Among the arguments in favour of fundamental indexing, the most suspect is the following claim:
John Bogle’s (creator of the Vanguard mutual fund behemoth) back-testing research several decades ago that showed that most investors would be better off in funds that simply mirrored the then best market indices available, but at the lowest cost. However, times move on, research advances and other indices are created and tracked.
Bogle’s argument of the superiority of traditional indices is not just based on back testing; it is also supported by logic. Investors as a group earn returns that match the market’s less expenses. But, the new wave of “fundamental” indices is not supported by logic. It is based on mining the market data for a set of factors that would beat the market if the future looks anything like the past. John Bogle and Burton Malkiel defended traditional indexing in a op-ed piece in The Wall Street Journal:
We concede that there is some evidence, based on numbers compiled by Ibbotson Associates, that long-run excess returns have been earned from dividend-paying, “value” and small-cap stocks — albeit returns that are overstated by not taking into account management fees, operating expenses, turnover costs and taxes. But to the extent that investors are persuaded by these data, the premiums offered by such stocks may well now have been “arbitraged away” in the stock market, as price-earnings multiples have become extremely compressed.
Do you think it would pay to bet against Bogle and with the big names in the corner of fundamental indexing?
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5 responses so far ↓
1 Riscario Insider // Oct 22, 2007 at 10:04 pm
What makes investing frustrating is the conflicting yet plausible explanations. That and the volatility in returns
Just last week, I was explaining to an astute investor my desire to invest in established market indexes once I figure out which discount broker, which indexes, the allocations,… (now you know why I visit this blog so often).
My choices were called “dumb” indexes in contrast to the bevy of new choices. Who wouldn’t want “smart” indexes focused on narrower segments of the market? Why not bet on small cap stocks, for example? Now I’m confused again
2 FourPillars // Oct 22, 2007 at 11:12 pm
Riscario - “dumb indexes” and “smart indexes” are just marketing words, ignore them.
Invest most of your money in the main broad-based, tried & true indexes and you will be fine. It’s not lotto 649 - you don’t have to pick the winning ETF in every category to be able to retire.
Mike
3 Canadian Capitalist // Oct 23, 2007 at 7:51 am
The vast majority of indexes are just garbage. Why would an average investor want exposure to a nanotech index of Indonesian stocks? Oh, I know why. The extra fees and broker commissions and an army of investment advisors who can tell you which one to pick (for a fee, of course).
4 Jon D. // Oct 23, 2007 at 4:32 pm
What?!? You’re telling me I shouldn’t be invested in the Southwest Sourdough and Breadmakers’ ETF?
5 Canadian Capitalist // Oct 23, 2007 at 7:02 pm
Here are some funny ones:
HealthShares Metabolic Endocrine Disorders
Claymore MACROshares Oil Down Tradeable Shares
PowerShares Dynamic Networking Portfolio
PowerShares Cleantech Portfolio
Claymore/Sabrient Insider ETF
HOLDRS B2B Internet
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