by David Merkel, Aleph Blog
Are index funds that are capitalization-weighted the best funds to invest in? Ā No. Ā So why do we talk about index funds so much? Ā Because they represent the average dollar in the market. Ā In principle, everyone could invest in a comprehensive index fund, and there would be no effects on the market.
But indexes can be enhanced. Ā Tilt your investments to:
- Avoid the biggest firms, their growth opportunities are limited.
- Buy cheap stocks, they out-earn growthier stocks, and have fewer disappointments
- Buy quality stocks, again, fewer disappointments.
- Buy stocks that have been running, they tend to do well in the future.
- Buy stocks with conservative accounting, they tend to outperform.
But the moment you do that, you are an active manager, because not everyone can do what you are doing. Ā Also, each of the anomalies I have indirectly referenced can occasionally be overvalued. Ā As an example, the biggest stocks presently look cheap compared to smaller stocks.
Trying to create āsmart betaā is interesting, but letās just call it enhanced indexing. Ā And if too many people try to do enhanced indexing, guess what? Ā Those stocks will become overvalued, and will eventually sag, badly.
There is no magic bullet in investing. Ā There is the work of evaluating valuations versus future prospects, and that is a challenging task.
If you want average performance, which is better than most get, buy a broad index fund with low fees and hold it. Ā If you want better performance, tilt your portfolio to reflect factors that usually outperform. Ā If you want still better performance, ask what factors are overvalued, and remove them from your portfolio.
As for me, I am happy buying safe and cheap stocks and holding them for three years or so. Ā Iām happy with my picks, and so I adjust my portfolio in small ways quarterly. Ā No need to over-trade. Ā I just keep following my strategy.
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