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Index Investing 'Wins' the Nobel Prize

Stocks in this article: SPY SCHB TDC

Even a 20% weighting for a sector, as financials had during the middle of the last decade, is at the very least a flashing yellow light.

Another warning sign would be an inverted yield curve where short-term rates are higher than long-term rates.

Banks borrow at short-term rates and lend at long-term rates, but if the yield curve is inverted then that lending model is unprofitable and banks stop lending, which is recessionary.

An important point, however, is that individual investors should not be focused on beating the market. What really matters to individuals is whether they have enough money when they need it, typically when they retire.

A person's savings rate likely will be a larger determinant of whether he or she has enough for retirement. An investor who beats the market every year but only puts away $1,000 each year is far less likely to have enough money for retirement than the investor who lags the market but saves $25,000 each year.

There's another thing that savvy investors do. They avoid succumbing to behavioral biases at the wrong time.

Investor prone to panic selling probably should not build portfolios with index funds, because these investors are likely to sell when markets are slumping, taking sharp losses.

Famed investor James Montier from GMO has talked about the danger of permanently impairing capital. Investors who sell at the lows and never come back have permanently impaired their capital and damaged, if not ruined, their financial plan.

This subject is too broad for just one brief article, but the bottom line is this: Investors need to choose strategies that gives them a reasonable chance of accumulating enough money for their goals while avoiding doing the wrong things at the wrong times (i.e., panic selling)

Indexing will be the right answer for some investors, but no single strategy can be the best for everybody.

At the time of publication, Nusbaum had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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