Why you should invest in index rather than stocks?

Getting an investment right is often a matter of luck, but most of the time, and resulting in an average of all investment decisions in the medium/long term, most of the time the return obtained is a matter of a well-planned investment strategy.

Investing in stocks, or their collective equivalents such as mutual funds, requires time, knowledge and dedication; at least so that we know with some guarantee what we are investing in, and whether we really have options to see a juicy return in the form of revaluations. But there is another option that, although it may give lower returns than some stocks in particular, offers a much safer return, at least 100% safe from bankruptcies or corporate extinctions. The option is to invest in indices.

Any investment decision requires a thorough analysis: if not, it is better to go to the indices
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Statistically, for most people, it’s not usually good investment decisions to make when you use the heat of a bubble. Neither are those who simply have the money raising dust (and other people’s profits) in the bank account. And while it is true that each type of investor at each moment of his life has some needs for his savings, which must be translated into a different way of investing them, it is no less true that in the markets, the safest return is in the long term. Security is out of gold fevers that leave more and more victims than the new rich, and requires taking the time to analyze every balance sheet, every company, every market.

But not everyone has the time (or the will) to scrutinize every accounting entry of listed companies that are a potential investment destination. Something similar happens with investment funds that often also require in-depth analysis, at least to know if they are well managed and if their management style is adapted to our needs. Focusing on analyzing for that average investor, with no time or knowledge to analyze beyond a few minutes a day, we always have the indices there.

And how to invest in indices? Well, the truth is that to invest in an index as such, the best option is the quoted funds or ETFs that replicate them. This financial product, which revolutionised the investment market a few years ago, combines very low management fees, real-time trading such as shares, and dividends. Indeed, in addition to today’s topic, index ETFs are an exceptional formula for optimizing the profitability/effort+time equation.

In order for profitability to come to your statement of securities account, all that is needed is for the index to take the bullish path. On this last point in particular, which is the crux of the matter in the end, we can only recommend in general terms that you frequently read serious salmon halves like us, so that you can measure the pulse of the market at any time you need to make an investment decision.

Well, there is an empirical basis for this, but always under the previous premises of needing an investment formula that optimises this exchange of profitability/effort+time. Because obviously, a good investment in the shares that are most revalued in the market will always yield more returns. After all, indices are only a weighted average of the shares that make up the index, and mathematically there will always be stocks with a higher return than the index, but don’t forget: there will also be as many stocks with a much poorer return as the selective (and not selective) ones.

What is more, there will be stocks (and even whole companies) that will disappear from the face of the markets, resulting in a sinister balance sheet of 100% losses for the hardest-hit and most suffering investors. And that is precisely where we would like to focus on today’s issue: it is precisely by investing in indices that you are completely safe from this fateful (but not infrequent) event of corporate deaths.

And to return to the question that led to the last title: yes, there is an empirical basis for affirming that indices are the best neglected investment formula. The empirical basis requires a somewhat lengthy analysis of the life cycle of a selective index. And although we really need a senior index for the temporary sample to be somewhat rigorous, the results are going to be equally worthy of consideration.

The crises we are talking about may no longer be so fresh in popular memory, but I can assure you that both of them have been very dramatic for our socioeconomy (I hope you will at least keep the last one in mind). We are talking about that”.com” crisis that devastated the markets, and the most recent and terrible Spanish real estate crisis.

In the first of these debacles, the”.com” crisis, we must remember how there were prices related to technology that rose like a real rocket: Telef√≥nica was the first of them, despite being a giant. But there were other protagonists in this disaster. Due to the size of our domestic selective, we can only speak of one of these”natos.com” players, unlike other markets such as the US and its large NASDAQ.

This”nato.com” star is Terra, the unsuccessful company that led the.com bubble in Spain, and which even surpassed ENDESA in terms of market capitalisation with hardly any assets and little more than a generic Internet portal. The company, once the flagship of the new economy, was de-listed in 2005 with a 98% drop from highs, and having volatilized the savings of countless small investors. However, the Ibex-35 is still there.

The other major crisis that the Ibex-35 has survived with revenues is the already”fresh” Spanish real estate crisis. Due to the generalization of the bubble within the Spanish economic reality, in addition to the always important relative weight that the construction sector has had in the economy of Spain S.A., in this case we have many more protagonists. The star of this bubble was the vibrant real estate bubble Astroc, overheated where they were, but that gave yields that seemed to be the result of a rocket that was never going to stop rising (like the price of flats). But it ended up going down (and how they did it!), just as some of us predicted.

Astroc’s travel companions were most (if not all) of the rest of the construction and real estate companies. After years of drought in the real estate market, there have been several victims. Disappearances, bankruptcies, mergers for survival have populated the sector of both listed and unlisted companies. Companies such as FCC, which was once a business example of management and profitability, have ended up impoverished and in a situation of weakness, which has taken them out of the selective market in one way or another.

We have analysed the national case of the Ibex-35 because we have to do so, but this temporary sample we spoke of earlier, in the case of our relative Ibex-35, does not meet the minimum standards of statistical rigour that some of us demand of ourselves: it is too young an index. In fact, as I was saying, the Ibex-35 as such saw the light back in 1992, which distances us from its creation for a mere 26 years.

This is really not much in relative terms when compared to longevity and business lifecycles, nor for the average return cycle for savings accumulated over a full working life. The point is that this comparison is so fair in timing that it does not allow for a more extensive comparison, so that cyclical and/or random market and economic events can be ruled out. And it is precisely today that we are dealing with the issue of investment in the long term, with a time horizon of a working life.

But the”truncated” sample of the Ibex-35 becomes revealing in other more senior selectives
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Fortunately, we have around us other indices with more history than ours, and which are listed in an economic system very similar to the European and Spanish ones. Indeed, I’m talking to you about Comrade Dow. The DWIJ, or Dow Jones Industrial Average, is a selective that was created at the end of the 19th century, more specifically in 1896. Apart from the fact that it is undeniable where the cradle of popular capitalism lies, it is interesting to analyse those 12 companies that were included in the index at its launch, and to know what has happened to them today.

Business Insider recently did this informative analysis exercise in this article. As you may have seen, and as expected, the economic and business reality shown by the analysis of the composition of the index smells like naphthalene. And it is entirely logical, since that original Dow reflects a socioeconomy of almost 125 years ago. This is indeed a truly historic composition. But let’s move on to today’s analysis, and see if it would have been more appropriate to invest in the index, or in stocks, in this sample period.

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