This Day On The Street
Continue to site
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Index Investing 'Wins' the Nobel Prize

NEW YORK ( TheStreet) -- Yesterday we got the news that the 2013 Nobel Prize in Economics was awarded to Robert Shiller, Lars Peter Hansen and Eugene Fama.

Fama has long been a well-regarded proponent of the efficient-market hypothesis and investing in index funds.

The short version of this idea is that because asset markets are efficient, it is impossible for individuals to beat them. If it is impossible to beat the equity market's efficiency, then picking individual stocks is futile, so investors should simply use broad-based index funds to construct their portfolios.

People who argue against this thesis typically cite the many professional investors who have indeed beaten the market routinely -- folks like George Soros, George Soros, Stanley Druckenmiller and David Tepper. (Tepper was the guest host on CNBC's "Squawk Box" program Tuesday morning.)

Nevertheless, many individual investors choose to build their portfolios with index funds. These investors will get the returns of the markets the funds track, minus expenses charged by the funds.

But because these funds are not actively managed, they typically have the cheapest expense ratios.

One popular index fund, the SPDR S&P 500 (SPY) has an expense ratio of only 0.09% while the Schwab U.S. Broad Market ETF (SCHB) charges only 0.04% and is commission-free for Schwab (SCHW) customers.

A portfolio that holds only index funds won't have significant exposure to single-stock selloffs, such as the one suffered Tuesday by Teradata (TDC). Shares are down 14% because the company lowered its earnings outlook.

Index investing is a valid strategy, but it has its drawbacks, and markets are not always efficient. There were plenty of signs/warnings of excessive valuations leading up to the tech wreck in 2000 and the financial crisis in 2007, but markets kept going up until they imploded. Of course, index funds felt the full brunt of those implosions, because they are the market.

One thing savvy investors should watch is the sector weightings of the S&P 500. When a sector grows to be 30% of the S&P 500, as technology did in 2000, or as energy did in the early 1980s, then it's usually a warning sign.

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
SYM TRADE IT LAST %CHG
SPY $211.65 0.00%
AAPL $130.28 0.00%
FB $81.53 0.00%
GOOG $565.06 0.00%
TSLA $218.42 0.00%

Markets

DOW 18,080.14 +21.45 0.12%
S&P 500 2,117.69 +4.76 0.23%
NASDAQ 5,092.0850 +36.0220 0.71%

Partners Compare Online Brokers

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs