What If Everyone Wanted to Retire Early? A Thought Exercise on Market Valuations

There are some interesting contradictions in the world of financial independence. Though so many of us are evangelists for this approach to life, eagerly spreading the word, there’s a pretty massive body of evidence telling us that, in fact, if everyone wanted to do what we’re all doing, it wouldn’t work for any of us. In other words:

The current construction of financial independence and early retirement only works when most people don’t do it. 

Consider those drastic sale prices that frugal folks love to take advantage of, like when brand name cereal goes on sale for $1, or that big screen TV goes on sale for $100 on Black Friday. Stores call those loss leaders, and offer them (at an actual loss, oftentimes) with the understanding that they will lure shoppers in and those shoppers will in turn spend money on high-margin items. Those of us who only buy the loss leaders are essentially capitalizing on the loophole, but if everyone did what we did, stores wouldn’t be able to afford to undercut themselves like that and the loss leaders would disappear.

Consider the Index Fund

Or let’s talk about the darling of so many FIers, the passively managed index fund. The idea of the index fund is simple — don’t try to pick winners, just buy a slice of the entire stock market — but for index funds to work as intended, we need lots of people not indexing, so that the prices of shares actually bear some relationship to reality.

Mr. ONL and I are dedicated index investors, but we know there are a lot of potential problems with them, and that those problems only become magnified the more people invest in index funds. For example:

  • Being included in an index is known to boost a company’s share price on average 10 percent, but often more, even if the fundamentals like price-to-earnings ratio don’t support that valuation. According to the New York Times:

Most disturbing is the increasingly distorted levls of the valuations of some of the largest index funds. The combination of a long-toothed bull market and the significant shift to passive investing has indiscriminantly buoyed all stocks in major indexes like the S&P 500 and Russell 2000. Stocks that might not be bought singly on their own merits have been lifted by the package buying. Some portfolio managers, academics and market trackers now contend that the soaring of the mediocre alongside the exceptional has produced unusually elevated valuations.

  • The New Yorker makes a very similar argument, adding that index funds run the risk of persistently and frequently creating bubbles:

It’s not hard to imagine large-scale passive investments warping the stock market in similar ways. Typically, stocks are indexed by market capitalization—the value of a firm’s share price times the number of shares—from highest to lowest. A market with more passive investors than active ones will continue to push money into the largest firms, whether these companies are actually performing strongly or not. Timothy O’Neill, the global co-head of Goldman Sachs’ investment-management division, told me that essentially every new indexed dollar goes to the same places as previous dollars did. This “guarantees that the most valuable company stays the most valuable, and gets more valuable and keeps going up. There’s no valuation or other parameters around that decision,” he said. O’Neill fears that the result will be a “bubble machine”—a winner-take-all system that inflates already large companies, blind to whether they’re actually selling more widgets or generating bigger profits. Such effects already exist today, of course, but the market is able to rely on active investors to counteract them. The fewer active investors there are, however, the harder counteraction will be.

  • And, very smart people like Charlie Munger think the rise of indexing undercuts corporate governance, creates permanent owners who will never sincerely threaten to sell, and [my words, not his] could allow CEOs and boards to make decisions with little regard for the shareholders. A piece in Forbes makes a similar point:

“We are now in a situation where index investors are the major shareholders in most of the large- and medium-sized public companies in the United States,” says Luis M. Viceira, the George E. Bates Professor and senior associate dean for International Development at Harvard Business School. “That raises the question, who is exercising control in these corporations?”

In other words, the more people who index, the less shareholder oversight and corporate governance pressure there is, the less accountability there is, the more likely bubbles will be, and the less share price will have to do with underlying essentials. Fun!

So let’s say it all together: Indexing only works if we don’t all do it!

(Bummer, I know.)

But let’s take a big step back away from index investing, and talk about investing for early retirement as a whole. If everyone did what we’re all doing, would it still work? Let’s discuss!

What If Everyone Wanted to Retire Early? A Though Exercise on Market Valuations // index investing, early retirement and financial independence in their most commonly discussed forms all rely on one simple principle: They only work if most people don't do them. Let's dig into this idea a bit more and talk about what would make early retirement more accessible to more people.

The entire FI community is built around the idea of the shared secret: We know something most people don’t

And though here I am, writing on the internet about early retirement, I’m definitely in the camp of wondering how far this idea can spread before it starts to fall down. In other words, like with index funds, is there a point at which it no longer works if too many people are doing it?

Spoiler alert: I think the answer is yes. 

Just as we can’t all travel hack our way to fabulous vacations and expect credit card companies, airlines and hotel chains to keep offering those bonuses (they are hoping you start traveling with them often, and paying cash money for it, so that the deal is actually profitable for them), and we can’t all buy only the loss leaders and expect stores to stay in business, I think we can’t all follow the current construction of the FI life and have it continue to be tenable.

Here’s my case. Let me know in the comments if you agree.

The Idea Behind Stock/Equity Investing

You already know this, but the entire idea behind investing in shares of something is that you see value in that thing, and you want to purchase a slice of that value, either because you think its value will increase over time, or because it pays an attractive level of dividends, and you want in on that.

Though stock investing has become this mystical-seeming thing to many investors because the people who keep track of all the details — CAPE ratios, profit-to-loss statements, growth plans, capital owned, overseas projections, etc., etc. — act as gatekeepers, it’s a very good thing that those people are keeping tabs on companies’ numbers. Because without that scrutiny, share prices could quickly become divorced from actual value.

All of those factors are important in many ways, but fundamentally as a long-term investor, you’re asking a simple question: Does this company make money, and is it likely to keep making that money or make even more in the future? 

If the answer is yes, assuming the details line up, it’s probably a safe investment. If not, run away. Simple, right?

How Companies Make Money

Here’s another thing you already know. Virtually every company out there makes money one way, and one way only: when people buy things.

Those “people” might be individual consumers, they might be small businesses, they might be megacorps or governments or private institutions. But profit happens when goods and services are exchanged for currency.

Which means: For a stock to look attractive, it needs to be equity in a company that’s making money or expected to make money, which means lots of people are buying what it’s selling.

