Have Index Funds Become Too Popular? Are They Creating a Bubble?


It seems that more and more people are investing in index funds today, as entrepreneurial influencers and popular investment gurus have begun to count them as among safest investments. A rise in general awareness has also contributed to this growing popularity of index funds. But, are they becoming too popular? More importantly, are they creating a bubble that will burst soon?

No, index funds are not becoming too popular, and neither are they creating a bubble. Index funds are merely instruments that are designed to mimic the market performance of an index, and any financial crisis is unlikely to stem from them. 

To some extent, the growing popularity of index funds is actually better for the overall market and is likely to improve the return rates for average investors. If you want to learn all about index funds, and why their popularity is actually a strength, read on. 

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Why Have Index Funds Become So Popular?

Index funds have become so popular because they are an easy way to get into investing. They’re extremely low-risk and are passively managed so you don’t need to worry about looking over your portfolio all the time. And with the low fees, you can invest in these quickly and easily.

Let’s get into more detail about these reasons.

Index Funds Are an Easy Way To Get Into Investing

The idea of investing scares a lot of people. They watch movies or read stories about how people lose all their money in the stock market. Or, they may ask for advice from a friend or financial advisor who scares them off with technical analysis. 

Index funds take away all of the technical jargon and “skill” needed to start investing. All you’ll need to do is put your money in, forget it and then come back in 30 years (or a really long time) to reap the benefits of compounded growth. 

Index Funds Carry Extremely Low Risk

New investors are often timid to take risks because they don’t want to lose their start-up capital. This is entirely understandable and it shows why index funds have become so popular because no one has ever lost money if they invested in them for more than 30 years.

But why are index funds so low risk? Well, this boils down to 2 reasons:

  • Index funds spread your money across hundreds of companies in dozens of sectors. This means that if one company fails, another will succeed, and your average return will be positive. 
  • Index funds are held over a long period, which reduces the impact of economic crashes or depressions. 

Index Funds Are Passively Managed With Small Fees

If you want a human stockbroker, you’ll be charged a lot of money, for not a whole lot of reward. 

On the other hand, an index fund is passively managed, so the fees usually don’t even reach 1%. And, index funds usually beat most actively managed funds over a long term horizon anyway, which is something a stockbroker can’t guarantee.

So, there’s a whole lot of reasons to love index funds. They offer diversification, are historically proven to deliver great returns, and contain almost no fees. But, could they become too popular? 

Could Index Funds Become Too Popular?

Many investors fear that growing interest in the stock market could lead to lower returns from index funds. But is this the case? 

Index funds cannot become too popular. Since they have grown in popularity over recent years, they are seen as a safe way to enter the investing world. More investors are actually good for index funds, as it will grow the economy faster. 

Many more people are starting to come to terms with inflation, realizing that their money decreases in value every year. But then, they hear about the 8% return on index fund investing and start pouring in their money without really knowing what they’re doing. 

Should this cause worry? 

Actually, more investors are an excellent thing for index funds. The more money that the top companies receive through investments, the more they can grow their business. This leads the company to increase value, leading to significant capital gains and even a high-return dividend. 

New investors can increase the rate of growth for many companies, which is only good news for shareholders. 

Now, you may be thinking that if everyone invested, then there wouldn’t be any point because everyone’s money would be increasing by the same amount, rather than decreasing. 

This is a valid concern. But let’s consider a few vital things. 

Market Cap Weights Index Funds 

Simply put, this means that the buying and selling of index funds are proportionate to other securities because they’re proportionate to the current market cap. So, an increased interest in index funds won’t cause any security to become over or underweight. 

People Don’t Play the Stock Game Perfectly

Many investors, specifically new ones, generally don’t play the game right. For instance, they may want to sell instead of buy during a crash. But more importantly, they might be less inclined to hold for an extended period, so their money won’t compound and grow. 

This is good news to seasoned investors, as it’ll mean they can continue to grow their wealth while others sell. 

Not Everyone Is Going To Invest 

The stock market is seen as incredibly risky. Even when you explain index funds to the uninitiated, many think back to movies or stories where they hear of individuals losing millions. This proves that, even with the significant rise in the popularity of index funds, not everyone will put their money where their mouth is. 

The proportion of investors compared to non-investors is still going to favor the former for the foreseeable future, even with index fund investing.

So, index funds have not become too popular. However, the rise in popularity is good for the stock market. More money invested will grow the world economy, which can only be positive for the future. 

Index funds are also not in a bubble, since all these instruments do is follow the market. If the market is in a bubble, these funds will surely be in a bubble – but they can’t form a bubble of themself.

Can You Invest Too Much Money Into Index Funds?

You can invest too much money into index funds, even though they are one of the safest investments you can make. By investing all of your money into index funds, you risk missing out on other opportunities that may have the potential for exponential returns. 

This is safe, but putting all of your money into index funds could make you miss out on some ample opportunities. This is because an index fund doesn’t allow you to allocate your money to individual companies. 

So, if you have reason to believe that a particular company is undervalued (through fundamental or technical analysis), you wouldn’t be able to capitalize on this and put your money into the company. As a result, you could lose out on some serious returns. 

Investing only in index funds also closes your eyes to other investments, such as:

  • Real estate 
  • Dividend stocks  
  • Cryptocurrency 

Real estate is one of the best investments to generate passive income and increase your cash flow. In addition, it can help you reach early retirement, and if you become too focused on index funds, you may just lose sight of this. 

Dividend stocks are also a great way to generate income and offer returns of up to 10%, compared to an index fund’s average of around 2%. Cryptocurrencies can offer returns of over 1000x if you play your cards right. 

A $1000 investment can make you a millionaire, which just isn’t the case with index funds. 

So, while index funds are a fantastic investment, there is a risk that investors can enjoy them too much, which distracts them from other excellent opportunities. 

What Is an Index Fund?

An index fund is a diversified investment intended to mimic the performance of an index. Investors put their money into index funds and the company’s offering these investment tools then split their money between many shares across a variety of industries and sectors. 

Most index funds will split your money across at least 100 companies, helping you create a diversified portfolio. 

Popular index funds include Vanguard’s S&P 500, which puts your money into the top 500 companies in America. Index funds grow on an average of approximately 8-10% annually. They also pay a dividend ranging from 1-3%. 

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Conclusion

Overall it’s clear that we don’t need to worry about index funds becoming too popular. There is no bubble waiting to pop and diminish our capital gains, due to the rising popularity of index funds itself. If you want to make low risk passive investments, the market does not offer many better alternatives. 

Of course, when you invest, your capital is always at risk. While the past performance of index funds is strong, it cannot predict the future. So always do your research before investing, and remember that only you are responsible for what happens with your capital. 

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    1. Index fund. (n.d.). Investor.gov. https://www.investor.gov/introduction-investing/investing-basics/glossary/index-fund
    2. Investor bulletin: Index funds. (2018, August 6). SEC.gov. https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_indexfunds
    3. Mutual funds and ETFs. (n.d.). A vibrant market is at its best when it works for everyone. | FINRA.org. https://www.finra.org/investors/learn-to-invest/types-investments/mutual-funds-etfs

    Navdeep Singh

    Navdeep has been an avid trader/investor for the last 10 years and loves to share what he has learned about trading and investments here on TradeVeda. When not managing his personal portfolio or writing for TradeVeda, Navdeep loves to go outdoors on long hikes.

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