Index Investing — Did the “Passive” Approach Beat the Markets?
Most stock market followers will know just how difficult it is to pick a winning stock. There are just so many factors to take into account. Do you follow a company’s financial results? Do you stick to the charts? Or should you just simply throw all of your money behind the index?
Ever since index trading became popular in the 1970s, stock investors have wondered whether putting their trust in stock indices might save them a whole lot of grief and effort rather than cherry-picking “that winning stock”. Of course, there are cherries out there, but often they’re only available for picking once they’ve made their move and the train has left the station.
In 1975, Vanguard, a US index fund, was established with the clear aim of attracting those investors who neither had the time, knowledge, or luck, to find those ripe cherries. This fund, aimed at the retail investor, was intended to provide a simple, flexible vehicle that investors could use to benefit from a generally positive market move of a specific sector. Initially met with skepticism, the fund did gain momentum, even after only raising less than 20 million USD when it was first launched. However, following the wild movements in the stock market since its debut, stock index funds have become more popular.
With low fees, and with far less hassle than wading through reams of company financial data, investors could now place a bet on general market sector direction. Most investors will do well if they follow the index rather than trying to pinpoint individual stocks. Of course, individual investors can and do beat the index, but they are a small minority of the general investment community. And then there is always the issue of fees, which are far higher when trading individual stocks. Why not pool your funds and invest in a relatively small number of indices, thereby lowering your commissions, while gleaning the benefit of positive market movements?
Some critics have claimed that index funds help to create market bubbles. They say that maintaining a somewhat passive approach to stock investment takes some of the heat and energy out of the market. This is a difficult point to prove. Of more significant concern might be what happens when capital moves to an indexed fund from an investor who has been unable to beat the market average by steering clear of volatile stocks. With the move of more cherry stock pickers to index investment, this might contribute to bubble stock events.
One view is that with the transformation of cherry pickers to index followers, many bad investment managers may have gone bust, and that is a logical conclusion. But remember - the trade in individual stocks continues. All that is really changing is that investors are becoming smart about the best way to invest in market movement. In fact, index trading may have actually increased stock market liquidity. So, if you’re a little tired of “just missing the big one”, why not consider investing in stock indices? You will certainly have less frustration, and it may make and save you money in the long run.