 Good day, fellow investors. We continue with the summary of Seth Claremont's book, Margin of Safety. Today we are at the second part of chapter 3, index funds. How do index funds invest? What are index funds? How to invest alongside in index funds and how to take advantage of what's going on in the market because index funds control the market. The topics are what are index funds, benefits of investing in index funds, how to invest with index funds, the trend going on in within index funds and mindless investing market efficiency. So what are index funds? Indexing is the practice of buying all the components of a market index such as the standard and poor's 500 index in proportion to the weightings of the index and the passively holding them. So an index fund manager simply looks at the SAP 500 index and automatically through a computer buys parts of that index or buys just the index. You own the whole market on a market capitalization so you don't have to think about anything the market does the thinking for you. So those people who have no time to invest, no time to understand investing, to understand accounting, to understand investment research can simply buy a part of the market that should represent the economy and then get a return as the economy is giving you over the long term. Stocks have performed really well over the long term 100 years and those that invested in index funds that didn't exist more than 30 years ago but those that had similar strategies did pretty well over the very very very long term. What are the benefits of investing in index funds? So one matching the market and you perform better than the average investor because an active investor, the average active investor that makes the market is bound to under perform it because of transaction fees, because of management fees etc etc. So if you invest in index funds you will just slightly underperform the market because of the small small index funds fees. So that's the first benefit. As I said already number two low-cost so market performance in like line to the market, low-cost no trading fees you passively invest. So you hold the part of the market which again limits your costs of investing and keeps your returns in line with the markets or just slightly below them. Number three efficient market hypothesis. This means that the efficient market hypothesis on what index funds are based tell you that at each moment in time the price of a security on the market is correct because it shows all the information positive and negative about something because the market knows everything so the price of a stock right now is the correct price for that stock and no thinking is necessary. So if you just buy that stock at that price you are doing okay because the market tells you what is positive what is negative and the price is correct because it holds all the information about that already in and investing trying to beat the market is futile because the market has all the information and you can never have all the information. So this leads to the next benefit of index funds which is you don't have to know anything about investing you don't have to do fundamental analysis you don't have to do practically anything you can just let the market do everything for you. And then number five stocks should usually do well over the long term. What does it mean investing index funds over the long term? People are strongly biased by the last 35 years which were extremely good for the index funds SAP 500 returning 10% but index funds can also not return good returns over 15 10 of them over 10 15 20 30 years have zero real returns. So that's also something to think about. So index funds investing to make it really worthwhile there are two ways to do it invest over the long term so you invest now for the next 40 50 years 30 40 50 and then invest constantly month per month because if the stock market crash and you invest month per month you buy more of the stock market when it is low it's called dollar cost averaging and then you're practically happy when stock markets crash because you know you buy more and when those come come back your returns will be higher. So this is the benefit of index funds you don't have to think you just set it on automatic 5% of your income in index funds and you will do okay over the long term it is expected that index funds will return over the next 20 years 4 to 5% per year if you reinvest the dividends a little bit more as that compounds especially if stocks crash so that is what you have to expect if you are happy with 4 5% hopefully a little bit protected for inflation as you are investing in businesses that can increase prices if there is inflation that should be the benefits of index funds and now if you're happy with investing in index funds please stop watching this video because now I'm going to tell you the opposite side of the story what are the dangers of index funds the dangers of investing in index funds as said Claremont had seen them in 1991 when the book is published those are just bigger now as nothing has changed in the market psychology so if you are an index fund fund investor please bye bye I will not see you anymore thanks for watching and I'll see you never again if you're not an index fund investor if you want more than 4 5% per year over the next 20 years if you're a value investor then stick and learn how to take advantage of what's going on with index funds so let's start mindless investing to quote Warren Buffett 1988 letter in any sort of a contest financial mental or physical it is an enormous advantage to have opponents who have been taught that it is useless to even try so Claremont believes that over time value investors will outperform