Market Valuations When Everyone Wants to Retire Early

The potential bubble problem with index funds is a case of being a victim of your own success. The idea behind indexing makes total sense, but its fundamental flaw is that it relies on most people not doing it. (And even with that flaw, we’re not changing our approach anytime soon. We can’t quit you, Vanguard.)

The same is true of the conventional early retirement wisdom. Which isn’t to say that early retirement wouldn’t work at all if everyone did it, but we’d have to figure out a very different way to make it work. (And no, not everyone could switch to real estate investing. If everyone’s a landlord, who do you rent to?)

But as we as a community tend to talk about financial independence these days, it tends to follow a pretty simple formula:

Buy less stuff + Invest that money instead
= Financial independence

Again, simple. But let’s break it down.

The Law of Supply and Demand — and Early Retirement

Consider if everyone followed this formula, buying less and investing more. We’d suddenly have much lower demand for consumer goods, but paradoxically, more demand for stock in the companies selling (now unsuccessfully) those consumer goods. In fact, demand for equities would quickly outstrip supply, and prices would jump and keep jumping as people get better at saving instead of spending.

Meaning: share prices would skyrocket, even as corporate profits start tanking. 

The fundamental problem is we’d create a different kind of bubble, one in which share prices would become totally divorced from earnings, profits, and even the value of assets owned by publicly traded companies. Share prices would be based entirely on demand, not on the value (supply) provided by the stock.

A pretty messed up way to apply the law of supply and demand.

Betting on GDP (If We Still Have Jobs)

Charlie Munger and others who are concerned about indexing creating too little corporate oversight, but if everyone jumped on the FI bandwagon, I don’t think that would be our problem. What the corporations themselves do would be fairly irrelevant, except for a few that represent things we can’t avoid spending on, like food and energy. Instead, stocks would become true bets, more like actual gambling and less like equity investing, and index investing would become essentially betting on the growth of gross domestic product (GDP).

In other words, equity investing in a world in which everyone wants to retire early would be a bet writ large on the entire economy. 

That is, assuming anyone still had a job. Because if companies aren’t selling stuff, how do they afford to employ people? We’d see a huge shrinkage of employment, outside of those unavoidable purchase categories, meaning it’s an open question how much people would have to invest in the first place, and how much those share prices would actually climb.

So What Should We All Do Instead?

Though I think there are some huge systemic barriers that make early retirement a total fantasy for a lot of people, I’m not interested in hoarding this secret for the lucky few of us who know about it now, and pulling up the ladder behind us. I think about how much we’ve gained just in the journey of pursuing FI, and how much that has improved our lives and outlook on the world. That’s something we want more people to experience.

And I’m also not interested in telling everyone that they should continue to be mindless consumers and to buy all the things so that we can keep this early retirement dream alive for a privileged few of us. As an environmentalist, you know I’m not about continuing to make more disposable stuff (or quality stuff to “declutter” one day, which usually means throw into the landfill, even if you donate it intending it to be repurposed).

So what’s a different way to make this work for more people?

Mr. Money Mustache sort of tackled this question several years ago. I say sort of because in the set up, he shoots down critiques of the notion of everyone being able to retire early, but then he doesn’t really address that. He only talks about what happens if everyone becomes frugal, not if everyone starts enacting the high savings rate and aggressive investing vision with an eye toward not working. His answer relies on people continuing to work, albeit in ways that are more beneficial to the planet and humankind (which I fully support, if you’re into working for a living).

I think making financial independence closer to universal could look a few different ways:

  • Most people could keep working in some small amount, far less than full time, but enough to provide for their basics and to cover a few creature comforts that also keep stocks afloat.
  • We could be less reliant on stock returns to provide for us in early retirement, save more than we otherwise would, and settle into a far simpler existence without the perks like hacked travel or increased spending power from bull market portfolio growth.
  • We could adopt universal basic income, which would cover everyone’s basic needs, allow those who wish to do more work to do so, but give more people the freedom to invest their time in meaningful work like volunteering, parenting, taking care of family and friends, and other projects that benefit society.

Of course, all of that said, we’re nowhere near a situation in which even a sizeable minority of people are ready to save a hefty portion of their income, so this “problem” is currently completely imaginary. But it’s always interesting to follow an idea to its logical conclusion. Or, at the very least, to remind ourselves how lucky we all are to have found this secret loophole, and to be grateful that we found it while it still exists!

You Must Have Thoughts!

Alright guys, it’s your turn. Lay it all on us. Agree with anything here? Vehemently disagree? See some flaw in my logic you wish to point out? Have an alternate economic theory that you think applies better? This post is here purely for discussion, so let’s dig in!

Want to find out who we are TWO WEEKS before we share it here?! Sign up!

Anon-in-snow

Subscribe to get our bimonthly newsletter with tons of top secret info we'll never share here on the blog. Plus get the big reveal two whole weeks early!

No spam or slimy sales pitches ever. Unsubscribe any time -- no worries! Powered by ConvertKit

69 thoughts on “What If Everyone Wanted to Retire Early? A Thought Exercise on Market Valuations

  1. I think that there would be greater impacts in other areas if everyone FIRE’d early… the stock market would be the least of our problems. Imagine the line at the post office! :)

  2. Very interesting post.

    It is tough to imagine a situation where everyone is retired and ehat it would do to an economy. Japan for example is an aging society, and the number of retirees is expected to increase. Their economy is expected to have a lot of adjustments to go through, but there are also limits o how much you can replace humans with automation as well.. This is as close to a retirement nirvana with large retirement population as it could get :-)

    You touched upon it, but one of the dangers behind index investing is the fact that many are valuation insensitive. Therefore, if you have to buy at inflated valuations, your forward returns may not do as well, even if the underlying businesses keep growing, and producing more output and profit.

    The counter argument is that valuation is hard – there is no hard and fast rule, and things change based on the environment we are in. So high valuations can be seen mostly in hindsight.

    But using hindsight, we can see that the Japanese retiree in thr late 1980s, or the US retiree in the late 1990s-2000 did not do very well. Valuations we super high back then, after being high for a while. We dont know if we are in 2000 or not. But we also know that past performance is not indicative of future results.

