Passive investing, particularly index investing, is pitched as a diversification strategy to mitigate risk, with the market portfolio of stocks, bonds, real estate and much more being the ultimate diversified portfolio. Diversification, indeed, reduces risk. But one must be careful. Chapter 1 warned of situation where diversification can go against the investor, for example when correlations move towards 1.0 in down markets.
There is another issue. With so many investors invested in passive index funds, what happens if stock prices decline significantly? Passive investors might draw funds from the passive investments, forcing the funds to sell off the securities they hold to supply the liquidity for redemptions, depressing the prices of the investments they hold, inducing further withdrawals. That could be a nasty cycle. Investors might prefer a passive fund to a bank account but, just as there can be a run on a bank, so there can be a run on a passive fund.