A quick digression for those of you who aren't familiar with alpha and beta. In traditional finance, return not correlated with a broad market index, such as the S& P 500, is referred to as alpha.
The return which is correlated to the market is beta. An index fund should have the same return (positive or negative) as the index it mimics. (One of the controversies surrounding some ETFs is their performance has not tracked their underlying index.)
The theory behind Alpha and Index Funds is multi fold: 1. the major indices are a good place for an investor to be, both from a risk and return perspective; 2. you can't outperform the major indices, so don't waste your time; 3. find those investment niches with high alphas to increase your return and reduce the overall risk in your portfolio.
Even if you don't subscribe to this theory, you might find it an interesting exercise to review the alphas -- every investment has one -- of your current holdings. They will tell you something about the correlation and diversification of your portfolio.
Where to focus your alpha energy? Investments in real estate, commodities, and energy are less correlated with the stock market (although I've never thought commodities were suitable for individual investors).
The Wall Street pros also recommend stock fund mangers who have unique strategies and can demonstrate a high alpha relative to the market (and, of course, positive relative performance).
Ask your investment adviser for suggestions. The alphas for individual mutual funds (and individual stocks) are available from some brokers and online premium services.
Alpha and index fund investing makes a great deal of sense. You know what to expect in terms of risk and return when you invest in an index fund.
Having a portion of your portfolio in index funds leaves you free to concentrate your investment time and energy (think alpha waves) on those investments which can make a difference.
Picking high alpha investments, which by their nature are less correlated with the stock market, should reduce the risk/volatility of your portfolio and, depending upon the investment, provide above market returns.
In a way, index funds are the modern-day tortoise in the race for a solid investment plan. Nothing flashy, just steadily keeping pace with a particular index, and if, by chance, that index does well, then the fund excels also.
Index funds, which are a type of mutual fund, are a pretty simple concept in the world of investments. In an index fund, stocks are grouped together from companies included within an index, for instance the S&P 500 or the Dow Jones Industrial Average. The percentage of stock is kept the same as the indexes themselves in an attempt to mirror the index. While it's a rather basic concept, it's one that for some has proven to be successful over time.
The Dow Jones Industrial Average (DIJA) is a price weighted index of 30 of the largest, most widely held stocks traded on the New York Stock Exchange. The S&P 500 is an unmanaged group of securities considered to be representative of the stock market in general.
Whether or not you want to invest in an index fund depends on the type of investor you are. Each person has a distinct style and keep in mind that index funds are different from normal mutual funds.
Most mutual funds are actively managed so a fund manager is constantly picking new or different stocks to go into the fund. This active attempt to beat the market is based mostly on timing and choosing the right stocks and bonds. This can sometimes pay off. Other times it does not. Index funds, on the other hand, are a passive investment meaning they are not actively managed.
But one of the most attractive parts of index funds stems from the lack of active management. Because they don't require the same constant administration and attention as an actively managed mutual fund, their expense ratios are generally lower.
Some say if you can't beat a market, you might as well join it which is one of the biggest attributes of an index fund. The funds are great for people who wish to follow the market.
So are index funds for you? That depends on your investment style. As always, you should check with a financial professional before investing, and decide if index funds fit in with your overall investment strategy. But in the end, index funds offer an alternative way to potentially increasing your wealth and achieving your financial goals.
Both Bill Byrnes & Robert Valentine are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Bill Byrnes has sinced written about articles on various topics from Financial Planning, Currency Trading and Financial Planning. Bill Byrnes is co-founder of MUTUALdecision, , providing investors with data on the top mutual funds, and author of the MUTUALdecision Blog. He's been. Bill Byrnes's top article generates over 6600 views. to your Favourites.
Robert Valentine has sinced written about articles on various topics from Financial Planning, Retirement and Health Care. Robert Valentine is a well-known expert in the matters concerning investors. His popular articles have been published by. Robert Valentine's top article generates over 12100 views. to your Favourites.