    Isn’t it surprising that there are few public early retirees that retired in 1999-2000 and are still retired? This just goes to show how lucky we are to have been investing at lower prices over the past decade, and now to have higher prices. But you know, luck goes both ways too (hooe not) I am hopeful to be wrong, but i am hoping that most early retirees have been through more than one market cycle. And are prepared for anything.

    Looking at foreign markets, I can see that anything can happen. For example, after the second world war, the French Market went nowhere for 2 decades. It may be a low likelihood event for US future returns, but then it may not be. We dont know if our optimized retirement models using 1926-2000 US centric data will perform as expected in 2018-2078. I hope they do, because my retirement will be in jeopardy if many of the relationships you expect to hold up do not hold up.

    I am not saying stocks are expensive and will crash. I think they are fair. But certain things that “you have to own” in an asset allocation makes no sense to me – like international bond funds. Or too much bonds today – the best estimate is you will do is break even from inflation. In the best case for the bond portfolios, the country will get deflation so that 2%-3% coupon will actually support 3% withdrawal.

    The other thing index investors need to work on is managing their emotions. You may be surprised, but most public index investing figures today did not follow the simple retirement plans they are preaching to you. They chased the best perofrming strategies quite often. Are they doing it today, or will they stick to an investment strategy and an asset allocation for once? Will they stick around when stuff hits the you know what? Will they stick to their asset allocation if stocks go nowhere for a decade? Will they time the market if it keeps relentlessly higher, missing out on future gains?

    1. You make a lot of great points. Have you read Paul Krugman’s “The Return of Depression Economics”? He goes into a lot of depth on those historical stagflation periods in other countries, particularly Japan. And for anyone who thinks that things always go up in the U.S., it’s worth absorbing those lessons. Like, sure, things will probably always go up EVENTUALLY, but eventually could be decades away. We’re not immune to those same forces that causes extended flat markets in the past, particularly if we become more protectionist in our trade and immigration policies, something that has been shown in every instance to weaken GDP growth. And re: early retirement bloggers and market timing, I did an overlay in this post of when bloggers retired vs. where the markets were: https://ournextlife.com/2017/05/10/conservative-projections/. #recencybias ;-)

  3. I’ve often thought about the inherent contradictions of FI principles and the market economy, and this is a nice long-form crystallization of some of my thoughts. For example we will all celebrate any increase in real GDP as this boosts the stock market and therefore makes us all closer to FI, or cements our position. But any moral argument would struggle to condone GDP growth as a definitive measure of societal “success” . For example the recent hurricanes have been great for GDP growth since any destruction and rebuilding moves money around the economy. But it’s not a win for society in any way.

    On the proliferation of index investing bringing the death to an efficient market, I’m skeptical. There is massive incentivized energy to exploit market inefficiencies by many. If index investing does stifle market mechanics then there will arise active strategies to exploit this – I’m sure of it. If I knew how though,I wouldn’t be here….

    Thanks for the post.

    1. Well said re: the inherent conflict between GDP growth and societal good in many instances. And I’m not convinced, either, that indexing will be the death of market efficiency, but I do think indexing could end up being a victim of its own success, one way or another. (And I, for one, am not excited to have to pay the higher costs of active investing in the future!) ;-)

  4. I actually think it would turn out to be beneficial on the whole

    Index funds are the preferred mode of investment since they are the best in returns/risk. After a tipping point this will not be true and I believe we will reach an equilibrium between people choosing index funds versus those picking stocks. The advantage that index funds have today would be diminished, of course.

    When all of us buy only what we really need, I agree that demand will come down, companies will be less profitable and salaries will also come down. I think this means firstly no premium products (no iPhones for you!), secondly – cost of production comes down right from raw materials like oil, coal and iron ore to finished products that we use. This means lower expenses. So our savings rate should remain the same.
    Again here, I expect the economy to settle into an equilibrium. We will have a big jolt when the shift happens from consumerism to saving, but when that shift is complete things should more or less behave the same as today.

    The only negative impacts I see are what you have mentioned. We might not be able to retire as early as we do today. And we will loose out on some of the costlier perks like travelling.
    When I compare this with the benefits – less impact to the environment and better communities- I am almost willing to see how it works out ;-).

    1. I think some of those assumptions make sense if we assume a level playing field, but given the tremendous wealth gap we already have, I do think there would be massive consequences particularly to those already living on the lowest income levels if we were forced to find a new equilibrium. So I vote for not finding out how that will work out, but instead tackling some of those inequalities first! ;-) (Amen on less environmental impact, though!)

  5. I worked as a bank teller in a middle to lower economic class neighborhood. Your fears of everyone becoming FI via indexing are unfounded. It is only a select few (maybe 10%?, maybe 20%?) who have the personal control and thought process to plan and save for a long term retirement. Some conversations I wish I could have had would have been “You’re overdrawn, (AGAIN) because you can’t stay away from the track/casino/liquor store.” And yes, it did influence which stocks I purchased since I could see the usage and then multiplied that by number of people in that economic group. Cold, hard hearted? Yes, but my best stock is still Altria.

    When I helped out at the branch in the rich part of town, I saw the $500 to $700 car payments and the corresponding mortgage payments and knew that this crowd too, was unable to control spending. Do I wish that everyone had the peace of mind that comes with FI? Of course. But it is not a universal pursuit. So I buy my loss leader and let the folks who can’t afford it keep spending. Because free will.

    As for the indexing vs individual stock: we mostly index but have about 10% in individual stocks in companies we believe will do better (see Altria). Plus that big cash pile. Because cash in not trash and provides great comfort in a downturn.

    1. I wouldn’t call this a “fear.” Merely a though exercise, as the post title suggests. ;-) It’s always heartbreaking to witness individuals at their worst, as you did. Though I’m a big believer that 1.) we tend to notice the outliers more, so those aren’t representative of everyone, and 2.) we as a country do a lousy job of educating and motivating people, as well as creating persistent systemic barriers. If we actually addressed those factors and gave people both the means and the motivation to make different decisions, particularly earlier in life before bad habits become ingrained, I think we’d find that most people are capable of saving and managing their finances quite well.

