Can we have a quick discussion on how market cap weighted index funds work?

So in the last several days there have been a few posts on how ETF may cause the next bubble/crash and I think it is caused by people not understanding how most market cap index funds work.

The theory is as Apple, amazon, Microsoft market cap grows, the index funds have to purchase more of them what causes the price to rise what causes the index funds to buy more of them and causes some sort of positive feed back loop and in a crash a negative one will also develop.

So what people fail to grasp is index funds hold actual shares of those companies . So as the share price of the company rises, guess what, the index funds holding of that company automatically rises too! Remember they actually own shares, its not like they invest a flat $3 billion into apple then need to purchase more.

They have 10 million shares that are worth 2.5 billion. As apples share price increases their 10 million shares are now worth 3 billion, they do not need to buy more shares to increase their holding because they already own apple shares!

As long as an index fund is created at the proper weight or is expanded when new money flows in at the proper weight it is self-balancing.

There is no positive or negative feedback loop going on.

Submitted August 31, 2018 at 04:46PM by SirGlass

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