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Why Value Indexing?

November 13, 2010 Leave a comment Go to comments

In the 4 years that I’ve been studying investing and managing my own investments, indexing has always been the approach that stood out for me. It helps an investor avoid some emotional mistakes, but it can still expose you to downturns as other investors shift from one end of the emotional spectrum to the other. As it gets more popular this is likely to be magnified. No one can predict every downturn. What you can do is decide if a market’s price is unusually high or low and invest accordingly. If you flip this around this means looking at the earnings or yield of an investment, which is what any good investment decision should be based on.

The main purpose of my approach is to make indexing a bit smarter. I would prefer to have index funds instead of actively managed ones, but many people who talk about indexing don’t make any attempt to decide if the market as a whole is a worthwhile investment. If that’s beyond your level of understanding you shouldn’t try it, but I believe it is possible with the right knowledge. Most investors don’t just buy one asset class so they need to decide on an allocation between many options. That’s where the Value Indexing approach comes in.

As my introductory post states, my aim is to follow market indexes while adjusting my exposure to individual investments based on whether I find them attractive. In the long run I believe that stocks in developed countries will provide reasonable returns, while bonds will largely avoid losses. Without trying to choose individual stocks I can decide which markets are more attractive at the moment and shift more assets there. This usually doesn’t mean large changes; it would take an extremely high valuation to force me out of stocks entirely and I would prefer to make a gradual change over several years instead of putting everything into cash one day.

In the long run I hope that this approach allows me to enjoy indexing while avoiding a few of the bigger and more visible risks. This means a slightly lower chance of big losses, and potentially slightly higher returns over time. It may not be very much but I can take pleasure in avoiding excessive speculation even if I don’t get a big reward for it.

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