  6. I’ve thought a LOT about this question over the years, and I’ve come to one conclusion: It’s almost impossible to draw any reason bottom line conclusions on this (but after all, that’s what theoretical questions are all about). The reason is because we tend to use our market AS IS as the environment in which to consider a whole sale early retirement for everybody. But, the AS IS market wouldn’t look anything like the market within a society full of early retirees.

    For example, to me, it’s not that index investing *wouldn’t work*. I think a more accurate description would be something like: Index investing wouldn’t look anything like it does today. That’s because as our society retires early, our stock market would change and adapt accord to the market conditions. Perhaps it’s just the naive optimist in me, but I believe that index investing would work, but in a very different way that it does today.

    I don’t consider myself schooled enough in economic theory to draw any specific hypotheses about what might happen, but in short, I generally believe that the market is a flexible and mobile creature. It will respond to the demands placed upon it. If everyone retired early, I do believe the market would operate in a healthy and productive manner.

    It would just look quite a bit different than it does today. Pricing structures would differ. Bubbles would differ. Everything would change to MAKE such an environment work.

    And to me, that’s the beauty of the market.

    1. I’m with Steve here – the world and market environment is going to change.

      As just one example, job automation may dramatically reduce the number of jobs available. This could lead to a Universal Basic Income with no or very short work weeks and still high levels of production and consumption. Lots of people would be “retired” because they never had to work. Would it even be called “retired” anymore?

    2. Couldn’t agree more! Absolutely indexing and the markets as a whole would have to look quite different, and it’s hard to imagine what that might be without knowing the changes that would spur the evolution. BUT, I also think indexing will likely become a victim of its own success, and the nearly free ride we all enjoy today will likely not last forever. ;-)

  7. You sure do ask good questions, Ms ONL! That’s why conversations with you (online and offline) are so much fun:)

    What would the world look like if everyone was frugal and invested their money?

    Along the lines of Steve’s comment, I think the equation is so complex that we can’t even imagine the reverberations and what that would mean in every area of society. But I’m also an optimist and I think the world, markets, businesses, etc would adjust. There is built in flexibility in most of our institutions. That’s actually one of the big benefits of a market based economy. It’s adaptable to real market pressures.

    But the main reason I’m optimistic is less about the mechanics/institutions and more about the change in people. As you always point out so eloquently, a journey like early retirement is about personal growth. Self-disciplined investing, careful future planning, sincere contribution at work, and genuine introspection are all necessary parts of the process.

    So, if people in our society start wholesale changing in this way – I say GOOD!

    We’d be a more resilient, flexible, and hopefully thoughtful and kind people as a result. And we’d have MUCH more time to think and communicate with each other to solve some of our current big problems as a society.

    As to index investing, I’m not a wholesale aspirant anyway. And I think there are fewer across the board index investors than it seems. For example, Mr. 1500 has 50% real estate and 50% stocks these days. MMM makes loans and bought commercial property. Dividend Growth Investor invests carefully in dividend stocks that have value. And Wall Street is GREAT at making money off arbitrages and shorts when they’re obvious. There is enough non-index money to make that happen.

    Thanks for the thought exercise!

    1. Aww, thanks, Chad! Look forward to in-person conversation very soon at FinCon! (Plan on a Wednesday night FI meetup — details to follow!)

      I tried to only tackle the market valuations question here because, as you so rightly noted, there are a TON of variables in all of this. I do think indexing as we know it would have to change for it to stay effective, but that’s a great point that not everyone is indexing anyway! ;-)

  8. Are we talking about everyone in the US or everyone in the world? If it’s just the United States there might be enough people buying overseas to support everyone in the US to retire early. (It’s unlikely, but this whole idea is completely imaginary anyway).

    I’ve thought about the problems with index funds and I’m wondering if we are already seeing values divorced from what they should be. The CAPE ratios are high and people still keep buying. It’s not like people are going to stop their 401K. The only thing that I’ll add is that I buy the Wilshire 5000 index to get most of the United States to avoid the S&P 500 “pop.” Theoretically we could just kill of all the S&P 500 funds and push people to something broader like that, but it still becomes a bet on the overall US economy.

    I think it’s probably possible to pull of everyone retiring early, but you’d almost have to plan it like SimCity. You might have some universal basic income as you mentioned. You might have a health care system like Cuba’s which I’ve read does amazing things on very little money. You might have autonomous fleets of solar-powered electric cars to reduce everyone’s cost of transportation (at the expense of all the jobs that the auto industry creates).

    I asked the question of whether “Wealth Creation is a Myth” back in 2009 and this reminds me a lot of that: http://www.lazymanandmoney.com/wealth-creation-is-it-a-myth/. And in 2008, I asked if Spending and Saving is a Catch-22: http://www.lazymanandmoney.com/is-there-a-cure-for-the-economy-the-spending-and-saving-catch-22/. The idea of that being a healthy economy depends greatly on spending and I’m telling people that they should save.

    In recent years, I’ve been known to whisper a chant of “Buy, buy buy!” at times when driving through town. We have a lot of tourists in the summer, so I’m all for them helping out the local economy.

    1. We’re big fans of the total market stock index fund over the too-narrow S&P (though full disclosure that we do own a healthy position in the S&P fund — but haven’t bought more in almost 2 years). I think your point about the fleet of cars is really key here — we define wealth as having our own little kingdoms, but we truly do not collectively need as many cars, lawns, TVs, power tools, etc., as we all have. If we shifted toward a more sharing-focused economy, we could make fewer resources stretch a lot farther, so we could maintain a similar standard of living across the board even without high GDP growth. (Again, not that that will ever happen. Just for the imaginary exercise.)

      Re: U.S. vs. whole world, I was assuming U.S. But I’m not sure the world could support us, especially if we don’t get health care costs under control. We’re such a huge share of world economic output that I think *everyone* would feel it if ours dropped that much.

  9. I’m glad you touched on the MMM article as that is immediately what I thought of when I started reading. http://www.mrmoneymustache.com/2013/07/16/a-badass-utopia/ You do bring up interesting points on the corporations being accountable when money is blindly flowing their way. I wonder if there are any reports out there that show the percentage of stock holders as individual vs fund holders (and of which how many are index) . On the basic income front, that is a unique topic and our provincial government that was just elected and propped up by the Greens is looking at that very subject.

