• Entertainment
  • Finance
  • Marketing
  • Real Estate
  • Technology
  • Social
National Journal Community Of e-Experts
Finance 0

The Problem With Indexing

By Kurt Osterberg · On April 5, 2018

Indexing your investments is a good way to increase your chances of doing better than average. Most active investors trying to pick winning stocks (and avoid losing ones) don’t beat the index. Those who do are hard to identify ahead of time. Once you think you’ve identified a market-beating manager, they often allow their fund to get too big, which typically reduces their chances of repeating their past success. And sometimes they’re on the cusp of retirement. Or they’ve lost analysts who’ve helped them be great. In other instances, you might be correct in thinking they can outperform over the long term, but you’re about to capture one of their fallow periods. Nobody ever said this game was easy.

Yet, there are problems with indexing too. “Indexing” generally means following what’s called a “capitalization weighted” index. That means the rank of the stock in the index is determined by how much the stock market values it. Market capitalization is the total shares of a stock outstanding multiplied by the price per share. But is taking the stock market’s verdict about where a stock should be ranked in an index reasonable? Many people think it isn’t. After all, you necessarily own more shares of the most favored and possibly expensive stocks in a capitalization weighted index.

When the first index fund – the Vanguard 500 Index Fund – came to the market in the early 1970s, academic finance was dominated by the notion that the market prices stocks properly – or accurately, based on available information – at all times. That made it seem reasonable to rank stocks by how the stock market says they should be ranked.

But there’s a case to be made that ranking stocks based on their underlying companies’ economic fundamentals such as sales, earnings, dividends, and book value might also be reasonable. And if stock markets don’t always set prices properly, if they are sometimes the victims of emotion gripping their participants, maybe focusing on economic fundamentals of the businesses is a smarter approach to indexing. And, after all, if you rank stocks based on companies’ underlying economic fundamentals, you’re arguably not showing any disrespect for markets. You might just be elevating the markets for companies’ goods and services over the market that trades those companies’ stocks.

Print Friendly, PDF & Email

Share Tweet

Kurt Osterberg

You Might Also Like

  • Finance

    STEPN Sneaker NFTs Sell For $100, Previously Worth $1200

  • Finance

    NFT Prices in Free Fall – 5 NFT Collections to Start Buying Today

  • Finance

    5 NFTs Trending on Twitter Going Cheap to Invest in Now

No Comments

Leave a reply Cancel reply

Top Finance

  • 3 Best Large-Cap Blend Mutual Funds For Enticing Returns 3 Best Large-Cap Blend Mutual Funds For Enticing Returns
  • What is Value Chain Analysis? How to Deliver Value & Gain a Competitive Advantage What is Value Chain Analysis? How to Deliver Value & Gain a Competitive Advantage
  • Hedge Funds In The US Hedge Funds In The US
  • 5 Ridiculously Useful Non-Monetary Reward Examples that Improve Employee Engagement 5 Ridiculously Useful Non-Monetary Reward Examples that Improve Employee Engagement
  • Chart: Amazon’s Dominance In Ecommerce Chart: Amazon’s Dominance In Ecommerce

New Posts

  • STEPN Sneaker NFTs Sell For $100, Previously Worth $1200

    STEPN Sneaker NFTs Sell For $100, Previously Worth $1200

    June 20, 2022
  • NFT Prices in Free Fall – 5 NFT Collections to Start Buying Today

    NFT Prices in Free Fall – 5 NFT Collections to Start Buying Today

    June 20, 2022
  • 5 NFTs Trending on Twitter Going Cheap to Invest in Now

    5 NFTs Trending on Twitter Going Cheap to Invest in Now

    June 20, 2022
  • Bill Gates – ‘NFTs & Crypto Based on Greater Fool Theory’

    Bill Gates – ‘NFTs & Crypto Based on Greater Fool Theory’

    June 20, 2022
  • Actor Seth Green Pays $300,000 to Recover his Stolen BAYC NFT

    Actor Seth Green Pays $300,000 to Recover his Stolen BAYC NFT

    June 20, 2022
  • About
  • Contact Us
  • Privacy & Policy
  • Sitemap
  • Terms of use

Copyright © 2018-2021 NJCEE. All Rights Reserved.