Hi everyone, and welcome to another wise money tools video. Hope you're having a great week. So I want to ask you some did you ever see the movie "The Big Short?" So "The Big Short", very interesting movie a guy named Michael burry. He essentially shorted the mortgage market back in 2007-2008. So, I got to kind of paint this picture first you got to get a better understanding why shorting is to understand kind of what happened recently in the news. So just a quick explanation of what shorting is, in every transaction to make a full transaction. There's gonna be a buy and sell, right? I buy Apple stock, and someday I sell it closes out a full transaction. When people buy stock, most of the time, the shares sit inside of a brokerage account.

Now back in the old days, actually, even before my time, when people bought stock. They actually sent the stock certificates to you, then you had to protect them, put them in some sort of a safe or somewhere. You know, because they were just like money. Then when you sold the stock, he basically had to pack up the certificates, sign them, send them back to the brokerage company, he was a big pain, lots of hassle. So today are our so called certificates sit inside your brokerage account in what's called a book entry form. So when you open a brokerage account these days, one of the things you agreed to is to hypothesize Kate your shares of stock. Now hypothesis is a fancy word for you're gonna lend your shares to others.

So when someone shorts of stock, what they're doing is basically selling shares they don't own with the idea that in the future, they're gonna buy the shares and replace them. Since you have to have shares of stock to sell, essentially, you borrow the shares from someone else and then sell them. Then when you buy them in the future, they put them back into the person's account that they were borrow from. Now, what you might not know is that if you have a brokerage account. You most likely agreed to loan your shares to someone else who wants to short or sell shares they don't own at the moment. And in a nutshell, and as I mentioned, a full transaction is a buy in a cell. However, you can do a full transaction by doing the opposite you can sell first and then buy.

Okay, so shorting is simply selling stock you don't own by borrowing it from someone else, then replacing it once you buy the stock in the future. So first off, why would anyone want to sell a stock short? Well, the reason is they believe the stocks gonna go down there. There's trouble in the company and they think it's on its way down. Suppose a stock is selling at $100 a share, you're really pessimistic and you think that stock is gonna fall. So you short sell the stock at 100. So now you have $100 in your account essentially. Now the stock drops to 70. What you do is you then buy the stock at 70 replace those shares, and you've made a $30 profit. You sold at 100, bought at 70 made the spread. Now what Michael burry did is he did this on a massive basis, but what he did was short sell the mortgage market.

Now it was way out of control going into 2008 we had subprime mortgages, we had banks doing stuff that they had never done in the past this thing was getting way way out of control. And then what banks did is they started creating actually and brokerage companies to they started creating these derivatives off the mortgages. Well, derivatives are a whole nother conversation and even a whole course can be done just on those. But in a nutshell, banks would package hundreds, maybe even thousands of mortgages together and then sell them as one bond, if you will call the CDO is called a collateralized debt obligation. And basically, it would trade. Now what Michael realized that this just really couldn't last.

They were packaging mortgages, selling them as a CDO. Then they would package mortgages have mortgages, and that went on several levels deep, mortgages of mortgages of mortgages. And he just figured there's no way that this could last and so he wanted to short the market, thinking there was gonna be a bust at some point. Well, he was wrong for several years. He thought it was gonna happen sooner than it did but a long story and a very fascinating story as well, I might add, he ended up being right. And the mortgage bust of 2000, 2007, 2008 occurred. He personally made over 100 million dollars himself. And he made $700 million for his investors, all because the mortgage market basically failed. Okay, sorry for long story, but it's important to understand what's going on.

So that you know, this next article that has come on. And what spurred This video is that this same guy, Michael burry, has said that a similar bubble and a potential bust is happening in index funds right now. Now, one of the reasons why this caught my attention is because I've always been a proponent of saying. Look, if all you're gonna do is buy mutual funds and you're not gonna take the time to learn how to invest, probably the best thing you can do is just buying to the index. Most actively managed mutual funds. Don't beat the index. Anyway, but what he's saying and put a scare into a lot of those who have index funds is that they may be left holding an empty bag at some point. As this potential default in the future happens actually won't be a default, it'll be more of a market crash.

So in order to get a sense of what that means you got to understand how an index fund works. So let's take the S&P 500. The S&P 500 is made up of 500 different companies, but it is an over weighted index. Meaning if I put $100 into the index, my hundred dollars is gonna get spread out over those 500 companies. But the larger more the bigger companies like Apple, Google, Facebook and so far, are gonna get a bigger percentage of that hundred dollars. And the smaller companies many of which you might not have even heard of get pennies of those dollars. Okay. So his hypothesis, if you will, is saying that the index is getting trillions of dollars thrown into it. And because the index has to mimic the exact 500 stocks of the S&P 500 for instance. It has to buy those stocks, whether it wants to or not, there's no valuations. There's no looking at profitability, revenue, P/E ratios, any of the fundamentals that would normally be looked at if you were to buy a stock or a company on your own.

So these bigger companies, the apples and so forth, are getting extremely overrated with dollars just flooding in without regard to their current pricing. And his theory is because all this money's coming in and again, trillions of dollars are coming in buying these index Is that it's without regard, buying companies that may or may not be able to sustain their current price points. And his thinking is, this isn't gonna stop, people are still going to do it. And it's just gonna build and build and build. And it's gonna create this massive bubble. And the way he describes it, he says, It's like we're cramming more people into a movie theater, but we still only have the same two exits. And if anybody ever wants to exit this thing, it's gonna be an especially if a crowd wants to exit, it's gonna be a stampede rush, and people are going to get trampled on.

So I kind of see what he's saying. If people just keep in advert or without any regard to what's going on in the market, keep buying these indexes. And because the index has to mimic the portfolio, it's gonna constantly be buying more and more of these Specially larger cap companies that again may not be able to sustain their price points and as soon as the market as a whole or a group of investors or just the the news says, Wow, there's no way Apple is worth x, and it's multiple is trading at, you know, 2, 3, 4 hundred times earnings. This is gonna set in some sort of a panic. And again, using that movie theater analogy, people are going to run for the doors. And when they do, the indexes could drop off quite dramatically.

Now, is this gonna happen? I don't know. When is it gonna happen? I don't know. We could be years away from something like this happening. But it is worth at least understanding that what we really have to do here is understand how to invest. Why we invest have some evaluation methods so that we're buying into things that make sense. Waiting for opportunities to buy, when these great companies go on sell the way they S&P handled Now, the way that these large companies are inside the S&P. The way the index funds have to continue to buy these, we may not be able to really get good valuations off some of these big companies. And as a result, then it could be years, decades before we can buy into some of these companies that have good value.

So this wasn't necessarily, you know, meant to panic you. I don't think this is gonna happen anytime soon. But I wanted to keep you aware of this because again, I've been more of a proponent of index funds versus actively managed money. And if this does continue to happen, I can see how this could be a problem down the road. So again, the moral of the story, become a great investor understand how to invest why you invest, understand some valuations, and wait for opportunities when you can get wonderful companies on sale. And this really goes for any kind of investing out there. Make sure that you understand the whys and the reasoning of why you're getting into a particular investment. Hope that made sense that might be you know, a little confusing and there's a lot of to unpack there, short selling and all that is not an easy thing to understand and certainly want to be a very knowledgeable investor before you jump into that side of the market.

In the meantime now, if you have any questions, shoot him a question to wise money tools.com. If you ever want to have a strategy session, click on the time trade the link below. Set up a time we can discuss your particular situation, and some of the pitfalls that you might be running into if these markets start to turn. Other than that, I hope you have a great weekend. I'll talk to you later. Oh, don't forget to subscribe, and I will see you soon. Take care.