    1. I hope someone will try the UBI idea so we can see how well it works in reality! And the big funds are really the ones with leverage over the corporations, and there’s honestly no reason the passive fund managers couldn’t exert more pressure, except that that would take more time and drive up the fees.

  10. Herbert Stein’s Law: If something can’t go on forever it won’t go on forever. If the FIRE community, which is currently tiny compared to the overall economy, ever grew significantly then market prices will adjust and will start discouraging more and more in the FIRE crowd: Returns on capital will go down and compensation for labor will go up. Ergo: the FIRE community will never grow to a sizable portion of the economy.

    1. To add to that, the FI community is by definition exploiting inefficiencies in the economy, if only by being frugal but making money off of others consumption through stock investing. Which works well in consumer driven economies like the US. If everyone was doing it, it would become the average and the FI community would loose its appeal and something new would be created.
      I’d be interested to know however how much of the recent bull market could be attributed to automatic investing, through index funds and 401k, since it is much stronger in the US than the rest of the world, where indexing and pension investing is also more prevalent.

      1. If you find those stats, let me know! But you’re completely right that we are all basically exploiting a big loophole, and if that loophole gets closed, we’ll either have to find another one or work for a living like everyone else. ;-)

    1. I definitely think that’s true. And it’s probably a very GOOD thing if we don’t all follow exactly the same financial/investing model, so as not to make index funds a victim of their own success too soon! ;-)

  11. Instead of directly responding to your article, I’m going to give you some early retirement reading (you wanted that, right?)

    This is Andrew Lo’s 2004 Original adaptive market hypothesis. I would say that it’s fast becoming the new “financial markets gospel”- it’s certainly replaced the Chicago School of Economics definition of efficient market hypothesis. I would say it flys in the face of fundamental value investors like Munger.
    http://alo.mit.edu/wp-content/uploads/2015/06/AMHjpm2004.pdf

    Currently, about 1/3 of US stocks are in index funds with another 20-30% in “closet index funds” but the trading volumes are still high enough that financial markets have a price finding mechanism. Of course, the systemic errors in the price finding mechanism (as referenced in the paper above) make it seem that a focus on beta and active risk management makes an awful lot of sense for a person like me.

    Unfortunately, I also prefer reading about investing strategies to actually managing my portfolio, so our future wealth plans focus much more on deleveraged real assets rather than paper investments.

    1. Thank you for the reading! I will put that on my list for January after we quit! ;-) I’m not in the “index funds are doomed” camp, but I do think it’s smart to consider the potential downsides of an instrument that many consider gospel in the FI world!

  12. It is only a bubble if people panic and pull out of the investment. Otherwise the bubble lasts forever. If everyone buys and holds index funds, then everyone also gets to sell shares in retirement using the greater fool theory. That is why Social Security works. The next sucker is forced to participate, so you get a pension. This is starting to happen. Vanguard received 90% of all mutual fund purchases over the last 3 years.

    The bigger risk, and still small IMHO, is everyone becomes frugal and the economy tanks. Everyone buys less stuff, companies make less money, everyone gets laid off, and it spirals down from there. The endpoint where all humans have enough is desirable, utopian even, but there will be a lot of carnage along the way.

    1. Social Security is a good example, though, of why bubbles can only last forever if there’s consistent and predictable growth in the markets, and a constant stream of new people buying in while others drop out. The problem with SS is that people are living longer, therefore not dropping out as scheduled, meaning the new folks coming in have to cover many more retirees with their dollars than they used to.

  13. This is sort of similar to my career prospects – I work as a LEED Accredited Professional, which means I’m employed because there’s a need for specialty information in regards to sustainable building. If everyone built sustainably as a baseline, then my job would go away. That being said, twenty years ago (when I was still in elementary school), I expected we would be waaaaay farther along than we are now. Even in high school a bit over a decade ago, I worried that my future career path would be obselete in no time at all. Obviously that isn’t the case, and unfortunately I think serious green building (like FI) will be stuck in the minority camp for longer than it should.

    1. It’s similar indeed! And that’s why this is only a thought exercise, and not real hypothesizing, because I agree that a lot of things change far slower than we expect them to! ;-)

  14. The only way to avoid relying on your labor for a living is to instead own a factor of production. You’re talking about stocks, which is one option in the pantheon: there’s real estate (which you mention), businesses, arable or mineable land, intellectual property (patents or copyrights), and—if you really want to go back to the earth—flocks and herds. Most of the online FI community is in stocks and real estate, but there are plenty of examples of the others: Tim Ferriss advocates the lifestyle business, the Gulf Arab nations have plenty of non-laboring citizens thanks to natural resources, Stephen Wolfram created a hit with the Mathematica software and has spent the rest of his life doing whatever he wants, and every feudal lord going back to time immemorial earned a life of leisure by exercising control over the land.

    I think if stocks become so popular that their valuations are forever lifted and low returns become permanent, enterprising FIers will start looking to own other, cheaper, factors of production.

    But the key to it all is to remember your Marx: one way or another, if you don’t want to be labor, you have to be capital.

    1. Stephen Wolfram is pretty much my hero. Do you know that you can say to Siri “planes overhead,” and then you get the Wolfram Alpha output of which planes are in the sky over you, which allows you to deduce exactly which aircraft you’re looking at, where it’s headed, what kind of plane it is, etc.? So freaking cool. ;-) (But also not related to what you wrote!)

      As for the means of production, that’s fundamentally true, but in practice, if people stop becoming interested in paying for things like lifestyle products, intellectual property, etc., then there will be fewer means of production to go around. Not everyone can make money farming!

  15. Recently there have been a space of stories about index funds like vanguard starting to vote their position on shares. Now one could argue the views of vanguard might not be in line with the underlying holders, but the same could be said for any fund active or otherwise. As such I’m not sure I see a increased disconnect on governance in index investments. I do agree with your ultimate conclusion though that everyone retiring early won’t work. I also don’t think it’ll ever happen so I’m not losing sleep over it.

    1. Haha — I was definitely not suggesting anyone lose sleep over something that will obviously never happen. ;-) Even if everyone wanted what we all want, there are too many systemic barriers for the majority of people. And though it’s a positive that Vanguard is voting its shares, they still will never be able to vocally push corporations the way actively managed fund managers can because doing so would require more person hours, which means a big boost to fees, which runs against their exact argument. ;-)

  16. You’re correct, but not completely. I don’t think people would blindly continue to invest in the index. Here’s how I see it playing out in real life.

