Not an economist or otherwise particularly qualified, but these are easy questions.
I’ll answer the second one first: This advice is exactly the same as advice to hold a diversified portfolio. The concept of an index fund is a tiny little piece of each and every thing that’s on the market. The reasoning behind buying index funds is exactly the reasoning behind holding a diversified portfolio.
For the second question, remember the idea is to buy a little bit of everything, to diversify. So go meta, and buy little bits of many different index funds. But actually, as this is considered a good idea, people have made such meta-index funds, that are indices of indices, that you can buy in order to get a little bit of each index fund.
But as an index is defined as “a little bit of everything”, the question of which one fades a lot in importance. There are indices of different markets, so one might ask which market to invest in, but even there you want to go meta and diversify. (Say, with one of those meta-indices.) And yes, you want to find one with low fees, which invests as widely as possible, etc. All the standard stuff. But while fiddling with the minueta may matter, it does pale when compared to the difference between buying indices and stupidly trying to pick stocks yourself.
The concept of an index fund is a tiny little piece of each and every thing that’s on the market.
This is not true. An index fund holds a particular index which generally does not represent “every thing that’s on the market”.
For a simple example, consider the most common index—the S&P 500. This index holds 500 largest-capitalization stocks in the US. If you invest in the S&P500 index you can be fairly described as investing into US large-cap stocks. The point is that you are NOT investing into small-cap stocks and neither you are investing in a large variety of other financial assets (e.g. bonds).
Yes. What I wrote was a summery, and not as perfectly detailed as one may wish. One can quibble about details: “the market”/”a market”, and those quibbles may be perfectly legitimate. Yes, one who buys S&P 500 indices is only buying shares in the large-cap market, not in all the many other things in the US (or world) economy. It would be silly to try to define a index fund as something that invests in every single thing on the face of the planet, and some indices are more diversified than others.
That said, the archetypal ideal of an index fund is that imaginary one piece of everything in the world. A fund is more “indexy” the more diversified it is. In other words, when one buys index funds, what one is buying is diversity. To a greater or lesser extent, of course, and one should buy not only the broadest index funds available, but of course also many different (non-overlapping?) index funds, if one wants to reap the full benifit of diversification.
the archetypal ideal of an index fund is that imaginary one piece of everything in the world.
Maybe in your mind. Not in mine. I think of indices (and index funds) as portfolios assembled under a particular set of rules. None of them tries to reach everything in the world, in fact a lot of them are designed to be quite narrow.
A fund is more “indexy” the more diversified it is.
I still disagree. An index fund’s most striking feature is that it invests passively, that is its managers generally don’t have to make any decisions, they just have to follow publicly announced rules. I don’t think a fund is more “indexy” if it owns more or more diverse assets.
In other words, when one buys index funds, what one is buying is diversity.
Sigh. Still no. You’re buying a portfolio composed under certain rules. Some of these portfolios (= index funds) are reasonably diversifed, some aren’t, and that depends on how do you think of diversification, too.
The “classic” index fund, one that invests into S&P500, is not diversified particularly well. It invests in only a single asset class in a single country.
An index fund’s most striking feature is that it invests passively, that is its managers generally don’t have to make any decisions, they just have to follow publicly announced rules. I don’t think a fund is more “indexy” if it owns more or more diverse assets.
Yup. Take an actively managed fund that seems to be indexy by ygert’s standards today. It might not be so indexy tomorrow.
Two questions:
Doesn’t this ignore the very important question of “which indices?”
Is this advice different from the “hold a sufficiently diversified portfolio” one?
Not an economist or otherwise particularly qualified, but these are easy questions.
I’ll answer the second one first: This advice is exactly the same as advice to hold a diversified portfolio. The concept of an index fund is a tiny little piece of each and every thing that’s on the market. The reasoning behind buying index funds is exactly the reasoning behind holding a diversified portfolio.
For the second question, remember the idea is to buy a little bit of everything, to diversify. So go meta, and buy little bits of many different index funds. But actually, as this is considered a good idea, people have made such meta-index funds, that are indices of indices, that you can buy in order to get a little bit of each index fund.
But as an index is defined as “a little bit of everything”, the question of which one fades a lot in importance. There are indices of different markets, so one might ask which market to invest in, but even there you want to go meta and diversify. (Say, with one of those meta-indices.) And yes, you want to find one with low fees, which invests as widely as possible, etc. All the standard stuff. But while fiddling with the minueta may matter, it does pale when compared to the difference between buying indices and stupidly trying to pick stocks yourself.
This is not true. An index fund holds a particular index which generally does not represent “every thing that’s on the market”.
For a simple example, consider the most common index—the S&P 500. This index holds 500 largest-capitalization stocks in the US. If you invest in the S&P500 index you can be fairly described as investing into US large-cap stocks. The point is that you are NOT investing into small-cap stocks and neither you are investing in a large variety of other financial assets (e.g. bonds).
Yes. What I wrote was a summery, and not as perfectly detailed as one may wish. One can quibble about details: “the market”/”a market”, and those quibbles may be perfectly legitimate. Yes, one who buys S&P 500 indices is only buying shares in the large-cap market, not in all the many other things in the US (or world) economy. It would be silly to try to define a index fund as something that invests in every single thing on the face of the planet, and some indices are more diversified than others.
That said, the archetypal ideal of an index fund is that imaginary one piece of everything in the world. A fund is more “indexy” the more diversified it is. In other words, when one buys index funds, what one is buying is diversity. To a greater or lesser extent, of course, and one should buy not only the broadest index funds available, but of course also many different (non-overlapping?) index funds, if one wants to reap the full benifit of diversification.
Maybe in your mind. Not in mine. I think of indices (and index funds) as portfolios assembled under a particular set of rules. None of them tries to reach everything in the world, in fact a lot of them are designed to be quite narrow.
I still disagree. An index fund’s most striking feature is that it invests passively, that is its managers generally don’t have to make any decisions, they just have to follow publicly announced rules. I don’t think a fund is more “indexy” if it owns more or more diverse assets.
Sigh. Still no. You’re buying a portfolio composed under certain rules. Some of these portfolios (= index funds) are reasonably diversifed, some aren’t, and that depends on how do you think of diversification, too.
The “classic” index fund, one that invests into S&P500, is not diversified particularly well. It invests in only a single asset class in a single country.
Yup. Take an actively managed fund that seems to be indexy by ygert’s standards today. It might not be so indexy tomorrow.