Tag: Indexing

The Risk Factor – Buying Index v/s Equity

On 16/03/1980, Joe the baker and Jack the carpenter invested in the stock market. Jack bought S&P 500 Index. Joe, on the other hand, thought that index investment is boring, and buying diversified equity instead would give better results, so he bought the stocks.

There is a prevalent notion that Index funds are static and boring. True, they don’t fall prey to sentiment movements and behavioural biases, but they are far from being static. Let’s look at S&P 500. On an average, 22 stocks in the S&P 500 are replaced every year. Stocks may be deleted due to reasons like Mergers and Acquisitions, or change of Headquarters outside of U.S, or if the stock is viewed as a “problem stock” – ie, the stock is not financially viable. Since 1980, over 320 companies were deleted from S&P as ‘problem stocks’.

16th Mar
So, what happens to our friend Joe the baker’s investment today, is that, at least more than half of the stocks he had bought, are not in the Index anymore. Also, a large number of his investments have either turned to losses, or performed substantially lower than the index.More than half the companies which were a part of S&P 500 in 1999, are no more included in it today. This means, that the makeup of indexes like S&P 500 are constantly evolving.

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