    Everything you say would happen but some analyists would KNOW there is a huge bubble building. They’d KNOW the index is detached from reality – and they’d give you the numbers to prove how much. They’d tell or advise everyone to get out based on the growing numbers. There will be some that will jump ship fearing the bubble will soon pop. Those that are unsure will have that thought weighing on their mind all the time – “If it pops, I’m screwed”. The more these fence sitters see the detachment grow and hear it’s WAYYYY overvalued the more people will bail out.

    1. Fortunately this isn’t a “correct” or “wrong” thing — just a thought exercise. ;-) And while it would certainly preferable to have a de-escalation of indexing happen as you suggest, we’ve all witnessed enough actual bubbles pop in our lifetimes to know that even with perfect information (which is often not widely available), HUGE bubbles will probably always keep forming one way or another.

  17. Agree with Steve and FTF – if everyone did it, the markets would be different in some way, shape or form.

    Luckily, there’s always a new generation to spend & consume and even if they all did it while only taking on ‘manageable’ debt, I think we would still be fine. Also, with the markets being global everyone around the world will be going through different economic cycles with different growth & consumption rates. So for now, I’m not going to lose sleep over it…

  18. My experience with talking to people (outside this community) is they don’t want to hear about frugality and strategies to become FI. They have their hand in the candy jar and don’t want to hear about what would happen if they removed it. They like going to Costco and filling up the cart with stuff. They like their $60 a month cell phone plan, and they are willing to have credit card debt. Its kind of sad that our free travel the last few years has been subsidized on their backs, but I prefer that to having the proceeds go to JPMorgan Chase. So no worries, for the foreseeable future there will be lots of people to work at Taco Bell. And Index funds will also keep rolling along.

    1. I think there are a lot of people who look like run-of-the-mill consumers who could easily be converted to this way of life if they truly had a chance to understand it, and not just hear a snippet or two about it, often from a sanctimonious scold who professes that it can only be done with extreme frugality. (Ahem, not true.) But all of that said, this was just a thought exercise, per the post title. Not something I think has even a chance of happening. ;-)

  19. Simple summary: Never underestimate the breathtaking financial stupidity of the average consuming adult. Observe and take mental notes – and always do the opposite. This approach has never failed me. Ever.

    Field observation: Next time you are at a drive up ATM, watch the folks in front of you: they push button after button, look at receipt after receipt, shake their heads at each one, sometimes hand waving in frustration, and then finally pulling away, accomplishing nothing.

    FIRE for these folks is something you light a cigarette with.

    1. First time poster.

      As depressing as your comment is Falstaff, it is true unfortunately. I recently picked up The Millionaire Next Door from my library and the author mentioned something telling that stuck with me. He started early in the book talking about how the majority of the population’s retirement planning needs will be taken care of basic social security provided by the state. The income of the average consumer or household is so low that almost all disposable income goes towards providing for basic needs and not much if anything is left for savings or investing. The author’s premise was that his target audience was not those individuals or households but those who are in a higher income bracket who are able to save and invest or those who are self employed and are able to run a successful company and as a result, save and invest.

      When you look at it that way, I don’t think we need to worry about everyone doing and focusing on FIRE as we do. It would be nice if they could but simple economics as they are today makes it impossible. I’m from Canada and it just came up on the news a couple of days ago that the average individual income is around $35,000 and household income is about $70,000 before income taxes. I’ll say from a cost of living standpoint, that’s pretty tight.

      In regards to index investing distorting the stock market, I think the case can be made that money is simply shifting from mutual funds (actively managed funds) to ETFs (passive management). The reason is simply that there is an efficiency in costs and active managers underperform over the long term. Personally for me, I’m not looking for the one trick pony who can outperform for a year or two but who can be a good steady Eddy. Distortions in the market will occur and the herd mentality will allow this to correct by a large component of amateur investors panicking and selling at a certain stage. I see bubbles as the natural side effect of greed which is inate in most of us and there will be many more to come in the future. My goal is to rebalance annually by selling winners and buying losers in my ETF portfolio and maybe do it more frequently if there is a large mid-year swing. The rebalancing will remove some of the risk that bubbles create. I’ve been at this since 18 and now am 42 and will be clocking in 3 more years at work to meet my safety zone and equal my current work income from my passive portfolio and then can enjoy full independence without feeling that I need to give anything up. I’ve hit a few recessions but as long as you keep your cool and be disciplined about rebalancing, you’re pretty golden.

      In regards to consumption, I think most people have been brainwashed into being hyperconsumers. I’ve always been pretty vocal at work and in my personal life to discuss FIRE and I’ll say that even some of my smartest friends (who in many cases I feel are way smarter than me and definitely more interesting – LOL), just can’t break out of that forced conditioning. I’ve shown my portfolio balances to some close friends as well as the ETF makeup so that they know it’s for real and then have every opportunity to do the same (I don’t want to be the only FIRE in the gang as I want them to come have fun with me) but they don’t. It just is what it is.

      As for automation and the potential of a universal income, I’ll say the world has changed a lot in my lifetime. Some bad but also a lot of good. As other commentators have indicated, markets and people in general will adapt and things will be fine. If everyone could focus less on work and more on living rich and interesting lives, I believe that it could very well be a win win situation versus the current zero sum game most people find themselves in now.

      Ok, that was longwinded but a lot of fun to write.

      Enjoy! 😜

      1. Hi Stone! Welcome, and thanks for commenting. The part of Falstaff’s comment that I strongly disagree with is the “breathtaking stupidity” part. I think most people are doing the best they can under the circumstances, and while clearly most people are not making optimal financial decisions (and sheesh, neither are we!), they’ve got a lot of things to balance and are spread too thinly. As you said yourself, people smarter than you aren’t interested in going the FIRE route! ;-) (Plus that could just be for NOW. Maybe they’ll still come around. Don’t give up on them!)

