As indexing becomes more and more popular it is also coming under increasing fire. I’ve written a lot about some of the more common indexing myths, but I also wanted to discuss a few myths and misunderstandings that have become more common in recent months:
1. Index funds are increasingly exposed to tech and therefore don’t diversify investors
This one was front and center in a Barrons article last month. The basic argument is that equity index funds are turning increasingly into big technology funds. It’s true. As the US economy becomes more heavily tech oriented the stock market is also becoming increasingly tech oriented. And while this exposes equity investors to more technology risk we should be very clear about something:
ALL STOCKS ARE VERY RISKY
Yes, I was screaming that. The reason I screamed it is because there is this nefarious myth out there that you can “diversify” INSIDE the stock market. This is misleading. The reality is that all stocks are very risky. Even though we call some stocks “defensive” stocks or “low volatility” stocks the reality is that all stocks are volatile when it matters most. For instance, in a year like 2008 utility stocks fell 60%+ despite being considered the most defensive sector in the US equity markets. Dividend-paying stocks commonly thought of as being safer equities, also fell 50%+ in 2008. The point being that there’s no such thing as “safe” equities. When the shit hits the fan almost all equities go down significantly and you very likely won’t be able to pick which ones don’t go down a lot in advance.
This is why real indexers diversify OUTSIDE of equities. The only way to guarantee uncorrelated performance when equities are in a bear market is to own assets outside of the stock market.
So yes, the increasing value of tech stocks means the equity markets are becoming more exposed to specific tech sector risk. But that does not mean you can’t diversify that risk away by properly indexing with assets like bonds.