On this episode of Tape Talk we talk about Index Investing. What exactly is an index and what are the pros and cons of investing in them?
Defining an Index
So you’ve decided to follow the recent trend towards index investing. But wait a minute…what exactly is an index anyhow?!? Before we dive into the details of indices we need to take some time to define exactly what an index is. First, it doesn’t always represent all stocks in a market. Second, it doesn’t represent all stocks equally. Finally, an index changes constantly over time. Did you know that only one of the stocks in the current Dow Jones Industrial Average has been there since the beginning? Were you aware that the S&P existed over thirty years before it contained the five hundred (or more) stocks as the name now alludes?
How is an Index Made?
Can you explain what Market Capitalization is at your next cocktail party? It’s an important concept in explaining how an index works. That’s why we break down what market cap is and how its used in developing an index. Since the S&P 500 is a market cap weighted index it’s important for investors to understand this important investment concept.
Are All Sectors Equal?
Many people are under the impression that an index represents all stocks equally or at least all eleven of the sectors equally. However, since the S&P 500 is a market cap weighted index this is hardly the case. In fact, often times a few stocks or a single sector can start to dominate the index. This has some pros and cons and we take some time to break down how those affect your investments.
So, Should I Just Buy an Index Fund?
The natural question about index investing is whether or not you should start it or continue it. However, investing is rarely a one size fits all equation. The fact is, investing is about more than throwing your money into an asset, it’s about working toward your goals. This is why it’s important to have a financial and investment plan so you know where you want to go and whether or not your investments are taking you there.