        Certainly I don’t think everyone pursuing FIRE is remotely a possibility, which is why this is just a thought exercise. ;-)

        I like your attitude that there will be bubbles in the future, not because I like bubbles, but because that’s realistic! Markets never operate perfectly rationally, and none of us have perfect information anyway, so we should always be expecting bubbles, not expecting perfect market efficiency.

        So exciting that you’re so close to your end date! High fives for making it happen and sticking with a sound financial approach over such a long period! :-D

        1. Ms. ONL.

          You must think me harsh, but I’m not. It’s just that there can be no other explanation for the sorry financial state of most of the populace. Perhaps other words like “Remarkably Minimal Mental Capacity in the areas of Finance” sound better than “breathtaking stupidity”, but the condition is the same.

          I know, and care about, and am related to, many of these folks. It gives me a pain in my stomach when I witness their antics – but they will not stop or change their ways.

          They will pursue tattoos, piercings, booze, cigs, the latest iPhone, leased cars, yet another trip to Disneyworld on the credit card, and a full cable package (for zombie shows and Honey Boo Boo and such). Then when the bills come in at the end of the month they are like my ATM patron: puzzled and bewildered.

          What is the diff between “breathtaking stupidity” and Stones’ “brainwashed hyper-consumers?” Both phrases denote mental incapacity or amazing immaturity. Why pretend otherwise?

          The very folks who visit your website or Mr. MM or any other of the others like it are a completely different type of person – not better or worse than the others – but light years ahead of 98% of the population when it comes to money and the ways of money.

          Here’s to us! (sound of champagne glasses clinking).

        2. I’m most puzzled by the “there can be no other explanation” insistence. I believe that you’re making the fundamental attribution error (https://en.wikipedia.org/wiki/Fundamental_attribution_error) in assuming you know others’ intentions, and that they are ignoble while yours are noble. I also believe there are a LOT of potential explanations beyond widespread idiocy, including but not limited to: 1.) lack of widespread and in-depth financial education in schools, 2.) societal insistence on the “correct” retirement age of 65, which creates no visible model for retiring sooner and saving up for that, 3.) the near-criminality of banks and financial institutions, which gives people a pervasive feeling that they can’t win the game anyway, so why bother trying, etc., etc. In particular, I’m bothered by “breathtaking stupidity” because a lot of us were exactly those brainwashed consumers (um, hi, I was one, and I qualify as stupid on exactly zero measures), and it’s information — not newfound intelligence — that helps us make the switch. We’re not fundamentally different people, we’re just folks who had access to information, and who happened to be at a place in life where we could act on that information when we received it. I don’t blame someone who’s truly struggling to make ends meet for not finding the FI revelation as inspiring as many of us do.

          I appreciate you coming back to explain more after my snarky response, but I think it’s worth questioning your underlying assumptions because I think you have a low opinion of other people that must color your worldview, and that is sad to me.

  20. We had a friend ask this just the other day. “What you’re doing is great for you, but what would it mean for the world if everyone did this? There’s no way that it’d still be viable because market valuations wouldn’t hold up”.

    I’m going to send this article her way – thanks!

    1. I do think markets would have to find a new equilibrium! But fortunately, it’s pretty unlikely we’ll ever see this happen! (Fortunately for all of us, anyway… not for everyone else!) ;-)

  21. This is a great though-provoking article. Though in the end, I am not worried and I think things will be fine.

    You cited a couple of articles that explain how index fund undermine the system if everybody used them. Yes, if really everybody would them that’s correct, but it is a very extreme position. I’d like to see articles that actually take a less extreme position and reason where the tipping point is. I haven’t seen a such an analysis (ok, I haven’t looked for it either). This makes me think that these articles are essentially unfounded, and kind of click bait. I like the thought exercise of taking it to the extreme, but that doesn’t imply that this means anything in practice.

    For example, I think of index funds as the easy and lazy way to do investing. Sure, some people are experts in investing, and know and love what they do and are able to exploit some small arbitrages by active investing. But I’m not willing to spend time on it. If index investing becomes more popular, those arbitrages might become bigger, and active investors will be rewarded more. And then more people invest actively and the market will correct itself. Other commenters mentioned this as well.

    I’m glad you mentioned basic income. I believe this will become necessary in the next decades, because robots can take over many simple tasks and it will be very hard for many people to find active income. Alternatively, providing a social security that is large enough so that everybody can live in a small home and has enough food and be able to participate in social activities would be fine as well. Our Western societies produce so much wealth, it would be easy to share it, as long as there a will to do so.

    1. Is it sad that I think it’s more likely we’ll see a collapse in index funds than it is that we’ll see universal basic income? ;-) I don’t find either especially likely.

      The index fund naysayers aren’t all looking at the extremes, but just at the tipping point at which there are too many passive voices not pushing for good corporate governance and profitability. But I suspect that you’ll get what you asked for, since it’s a topic that’s getting a lot more attention lately!

  22. Interesting thoughts. The situation you sketch is partially based on the assumption we adapt our behavior to our surroundings. For example, I believe so many people are chasing FI because the economy we live in is aging and insecure as it comes to you own future. People are more taking care of themselves instead of letting others do it for them.

    In the Netherlands, I can count on a full pension as long as I work till a certain age. Why would I chase FI and maybe even retirement? Because the system we are using, can’t hold the large groups of people that are retiring now and will be retiring in the future. And so we adapt.

    But it can also work the other way. What if our surroundings adapt to our behavior? If people only bought index funds, the whole market as we know it would just change (as it does already). If companies haven’t got enough customers, the go bankrupt. But others will rise, providing to the wishes of the new FI people. If we no longer work to an old age, couldn’t robots take over a part of it to keep things going? And let us live our lives like we wanted? Our economy and environment needs to change because of it, but would that be a bad thing?

    1. No argument at all that it would be very good if the playing field changed to adapt to new circumstances! I’d be especially interested in seeing changes that would lead to more opportunities for those on the lowest rungs of the socioeconomic ladder, and that’s part of why I’m so intrigued by universal basic income!

