Investment Timing and Investment Selection receive the lion’s share of media attention… but they don’t necessarily add value for readers and viewers. When financial media does break away from the timing and selection conversation, they usually reach for the Index solutions – “Don’t buy individual securities, just buy the index.” Again, Buffett and Bogle are big proponents of this method largely because it can protect investors from their own bad timing and selection decisions.
But, we have to remember that how an index is constructed matters a great deal to that indexes “performance.” And, most indexes weight their underlying holdings differently. Many index based products rely on market capitalization as their method of weighting the individual holdings within the index and this portfolio structure has an effect on performance. In a period of time when larger companies do better, this method SHOWS very well. But, historically it has also gone through periods of under-performance. The key is understanding that Index Weighting Methodology is a portfolio structure decision that matters to client outcomes.
I totally agree with the concept behind the broad diversification afforded by “owning the index,” but I also believe the evidence supports a portfolio structure methodology that improves client outcomes. In this video, I talk about index construction and about alternative methods of weighting broad market holdings that evidence suggests will provide benefits to long-term investors.