Note: In place of some of the usual Jared Dillian Letter issues, I’m serializing excerpts from my new book, The Awesome Portfolio (you can preorder now!). This is part three (out of five parts) that you’ll receive—the book releases on September 8.

Last time, we talked about the Life Hedge. This round, we’re addressing the thing you were sold as the safe, diversified, set-it-and-forget-it solution: the index fund.

Why Indexing Failed You

I was pretty excited to learn about index funds in 1997.

• You can get exposure to 500 stocks in one fund. Diversification!

• You beat actively managed funds most of the time!

• The fees are low!

What a deal. Couldn’t pass it up.

The whole point of indexing is that it’s for people who are too dumb to pick stocks. Like, I can’t predict what stocks will beat the index, so I will just buy all the stocks and get the average return. And the amazing thing is, the average return is better about 80–90% of the time. If the average return is better about 80–90% of the time, most people are going to be content with average.

The first obvious flaw of indexing is that while you’re getting the returns of the index, which are pretty great, you are also getting the volatility of the index, which is terrible.

Take the S&P 500 index, for example. It’s a pretty volatile index. It moves around at a little less than 16% a year and 1% a day. 16% a year is a lot. 1% a day is a lot. You’re going to take your entire life savings and put it into something that is moving around 1% a day? You’re going to take $100,000 and put it in an index fund and end up with, as a base case, $84,000 or $116,000 a year?

Also, you might have heard that the S&P 500 has become more concentrated over the years—at the time of writing, just seven stocks make up about 35% of the index. Think about that—you own an index fund, but seven stocks make up one-third of what you own. And what stocks are those? Big, volatile tech stocks. The funny thing about this is that index funds were once sold for their diversification benefits, but at the present time, the diversification benefits have all but disappeared.

I mentioned earlier that even though you own 500 stocks in an S&P 500 index fund, you are not diversified. What? Yes, that is what I am saying. And the reason I say that is because even though you own 500 stocks, 100 million people all own the same 500 stocks. Everyone is in the same trade. So if someone wants to sell, they won’t pick out Walmart and ConocoPhillips and Duke Energy—they will sell the entire index, the index that you own. In a sense, the index has become a security.

Imagine a scenario where there is some sort of market panic and everyone goes to sell their index funds all at once. Actually, I think that already happened—in the pandemic, in March of 2020. The S&P 500 went down about 35% in a month. We can never know for sure, but I’d make the argument that wouldn’t have been possible before indexing took over the world...

We are all in the same trade. Stock market goes up, stock market goes down, we are all in the stock market. This is not a positive development.

My guess is the vast majority of investors have no idea what is inside their index funds. I’m not even sure that a plurality of them know that there are stocks in it. I have heard stories of people walking into financial advisors’ offices and asking for some of those “safe” index funds. I have had people ask me if their index funds are FDIC-insured.

There is a lot of good and bad to indexing, like a lot of things in life. I am one of the biggest critics of indexing, and yet, we are going to use indexing in the Awesome Portfolio—of course. It is the best way to get broad exposure to an asset class. It is simple and easy. And in recent history, it has worked amazingly well.

The point is that people take it as an assumption that stocks, and by extension, index funds, will go up forever. The stock market returned about 10% for the last 100 years, therefore it will return 10% for the next 100 years. The funny thing about that is that these are the same people who say that the past is no predictor of future results. There is no rule that says that stocks have to go up 10% a year in perpetuity—they might go up 6%, or 3%, or less. Or they might take a break for 10 years. All together now—this is why you have to be diversified across asset classes.

Adapted from Chapter 4 of The Awesome Portfolio by Jared Dillian, published by Harriman House. The book releases on September 8, 2026, but you can lock in your copy right now in your preferred format.

→ Preorder The Awesome Portfolio today. 

Next up: the flaws with one of the most common asset management solutions: the 60/40 portfolio.

Reader Question

Jared Dillian, MFA