  23. Brave of you to tackle this topic and such ideas have crossed my mind, though not as concretely as you laid out. My short form opinion on the optimistic side of things is that markets adjust, and quite quickly, in my opinion. Lots more money has flowed into index funds over the past decade, and perhaps the good times for those may be slightly less good than they have been in the future, but I am personally not looking for high flying returns in the 10-15% range. The math works for me at a much lower number (I’m following the 3% rule of thumb for my retirement) and I’m sure it will also work for you at a much lesser number. The possibly pessimistic side of me views things as follows: our human egos are big, and no matter what, people have all these crazy strong beliefs that they can beat the market or that they know something others don’t (I used to try and pick stocks and was partially in that camp myself). Also, despite my best efforts to influence people I worked with or who are my neighbors in counter-culture ways, the pull of American consumer society is so strong that folks can’t help themselves. I use my work experience as a proxy for the general population and despite me living in one of the most expensive places in the country, I got a lot of “I could never do that, I spend too much money, I like to travel a lot, or my wife doesn’t work, or I tithe to my church (that one was basically an insult loaded with assumptions that I don’t donate generously to anything), you must not have had any student loans” etc. I would love if this movement just caught on to 10-15% of our society, but given that in my very unscientific experiment, that 19 out of 20 people told me all the reasons they couldn’t do this right away, I don’t have any delusions that this will take hold anytime soon. I wish it would, though. Also, this is why I have 30% of my income producing investments in alternative sources. It will fun to see where this wild ride takes us, though.

    1. Thanks, my friend! As you rightly point out, you could do a thought experiment with any set of assumptions, and it’s totally fair to question my underlying assumptions. To keep the post from being 20,000 words (fortunately I’ve never gone QUITE that long. ha!), I had to pick a certain set, and chose the completely unlikely idea that everyone wants to do what we’re doing. I am under no illusion that it will actually happen, but I still like to think these things through. ;-)

  24. Great post. I believe that our nature of work and the number of jobs available are going to be completely changed in the next twenty years. Automation will re-make our job markets, and while new jobs will pop up (just as automation changed farming) there will be less need for or availability of “full time” jobs.

    We will have to adjust to grant a productivity dividend to all to replace the recent notion that our jobs should be the source of stability in our lives. Universal Basic Income, Universal healthcare and national service will be key parts of this transformation. How this will affect the markets I’m not sure, but it will likely be harder for individuals to amass great amounts of wealth in the way they can today. I think many FIers don’t like some of these ideas as it’s a movement set around self-sufficiency, but I don’t think there will be much of a choice, unless we want to live in a society where the very few haves live surrounded by armed guards to keep out the masses. I think even more than economics we will need to adjust our sense of worth away from full-time work. In this way, FIers are the early adopters and could teach others.

    1. I certainly hope you are correct! We’re definitely on the side of equity over self-sufficiency (because not everyone has equal opportunity to become or stay self-sufficient), so vote wholeheartedly for universal services and income. I just don’t see that happening anytime soon, especially given that we’re seeing the wealth gap grow ever wider, not beginning to narrow even a little bit. :-(

  25. If we set aside the index fund issue, I do not think that everyone on FIRE would be as big a problem as you say.

    Even with FIRE people need to work 10 to 20 years to be able to accumulate enough money to retire. Depending on how frugal people want to be.

    So you could see this as the same as if everyone was working 20h weeks instead of 40h. Everything could still be the same. And we may see something like that if automation goes the way some people predict!

    And since people continue doing interesting stuff, even sometimes working after FIRE, this would probably be even less than an issue!

    Maybe cheap labour would become more difficult to get!

    As for sharing this information, with human nature being as it is, I’m not afraid of everyone jumping on the FIRE train anytime soon.. no matter how well known this option become!

    1. No doubt this is an extremely unlikely scenario. ;-) I think the problem in your scenario is that there wouldn’t be that work for everyone to do for 10 to 20 years if others were saving instead of purchasing! What would fund their jobs?

  26. If everyone in the USA started working towards early retirement the US household savings rate would start to look a lot more like the China household savings rate. Decreased consumption in USA might seriouslydamage the Chinese economy and thereby destabilize the Western Pacific. Please don’t everyone try to FI/RE or we’re having WWIII. Kind of kidding.

    I agree with others who say the economy would adapt in some way or other. There are and have been countries that have quite high domestic savings rates, maybe not quite Early Retirement Extreme/Frugalwoods levels, but definitely 3-4 times higher than USA today. I don’t know that there would be quite the drain on productivity that a country experiences when the population ages severely the way it has in Japan or several eastern European countries. Part of the reason is that the “unproductive” retired population would not be likely to be quite as unproductive, but would instead merely transfer at least some of their productivity out of the market/cash economy (as MMM argues). I think the consumption decrease would be more serious as far as hitting demand, but the supply of market labor would also drop as people reached their financial goals and dropped out of the workforce.

    One of the other effects might be to greatly decrease suburban/exurban land values, as people flocked to bikable/walkable dense town centers (even small towns). That could cause catastrophic losses, worse than 2008, for many speculators, lenders, and current suburban homeowners. Of course with climate change some of these losses may likely happen anyway as far as low-lying coastal areas that contain much of the population of the country.

    1. Certainly for the sake of not writing a novel on the topic, I had to oversimplify several factors here. ;-) Of course the economy would adapt, however, I don’t think it’s as simple as just assuming we’d all be okay in that scenario. The U.S. has consistently had the fastest GDP growth and the highest market growth on the planet because of our high consumption levels (as well as population growth aided by immigration). China is a special case in terms of growth because it has a high supply of new workers, so its growth is coming more from workers joining the markets. But countries that have reduced consumption have generally seen their economic growth slow, and those that have closed their borders have seen it slow even more — look at Japan for a perfect example. We can’t expect things like the 4% rule to work if our market growth slows as it inevitably would with less consumption.

      As for the housing and real estate stuff, I think we’re likely in for some big adjustments there as is with climate change!

  27. Btw, I believe UBI is fine, even good, in theory, but in practice horrible. There is, in effect, a universal basic income in many areas of the Appalachians where vast portions of the population have social security disability payments that they subsist on. These are drug and despair areas. Lack of purpose is deadly.

    1. I certainly don’t think we can institute UBI and change nothing else and expect it to work. We need universal health care to go along with it and better social supports, especially for communities that have long been impoverished and neglected.

Comments are where the magic happens! Let's chat!