Index Fund Bubble in 2022? Michael Burry vs Warren Buffett

Index funds: A passive investor's dream. Make one investment but own the whole market. There's no doubt that index funds and ETFs are a very clever invention. It's the easy way to be diversified across the whole market and back stocks as an asset class, as opposed to picking individual businesses. Passive investing has worked incredibly well for millions and millions of investors for decades and decades and decades. So much so, it's now the most popular investing strategy that exists. Full stop.

However, two of the investing giants that I look up to definitely pose different opinions on the topic. There's Warren Buffett, the CEO of Berkshire Hathaway and the world's best investor. He is very quick to recommend index funds to everybody. However, Michael Barry, on the other hand, has been telling investors to stay away at all costs and fears that index fund investing is just one massive bubble. So let's analyze these two viewpoints and see exactly what we should be thinking when it comes to index funds.

It was all the way back in September 2019 when Michael Bury, yes this man that was in this movie that was played by this dude. It was all the way back in September 2019 when Michael Bury did an email interview with Bloomberg, where he revealed his viewpoint on index funds. Basically, they're dangerous and they're a massive bubble. He said passive investing has removed price discovery from the equity markets.

The simple theses and the models that get people into sectors, factors, indexes, or ETFs and mutual funds mimicking those strategies, yeah, these do not require the security level analysis that is required for true price discovery. This is very much like the bubble in synthetic asset-backed CDOs before the great financial crisis, in that the price setting in that market was not done by fundamental security level analysis, but by massive capital flows based on Nobel-approved models of risk that proved to be untrue.

And you know what? I love index funds, but Michael Bury, he's not wrong. Because index funds are so easy and so effective, they became incredibly popular. Now, every man and their dog owns shares in an S&P 500 index fund because they know it's good to hold a diversified basket of stocks that represent the market and hold them for a long time.

But Michael Barry's right: These investors don't actually pay any attention to what they're actually buying, which is totally fine; that's what the strategy is all about. But this fact means that a lot of money gets shoveled into certain stocks simply because they're in an index. You know, why do you own shares in Boeing? Uh, I don't really know; I just own the S&P 500, and Boeing's in that index.

You know, as Michael Barry says, this removes price discovery from stocks, aka there is some external force that's inflating the prices other than the underlying business performance, and that external force is simply all of these investors, all buying the index. But that's exactly how bubbles form. Bubbles form when underlying business performance is no longer the anchor for the stock price.

As Michael Barry says, like most bubbles, the longer it goes on, the worse the crash will be. And you know, I can completely understand this way of thinking, but then on the other side of that coin is Warren Buffett. Buffett is always recommending ETFs and index funds to the average investor. He recommends ETFs and index funds before he recommends buying shares of Berkshire Hathaway.

Seriously, I recommend the S&P 500 index fund and ETF for a long, long time to people, and I've never recommended Berkshire to anybody. And not three weeks ago at that same event, with the S&P 500 at all-time highs, he was still promoting the ideas of passive investing through an S&P 500 index fund.

This is how he explains it: "On March 31st, I ran off a list of the 20 largest companies in the world. I would now invite you to look at slide 2 or L2, which goes back a little more than 30 years, and look at the top 20 from 1989. 1989 was not the dark ages. I mean, we weren't just discovering capitalism or anything else, and people thought they knew a lot about the stock market. The efficient market theory was in, and there were... it was not a backward time.

If you look, the top company at that time had a market value of 100 billion, 104 billion. So the largest company in the world title in just shade over 30 years has gone from 100 billion to 2 trillion. At the bottom, the number 20 has gone from 34 billion to something a little over 10 times that.

One thing it shows, incidentally, is that it's a great argument for index funds, is that, you know, the main thing to do is to be aboard the ship. You know, a ship... you know they were all going to a better promised land. You used to know which one was the one they'd necessarily get on, but you couldn't help but do well if you just had a diversified group of equities. Your EOS equities would be my preference, but to hold over a 30-year period."

