Indexing, an outgrowth of recent developments in portfolio management, seeks to buy the “indexes”.
Investors either buy all of the components, or a basket meant to emulate an index, in an effort to achieve similar returns to popular measures as the Dow Jones Industrial Average.
Instead of actively buying and selling stocks, trying to get in during the good times and sell out before the market goes down, this strategy buys an index and then just rides it, during both the good times and the bad.
As such indexing is considered a passive strategy.
Αlso, instead of researching stocks, looking for unknown advantageous information, indexing simply takes a basket of stocks in an effort to profit from the overall economic growth instead of individual stocks.
Indexation is an approach that argues you can not beat the market, and you should merely invest in the market.
Individual stock selection, with this approach, cannot and will not outperform the averages overtime.
This approach argues that investors can not beat the market overtime and even if their returns are roughly equivalent, transaction and management costs of actively managed money, will create lower results.
The indexer feels it is better just to buy an index fund and relax.
Additionally, the costs of active management can be considerable while indexing costs are minimal.
Over a period of time, the indexes have produced great returns.
You are spared the roller coaster of individual stocks and particular sectors that fall out of favor.
Stocks and sectors with very high betas (they move in percentages greater than the overall market), will make the ride in individual stocks and sectors particularly breath taking.
For those that can’t stand the heat of volatility and unexpected air pockets, but nevertheless find it appropriate to be in equities, indexing may be the ideal solution.
Additionally, recent evidence suggests the Indexes have outperformed the vast majority of actively managed money.
Indexers view the market as a perfect discounting mechanism, digesting all available information and determining the proper valuation.
Beating the market is therefore an impossibility, unless one has a crystal ball or inside information!