Understanding Index Fund - 2
By Saghir Aslam
Rawalpindi, Pakistan
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the ummah will benefit from this effort through greater financial empowerment, enabling the community to live securely with dignity and fulfill their religious and moral obligations towards charitable activities)
In the beginning, index funds were weighted by the market capitalization of the stocks comprising the index. When that resulted in some of those indices being overinvested in pricier stocks, people started coming up with alternative weighting factors, such as revenue and valuation, in the hope of preventing investors from being concentrated in the most expensive stocks.
Passive or active management?
Proponents of index funds and passive management principles generally argue that over time such funds, which reflect the market sentiment, will outperform an actively managed fund. Others have the opposite sentiment.
"Some people would have you believe that active management is the only way to go.”.
"They spend a lot of time looking for the right active managers."
But active management is controversial. It's typically more expensive than an index fund because it requires more work on the part of active managers. Expense ratios are typically higher for active-management funds, meaning that beat an index, it needs to outperform it by more than the difference in operating expenses.
Many investing theorists believe active managers can't consistently match or beat broad market return rates, especially after factoring in fees.
But there may be many cases where active management works out better.
"When you step away from large caps, which would include the bulk of the companies in the widely known S&P 500, and venture into areas such as small-cap stocks or emerging markets where individual security information isn't as readily available and may require more research, you start to see where value is really added by active management in some of these areas of the market.”
In terms of investor options, index funds for equities are still far ahead of those available for debt.
Simply investing in low-cost, passive index funds even inefficient asset sectors such as the US large-cap stocks - isn't a solution to all of your investing needs.
Instead, work with your advisor to craft your portfolio and determine your asset allocation based on your investment goals and risk tolerance. Just as you wouldn't want to only own one equity, you may not want to solely rely on one strategy — passive or active.
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, or does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr Aslam does not have anything for sale.)
