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Which Index to Choose

Two trends that are supposed to hold over the long run are that small caps beat large caps and value beats growth. Naturally, there is lots of disagreement over why those trends should be true, or whether they are likely enough to hold in the future that you should weight your portfolio accordingly.

Over the short run practically anything can happen, and different indexes can be wildly out of sync in ways that can't be predicted or explained. These numbers show what happened during the recent bubble and de-bubble:

 

Annualized Returns, 1997-1999
ValueGrowth
Large Cap 18.88% 35.52%
Mid Cap 12.91% 31.26%
Small Cap 10.10% 12.26%
Annualized Returns, 2000-2002
ValueGrowth
Large Cap -9.50%-19.60%
Mid Cap 7.18% -6.71%
Small Cap 5.35% -5.60%
S&P/Barra Indexes

 

Note that the large growth stocks that did best during the late 1990s crashed the hardest afterwards. You can also imagine how lots of people holding value stocks during the boom felt like chumps for missing out on the easy money and switched to growth stocks in early 2000... just in time to get clobbered again. (That brings up a couple of old lessons. Whatever portfolio you choose is practically guaranteed to be a dog occasionally, sometimes for several years in a row; it's best to come to terms with that ahead of time so you won't need to panic when the inevitable happens. And if you're looking for safety, you probably want to think in terms of diversification, rather than sector-hopping.)

Also notice that mid-caps did freakishly well during this period - which is no guarantee that they will keep doing well in the future. (That's another old lesson: patterns you spot from recent experience may not be part of any reliable trend.)

So the key isn't finding the perfect index, so much as building a sensible and diversified portfolio, and then vowing to keep calm whatever the market happens to do.

 

Article Contents
Index Basics
Size, Growth, Value
Turnover
ETFs
Dangers of Timing
Portfolio Guidelines (1)
Adding Small & Mid
Adding Foreign Funds
Portfolio Guidelines (2)
List of Funds & ETFs
Books & Links

Article Contents
Why Index?

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