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Which Index Fund?

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By rclosch
August 25, 2003

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With Their eyes glued to the rear view mirror, many investors recommend index funds, particularly educated people of the efficient Market persuasion.

"The S&P has returned 10% per year for the last 100 years therefore index funds. Are an easy answer to all investment decisions."

Strangely enough I am more interested in the next ten years, than I am the last hundred. And, while their argument sounds good (You can not beat the market so just buy the market), I personally have some reservations

My first question is Which index fund?

Ten years ago the answer to this question seemed easy. Index Fund meant the Vanguard S&P 500 index fund. Yet now, Even Buffett has qualified his limited recommendation of index funds buy saying the index should be broad based.

500 stocks in today's market with tens of thousands of different companies publicly traded in the world economy can hardly be considered broad based. In addition the Index is weighted based on capitalization. So something like 80% of the value is represent by the 50 biggest companies

In truth, today any fund based on The S&P 500 is a sector fund that represents mostly over priced American large Cap Stocks. As Sectors go this one is really a dog. To make matters worse the only one of the fifty biggest American companies that is currently worth buying is not even in the S&P 500. This is a good fund to invest in if under performance for the next ten years is your primary objective.

In his book Beyond Greed and Fear Hersh Shefrin Describes what he calls The Gamblers Fallacy. This is the tendency of strategists to misinterpret the rule of reversion to the mean. For example since the S&P has returned something like 10% per year for the last 100 years. A reversion to the mean suggests that eventually it will provide us 10% per year for the next 100 years. The fallacy should be obvious. History tells us very little about the future.

There are of coarse broader indexes like the Wilshire 5000, but the stocks are still weighted according to size and so its performance is weighted to large cap. Better yet it contains most of the NASDAQ. So this sector fund not only includes Large Cap but also tech stocks.

Jim Rogers says that while nineteenth century was the British Century and the Twentieth Century was the American Century, the Twenty-first Century will be the Chinese Century. So maybe the index we need is the Chinese S&P?

Below is a partial list "ishares" (basically Index funds in Drag) Issued by Barclays Global Investors.


Global Index Funds

iShares s&p 100 index fund
iShares s&p global 100 index fund
iShares s&p global energy sector index fund
iShares s&p global financials sector index fund
iShares s&p global healthcare sector index fund
iShares s&p global technology sector index fund
iShares s&p global telecommunications sector index fund
iShares s&p Europe 350 index fund
iShares s&p/tse 60 index fund
iShares s&p Latin America 40 index fund
iShares s&p/topix 150 index fund
iShares NASDAQ biotechnology index fund

Dow Jones Index Funds

Dow Jones U.S. Basic Materials Sector Index Fund
Dow Jones U.S. Basic Materials Sector Index Fund
Dow Jones U.S. Consumer Cyclical Sector Index Fund
Dow Jones U.S. Consumer Non-Cyclical Sector Index Fund
Dow Jones U.S. Energy Sector Index Fund
Dow Jones U.S. Financial Sector Index Fund
Dow Jones U.S. Financial Services Index Fund
Dow Jones U.S. Healthcare Sector Index Fund
Dow Jones U.S. Industrial Sector Index Fund
Dow Jones U.S. Real Estate Index Fund
Dow Jones U.S. Technology Sector Index Fund
Dow Jones U.S. Telecommunications Sector Index Fund
Dow Jones U.S. Total Market Index Fund
Dow Jones U.S. Utilities Sector Index Fund

Morgan Stanley International Index Funds

MSCI Australia Index Fund
MSCI Australia Index Fund
MSCI Austria Index Fund
MSCI Belgium Index Fund
MSCI Brazil Index Fund
MSCI Canada Index Fund
MSCI EAFE Index Fund
MSCI Emerging Markets Index Fund
MSCI EMU Index Fund
MSCI France Index Fund
MSCI Germany Index Fund
MSCI Hong Kong Index Fund
MSCI Italy Index Fund
MSCI Japan Index Fund
MSCI Malaysia Index Fund
MSCI Mexico Index Fund
MSCI Netherlands Index Fund
MSCI Pacific ex-Japan Index Fund
MSCI Singapore Index Fund
MSCI South Africa Index Fund
MSCI South Korea Index Fund
MSCI Spain Index Fund
MSCI Sweden Index Fund
MSCI Switzerland Index Fund
MSCI Taiwan Index Fund
MSCI United Kingdom Index Fund

This only a partial list, but you get the idea. there are hundreds (maybe thousands) of index funds and they are all sector funds. Some of these will return something close to the returns of the S&P during the twentieth Century, some will do better some will do worse, but if you know which is which you are a lot smarter than I am.

And one final question. How is picking the right index fund any easier that picking a good stock?


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