Index Bomb: A Popular Investment Theory Knocks Markets Out of Whack

Nothing comes closer to heresy in financial circles than bad-mouthing index funds. Even managers of actively managed funds tend not to speak ill of the Vanguard 500s of the world. And really, why should they? Index funds beat the majority of investors, institutional or otherwise, year after year, have low expenses and are based soundly on a time-proven academic theory. What's not to love?

Well, I can keep silent and pretend nothing is amiss in my beloved fund world no longer. Somebody has to tell the emperor (the American investor in this case) that he is in fact, naked, and that somebody might as well be me.

Indexing giant Vanguard introduced its first index fund in 1976. Today, a cool $1 trillion -- about one in every 10 investment dollars -- is tied to indices, mostly through mutual funds. The growing proportion of assets tied to indices is changing the structure of the market -- and not in a good way. To understand why, a short history lesson is in order. ...