- Brendan Stec
The Logical Fallacy Behind Passive Investing
You stand up at a crowded stadium for a better view, and then assume everyone would see better if they stood up too. Except now everyone is worse off. You don't pay your subway fare, and then assume everyone is better off not paying their subway fare either. Except now the subway can't afford to run.
These are two examples of the fallacy of composition, a reasoning error that assumes what is true of a part is also true of the whole.
Just because passive investing is optimal for an individual (lower fees and outperformance) doesn't mean it's optimal for society. Passive investors are free-riders who rely on active managers to realize returns. This means if everyone invests passively, the market is longer efficient. This represents a market failure and ruins the important role of public capital markets in the economy.