|
|
Individual investors have always had numerous reasons for not investing in the
stockmarket. Either the market is too high or low or corporate earnings or growth
are in a downward cycle. For some timid ones, conditions just never seem to be right.
The wild swings of the local stockmarket due to uncertainties have literally forced
many investors to stay sidelined. During periods of uncertainty when predicting the
market outlook is almost impossible, it is normal for most to try to second-guess
the market. That is always a big mistake as they usually end up buying at the high
and selling at the low.
As we all know, timing the market is notoriously tricky. Certainly, investing in
the stockmarket can be very frustrating. As the old Wall Street saying goes "the
market will always act in such a way as to frustrate the greatest number of investors".
Despite fears of losing, getting out of the market completely is not necessarily
the best solution. Many studies have shown that the opportunity cost of being out
of the market is high. This is especially true for "moms and dads investors"
who are afraid of the slightest degree of volatility in the market.
Since forecasting the stockmarket precisely can be very difficult, monitoring the
market is a strenuous task even for full-time professionals. Some investors who are
tired of chasing the rainbows but do not want to miss opportunities arising from
market movements prefer to adopt the "dollar-cost averaging" method - buying
at regular intervals regardless of market trends or levels.
For others, they may prefer index investing - setting up portfolios that mimic the
broad market benchmark or invest in index funds managed by professionals. In the
U.S., index investing was a technique previously available only for institutional
investors. It has risen in popularity amongst retail investors. Currently hundreds
of billions of dollars are invested into index funds. Unfortunately, index investing
is not yet as popular in the local market as in matured markets.
What is an index? An index is a number that gives the value of something (example,
shares in a stockmarket) relative to its value at some other time. In statistical
terms, it is the sample population that is used to determine the performance of the
entire population. The Kuala Lumpur Composite Index (KLCI) is the key benchmark for
Malaysiaís stockmarket while the Dow Jones Industrial Average (DJIA) is the barometer
for the U.S. stocks. Indexes are useful in indicating market trends and as a benchmark
for comparison purposes.
Frequently investors measure the performance of their portfolios against an index.
Different investors may use different indexes as their performance benchmarks. For
example, fund managers who invest in local stocks will compare their portfolio performance
against the KLCI.
What is index investing or indexing? Indexing is an investment strategy that seeks
to match the returns of a specified benchmark or index. An index fund manager employs
investment strategies designed to match the performance of a broad array of securities
by buying most if not all of the stocks or bonds (a representative sample in the
case of very large indexes) that make up the index.
Indexing is typically passive in terms of investment approach (auto-pilot style).
Investors do not have to rely on a fund managerís ability to outperform market indices.
They believe in the efficient market theory. Indexing emphasizes low portfolio trading
activity and broad diversification. With other managed funds, the fund managers are
paid to pick stocks that he or she believes will perform better than the benchmarks
|
Active Portfolio Management
|
Passive Portfolio Management
|
| Periodic changes to portfolio in anticipation of price movements using both technical
and fundamental analysis to guide their portfolio changes |
Buy and hold strategy where in most cases the investments tend to replicate broad
market benchmark such as the Kuala Lumpur Composite Index (KLCI) or the Hang Seng
Index |
| High transaction cost |
Low transaction cost |
| More time-consuming |
Less monitoring |
| More incline to make short-term changes |
Less incline to make short-term changes, prefer to hold long-term |
Indexing has been made possible through increased market efficiency. It is harder
for investors to outperform the market by picking stocks when the market is matured
or efficient. Information is easily available and price abnormalities can be arbitraged
away. In other words, since securities prices reflect all the available information,
finding overvalued or undervalued stocks can be difficult.
In the U.S., one of the most matured markets in the world, active managers have found
it increasingly hard to outperform the broad market benchmark since the late 1980s.
Studies have shown that over time, the broad stockmarket index have outperformed
most general stock funds.
Over the past years, S&P 500 has beaten more than 70% of the actively managed
mutual funds largely due to the impressive returns of large-capitalized stocks. There
are however some years when the Index failed to outperform half of the mutual funds.
Nevertheless, on a broader scale, the indexís performance looks generally more impressive
than actively-managed funds (refer to Chart 1).
In the U.S. and U.K. where indexing dates back to the mid-1970s, about 25% and
20% of the pension money respectively are invested in index funds.
|
