Why it May be Preferable to Invest in Indices Instead of Stocks
Getting an investment right is often a matter of luck. But in most cases, and as a result of an average of all the investment decisions in the medium/long term, most of the time, the profitability 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 what we are investing in, and to truly have expectations of a juicy profit. But there is another option that, although it may give lower returns, offers much safer performance, at least 100% safe from sudden bankruptcies, or business extinctions – Indices.
Every investment decision requires a deep analysis: if not, it is better to go with Indices
Not everyone has the time (or the desire) to scrutinize every accounting note of listed companies that are a possible investment destination. Something similar happens with investment funds that often also require a deep analysis, at least to know if they have good management, and if their management style is suited to our needs. That i why we always have indices.
And how do you invest in indices? Well, the truth is that to invest in an index as such, the best option is the exchange-traded funds or ETFs that replicate them. This financial product that has already revolutionized the investment market a few years ago, combines very low management commissions, real-time trading such as shares, and also distributes dividends. Actually, in addition to today’s topic, index ETFs are an exceptional formula to optimize the profitability / effort + time equation.
But there is empirical basis to be able to say that the indices are the best investment formula
Well, the empirical basis has been there, but always under the previous premises of needing an investment formula that optimizes that exchange profitability / effort + time. Obviously, a good investment in the stocks that revalue the most in the market will always yield more profitability. At the end of the day, the indexes are only a weighted average of the stocks that compose it, and mathematically there will always be stocks with a higher return than the index, but do not forget it: there will also be as many shares with a return much poorer than the selective (and non-selective) index.
Moreover, there will be stocks (and even complete companies) that disappear from the face of the markets, throwing a sinister balance of losses of 100% for some investors. And it is precisely there where we would like to influence the issue of today: precisely by investing in indices, you are totally safe from this fateful (but not infrequent) event of business deaths.
And yes, there is empirical evidence to affirm that the indexes are the best formula of unattended investment. The empirical basis requires a somewhat extensive analysis of the life cycle of a selective index.
And although we really need a senior index for the temporary sample to have some rigor, the results are going to be equally worth taking into account.
The Dow Jones
We need look no further than the Dow Jones Industrial Average, created in 1896. Apart from the fact that it is undeniable where the cradle of popular capitalism lies, it is interesting to analyze those 12 companies that became part of of the index in its launch.
Business Insider has already recently done this illustrative exercise of analysis in this article. Indeed, this is a truly historical composition. But let’s go to the topic of today’s analysis, and see if in this sample period it would have been more appropriate to invest in the index, or in stocks.
The companies originally listed in the Dow are as follows: American Cotton Oil Company, American Sugar Company, American Tobacco Company, Chicago Gas Company, General Electric, Distilling & Cattle Feeding Company, Laclede Gas Company, National Lead Company, North American Company, Tennessee Coal Iron and Railroad Company, US Leather Company, United States Rubber Company. It was the reflection of an agricultural economy, of raw materials, and industrial ones as well.
As you can guess, few (or almost none) of those companies are still part of the Dow Jones, with the honorable exception of General Electric. The others have either been absorbed, merged or have passed to the business obituary section (read: bankruptcies) after their death.
That is why we do not see in the current Dow almost all those components of the Dow back in 1896, although it is not a guarantee that those companies have disappeared 100%, it is not at all guarantee that the share value of its small shareholders has been preserved. And of course we must also mention that, although some companies have been able to survive under another name or business umbrella, simply the mere fact of having left the selective Dow Jones at the time is almost certainly synonymous with large losses of shareholder valuation.
Of the companies listed in the Business Insider article, only one has survived – General Electric.
As you have seen in the detailed analysis before, only one of the original members has survived with minimal guarantees of revaluation higher than the index itself. The rest, really, have either ended up in a company that has come down (or come to nothing).
On the contrary, the Dow has always been here. Companies are removed and replaced by a new, more powerful company, it also supposes a survival guarantee for the participant that invests directly in the index, and a guarantee of profitability (or of non-losses) for your savings.
Therefore, if you need to invest your savings, but do not have the time or knowledge to do it with proper supervision, the best option of unattended investment and with certain guarantees of profitability clearly above the most conservative investment options, is to invest in ETFs.