So Buffett is very happy to publicly recommend index funds to investors. In his eyes, over the long term, it's one of the smartest investments you can make, and he's even suggested the strategy to LeBron James in the past. Seriously, I think somebody like LeBron, and we've talked about it, but I think you and LeBron have talked about it occasionally. I think I actually, if through the rest of his career and beyond, in terms of earning power, then just making monthly investments in them in the low-cost index fund makes a lot of sense.

So, on one hand, you've got Buffett making time at the Berkshire Hathaway annual shareholders meeting to spend 15 minutes talking specifically about passive investing, and then on the other hand, you've got Michael Bury saying this is a crazy bubble and the longer it goes on, the worse the fallout will be.

So why is there such a difference in opinion between these two fantastic investors? Well, the number one factor that causes these two great investors to have different opinions is time frame. You see, Barry loves to dig his head into what's going on now, what could happen over the next five years or so, and he makes investments based on that research. That's how he figured out the huge housing bubble that we had in the early 2000s; he was actually early on that one.

So Barry sees a problem brewing with passive investing in the not-too-distant future, but Buffett's viewpoint regards a much longer time frame. Not just 5 or 10 years, but multiple decades, even 50, 60, 70 years. He recommends index funds not for where they are now or where they could be next year but for where they'll be in 40 years' time.

Have a listen to this clip of him talking about the single best investment he said he could have made when he first started investing: "Actually, in 1942, when I bought my first stock, as an illustration of all the things that have happened since 1942, we've had 14 presidents, seven republicans, seven democrats. We've had world wars. We had 9/11. We had the Cuban Missile Crisis. We have all kinds of things. The best single thing you could have done on March 11, 1942, when I bought my first stock, was just buy an index fund and never look at a headline. Never think about stocks anymore just like you would do if you bought a farm. You just buy the farm or let the tenant farmer run it for you."

I pointed out that if you put ten thousand dollars in an index fund that reinvested dividends... I paused for a moment to let the audience try and guess how much it would amount to, and it would come to 51 million dollars. Now, this is very much the way Buffett thinks. He thinks ultra long-term. The time when he first started investing to the day that he gave that interview was 76 years apart, so his mindset is very much to buy index funds in any weather.

Because you could be buying index funds in the biggest bubble ever right now, and there still could be a massive crash right in front of you straight after you buy in. But if you fast forward 40 years from now, the world would have well and truly forgotten and moved on, and that massive crash that you took would just look like a tiny little blip in the history of the S&P 500.

You know, take this for example: Imagine you bought an S&P 500 index fund at the worst possible moment, right before the global financial crisis. In the short term, you would have been down 56.3 percent, so absolutely shocking and scary. But it only took you five and a half years to get back to where you were. And look, if you'd held on even to today, overall, you'd be up 163 percent.

So overall, that's the reason why these two investors have such different opinions. Absolutely, index investing, passive investing works very well in the long term, but like anything, it's not always smooth sailing along the way. Right, Barry sees it how it is, but Buffett looks beyond the current situation, and he simply backs American business generally over the long run.

So overall, guys, that is the video for today. That is why these two different investors, that are still both fantastic investors, obviously, have such differing opinions on index funds. But I hope you found that video useful. Overall, I'm still a massive fan of the passive investing strategy because I follow that Buffett mindset of dollar-cost averaging for decades and decades and decades.

So, you know, whatever you're buying the, you know, S&P 500 at right now in 40 to 50 years, it's going to be pretty irrelevant, right? Even if we've got a massive crash coming ahead of us in the next two years. So anyway, guys, thanks very much for watching the video. Leave a like on it if you did enjoy it or if you found it useful. Subscribe to the channel as well if you want to see more videos similar to this, all about stock market investing.

And if you wanted to check out how either Warren Buffett's active investing strategy works or you just want a full walkthrough of the passive investing strategy, the index fund style strategy, then I've made two in-depth courses which can be found over on Profitful, which is the business that I started. The links to that are in the description, and if you wanted to pick them up, you're also financially supporting the channel.

So I very much thank you if you wanted to at least go and have a look at those. But that is it for today, guys. Thank you very much for watching, and I'll see you guys in the next video.