the market and that choosing to match the market it is both lazy and short-sighted so we have the competition against us index funds that are not thinking so whatever they work on we have to understand how those work what are the forces giving so much strength to index funds and then take advantage of them them or be careful not to be trapped into them and that's also the key of Claremont's message with a little bit of a social component worrying about the risks of index funds the first thing is it is index funds are self-defeating but also self-reinforcing so over the last 45 years the S&P 500 went from 100 to 2700 what 27 times up which means that the index is self-reinforcing and just went up up up and up when that same power that tells you investors stocks can only go up blah blah blah interest rates can only go down when that's reversed the same process will become self-defeating and if there is a viewer that was investing in stocks in the 1970s till 1982 please write down in the comment section what was the attitude towards stocks in 1980 1976 1974 those were all gamblers better style away from index funds from stocks from whatever right so please comment I'm really looking forward to read that from all their investors number two said Claremont discusses replacing the stocks in the index costs a lot but also these index funds let's say mutual funds whatever they take advantage of the market I just remember Reuters investigation article that discussed how fidelity takes advantage of their index fund investors so in June 2011 Johnson led venture capital arm f prime capital partners invests about 9.44 million in ultra genetics in a series a funding round then they invest in a series b funding round then the company goes IPO and then in 2014 at a price per share 10 times above the first investment then fidelity starts investing again owned by the Johnson family starts investing in that while the Johnson family starts selling distributing shares and makes the money as their fund buys as index fund investor buy into the party very very very late five years later if we look at ultra genics pharmaceuticals since investors fidelity index fund investor or mutual fund investor or whatever invested the stock didn't go anywhere so no money was made there and the fund has to invest in it because they have to invest into anything that's how index fund works another trouble for index funds is the self-reinforcing cycle upwards we are in a 45-year bull market believe it or not 1982 the S&P 500 was at 100 points now it is 27 times higher that reinforced the whole cycle of index funds of mindless investing that mindless investing actually works in 2009 2008 it broke down the mindless investing system broke down but then the Fed came in as a cavalry to push stocks again up to save the system to save stocks to save the rich as we have seen in another video when we discuss the wealth gap so said Claremont believes that indexing will turn out to be just another wall street fed when it passes the prices of securities included in popular indexes will almost certainly decline relative to those that have been excluded so we have to look for those that have been excluded more significantly as Barron's has pointed out a self-reinforcing feedback loop has been created this is in 1990s and we are still in that feedback loop where the success of indexing has bolstered the performance of the index itself which in turn promotes more indexing exactly what have been what has been going on the last 35 years when the market trend reverses matching the market will not seem so attractive the selling will then adversely affect the performance of the indexers and further exerberate the rush for the exit so when index funds underperform or don't do good for five ten years now you see headlines the debt of value investing in five years you will see the debt of index funds and then when pension fund the baby boomers start retiring they will start just selling those index funds selling stocks and that will put pressure on the market in five years in 10 years in 15 years we will see but it is a big risk and then we have to go there and buy for now we have to start try to stay away from the over over expensive index fund invested stocks so the message is really simple by Setklarman and his book margin of safety it says you have to be careful not to invest in risky assets that are held and pushed up by index funds just because you have to own everything in the market and there have been so many inflows into index funds the number of ETFs went from 600 to 6000 in the last years so so much money came into the market and it's just pushing everything up as the tide rises so you have to be careful not to own those expensive assets because the tide will turn and then everything that has been pushed up will be pushed down as people sell and the second thing is that there are opportunities in those markets that are not affected by index funds there is no copper mining index fund so if you're investing copper miners they are not expensive from that perspective most of some of them are some of them aren't so that's also an interesting idea Russia is not included in index funds because god forbid investing in Russia so most of the market capitalization is the SAP 500 and all those peripheral indexes are not so watched at Brazil Argentina things like that because those are risky or crazy investments and there you might find good investment opportunities if you're willing to do the research and to do the work as said Claremont promotes value investing fundamental analysis research and laser focused investing strategies thank you for watching looking forward to the comments and I'll see you in the next video