The Index Fallacy – Society’s Most Accepted Mistake: We are bombarded with it everyday: Dow Jones breaks 17k! S&P surpasses 2k! The financial media loves to use index prices as a measurement of stock market’s performance because it generates excitement (or in some cases fear). In actuality, indexes are a very poor indicator of stock market performance and valuation because they do not take profitability, valuation, and inflation into consideration. Indexes constantly reorganize the stocks which comprise the indexes. If Blue Chip Company A is doing poorly, the Dow does not have to take a buy-and-hold strategy on Company A, instead they simply drop the company and replace it with a better one. This means that since indexes are immune to failing stocks and congruent to high performing stocks, they’ll always rise in the long-term. So does this mean it is wise to invest in an index fund? If you prefer to be an average investor, earning average profits, then sure. Otherwise you can choose to either be a below average investor (penny stock gamblers) or an above average investor (Warren Buffett). Instead of evaluating the stock market based on the value of an index fund, look at the median price-to-book ratio for all companies. You’ll notice that the median P/B ratio tells a much truer story on how over/undervalued the market currently is, which itself is a nice indicator of future performance. Invest wisely and earn your freedom. thestockmarketoutsider
Posted on: Thu, 14 Aug 2014 02:51:19 +0000
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