the power of consensus. Let knowledgeable people do the research and the pricing and ride their coattails. So it’s worth a few minutes to explore what consensus requires to be effective.

A quirky business-school professor of mine used to have his students predict where various markets would be at the end of the semester. He would then calculate the average prediction and make some moderate investments accordingly. He claims to have done quite well. His one requirement of the students was that they not confer about their predictions, but promise instead to submit them independently.