The Truth About The Index Fund Bubble: Is Your Money In Danger?

In 2019, Michael Burry, who was played by Christian Bale in The Big Short, claimed that index funds were in a bubble with prices exceeding their underlying value. He compared them to CDOs, which contributed significantly to the 2008 financial crisis.

But now in 2025, with years of additional market data available, we can re-evaluate whether these predictions have materialized and if they should concern everyday investors who are trying to build their financial futures—just like you. We’re going to look at whether index funds and ETFs are really approaching bubble status, whether this could trigger a collapse similar to 2008, and what, if anything, you should do about it.

We have to set the stage with some basic info so we can understand Burry’s actual argument that index funds are approaching a bubble. An index fund is a type of investment vehicle that pools money from many investors to purchase a collection of securities that mirror a specific market index. The most well-known example is an S&P 500 index fund, which holds shares of the 500 largest U.S. companies proportional to their market weight.

Unlike actively managed funds, where managers try to beat the market by picking winners, index funds simply track the index. They are passively managed. This results in lower fees, better diversification, and a more hands-off approach to investing.

And this is where Michael Burry saw a problem. He predicted that index investing was obscuring something known as price discovery and that as passive index investing increased, more and more investors would be buying investments based essentially on brand recognition. People might say things like, “Oh, well, it’s the S&P 500. It’s reliable. I’ll just buy that,” without any real analysis of the companies that make up the index.

This process, according to Burry, would cause the price of various index investments to increase beyond the true intrinsic value of the holdings that comprise them. The idea is that the imbalance between index investing and the actual analysis to justify that investment would, in turn, cause a bubble and subsequently a crash.

To help make this argument, Burry likened index funds to CDOs (collateralized debt obligations). CDOs are structured financial products that pool various types of debt into what are known as tranches—basically tiers of risk and return—that are then sold to investors.

In the 2000s, mortgage-backed CDOs became extremely popular, particularly those stuffed with subprime mortgages. Both tranching and overly generous credit ratings obscured their true risk, leading investors to treat them as safer than they really were. Strong investor demand encouraged lenders to continue issuing subprime mortgages, which fueled a feedback loop. Then we all know what happened next—the greatest asset bubble in history burst, leading to the 2008 financial crisis.

So Burry’s claim is that the price obscured from index funds is similar to the risk obscuring of CDOs, with both being touted as safe. But here’s the thing—that’s not exactly what’s happening with index funds at all.

First and foremost, S&P 500 companies aren’t exactly subprime mortgages. These are large, established American companies with strong market capitalizations. Secondly, CDOs actually drove demand for more mortgages, which caused banks to take on riskier and riskier debt. Index funds don’t do that. They’re not creating new companies to then package into an index fund. They’re just holding existing companies that meet a certain set of defined criteria. By and large, these are fundamentally different situations.

However, let’s look at Burry’s broader argument. Is it possible that the unprecedented rise in index fund popularity is somehow distorting market prices through reduced price discovery?

The most often cited figure surrounding this claim is that passive investing now makes up “over half the market.” If that were true, it might warrant some raised eyebrows. But unfortunately, that claim isn’t really accurate.

Passive investments do comprise over half of the equity fund market, but not the total market. As of late 2024, passive mutual funds and ETFs together accounted for a little under 60% of the equity fund market in the U.S., according to Apollo Academy. An analysis by Bloomberg Intelligence in early 2025 found that passive investments only account for about 13% of the entire U.S. stock market.

It’s also important to note “closet indexing,” which is when an active fund manager really just buys and bundles passive investments together. But even with that taken into account, the most recent estimates from 2024 suggest that only about a third of total market ownership is effectively passive.

So, what does that tell us? Does this upshot in passive investment ownership actually indicate an obscuring of price discovery? And are we really getting concerningly far away from the intrinsic value of the underlying companies that are passively held?

No. Because even with everything we just discussed, assets under management have little to no known bearing on prices. Stock prices are set by trading—the balance of buyers and sellers—not by how much of the market is simply being held. And trading volume is still dominated by active investment.

The most recent analysis of this phenomenon came from BlackRock, which found that for every $1 of passive investment trading, active investors traded $22. That means that for every $23 traded in the market, active traders accounted for 95% of it.

Trading is what actually determines prices. That means passive funds, even though they may make up a larger share of total assets, aren’t what’s driving daily price changes because they mostly just buy and hold according to an index. Instead, it’s active investors who provide the trades that move prices and keep price discovery working.

So, whatever bearing index investment has on prices, it’s minuscule compared to that of active traders. The idea that passive ownership is somehow hiding or distorting price discovery isn’t really accurate. What matters is the trading at the margin, not the amount of assets parked in index funds.

But what if index funds did come to dominate not only asset ownership but also trading activity? Might we be in trouble then? To answer that, we need to look at something called the Grossman-Stiglitz Paradox. It’s an economic theory that says markets can never be perfectly efficient. If they were, no one would bother researching investments. A perfectly efficient market eliminates price discovery, which would then create an imbalance between price and value. At that point, the market becomes inefficient again and re-attracts active investors to buy and sell to affect the price.

Ultimately, it’s a self-correcting problem. The beauty of this paradox is that it illustrates why the system can’t simply collapse from too much indexing. The market maintains a natural balance where active managers continue to drive price discovery through their trading activity while passive funds offer cost-effective, diversified investment vehicles for everyday investors.

To be clear, this is not a recommendation to pursue active investing. Consistently beating the market remains extremely difficult for the majority of investors. Rather, it’s an explanation of how these forces work together to balance the overall financial ecosystem.

Here’s the short version: the index fund bubble theory fails to hold water when scrutinized against actual market mechanics. While passive investing has grown substantially, it still represents a modest portion of market ownership and an even smaller fraction of the price-setting trading activity. Any actual inefficiencies will naturally create a self-correcting ecosystem.

For everyday investors building towards financial independence, this validates the old saying by Jack Bogle: Don’t just do something—stand there. The evidence suggests that a diversified, low-cost index fund strategy likely remains sound. No dramatic changes needed.

Index investing lets you ride out market cycles, smoothing the ups and downs on your way to long-term wealth and a great big beautiful tomorrow.