I would consider it an index but as you note there are quite a few shades of gray. Personally, I wouldn’t care for it because I think it doesn’t have a lot of the properties that make indexes good. Namely,

(1) A very small selection of stocks so there is not much diversification against specific company risk. The average stock in the dogs index would be about 10% of holdings — compare to VV with 755 stocks and single largest holding of 2.9%. Why not define a large-cap high yield index with hundreds of stocks?

(2) High turnover.

(3) The origin of the index smacks of excessive data mining (i.e., the discovery is subject to publication bias) to look for excess returns.

Totally agree with this. Owning many stocks only diversifies you against specific company risk (like the CEO and CFO committing financial statement fraud). It doesn’t necessarily diversify you against risk that are common to an entire country or sector (i.e. you have to watch for common mode failure).

“If a large group of people decide to go with the same vector function, you wouldn’t say they were diversified”

I think it depends on how that vector would respond to different risks that might be encountered. So they may or may not be diversified. Also as Large approaches the total population, then there may be distortion but I don’t think we are near that level.

I guess my main issue with the index approach is the implied statement that
1) It is impossible take advantage of inefficiencies.
2) There are no inefficiencies because smart people eliminate them.

This can only be resolved by
3) I’ll never be the smart one nor will I ever figure out who is.

Maybe that’s fair enough and why it’s being pushed to the retail/401k investors.

The Dogs of the Dow is simple: “Equal positions of the 10 highest yield Dow components.” Is that an index?

I agree that there is a whole continuim and you’re right that even the S&P500 index, is chosen actively. But I see the main difference as whether you believe that the markets is pricing the underlying securities fairly and hence the best strategy is to own everything in that asset class (to eliminate individual company risk) OR you believe that some stocks are mis-priced and that you can gain increased return at no additional risk.

From a practical perspective, I think if it takes you more than a few sentences to describe your portfolio with enough detail to replicate, it’s not really an index. For example, my micro cap index might be invest in all publically traded US stocks with market cap less than $500 Million dollars. Short and simple.

It’s not about what’s in the portfolio. It’s about how many other people behave in exactly the same way. That’s true diversification. People still believe they can diversify by holding different stocks because everybody used to be value investors or trade in single stocks.

This is no longer the case.

So the model breaks down.

Yes?

At what point does it stop being an index? In my opinion the scale from including a stock according to cap or price to ratios like P/B or P/E to dynamic models like TTM values or RSI, that kind of stuff, and ultimately to human brains is continuous.

The only reason there’s no “human brain” index is that the Artificial Intelligence index hasn’t been invented yet.

Maybe we need a well-defined definition of what an index is? Is my portfolio an index? How does it differ from the S&P500? The S&P500 is chosen by a committee. The DJIA composition is chosen by the Wall Street Journal, right? (or some other financial publication, I forget).

Here’s an idea for a truly diversified index.

Every investor gets assigned a unique key that determines his portfolio. Nobody else will over that. Overall such a key could be designed so that nothing is correlated. This would be the ultimate in diversification.

My point remains:

Owning many stocks .NEQ. diversified!

That assumption does not account for systemic feedback effects. Hence, it creates an inefficiency. Sorry if I keep harping on this, but the results are exactly what we saw during 2008/09. There was nowhere (okay a few places) to hide despite the supposed diversification.

I definitely believe in the FF three factor model, but actually I think many (most?) of the people following it are indexers. I count myself in that category. But I don’t think Fama would say that you are “beating the index” and outsmarting an efficient market but rather you are investing in riskier stocks.

If you are a value investor, the index you should be comparing yourself to is something like DFA large cap value (DFLVX), DFA small cap value (DFSVX), or the MSCI indexes depending on how small/valuey you go. The S&P 500 is in my mind not an appropriate benchmark.

Would love to see the results of a real, reviewed, and validated study showing the value of “brains”. Haven’t seen one yet (except those put out by industry with intentionally flawed methodologies) but I have seen lots of studies with evidence that the impact of “brains” isn’t distinguishable from random.

What I’m trying to get across here is that an index is just another kind fund. The only difference is that it has a low fee and no brain.

So the real argument is whether brains are worth a fee and if so how much. I definitely believe it’s possible to trade against the index funds. I posted an example in a recent comment.

Okay, I certainly haven’t seen your source… but I’d double check that. When I’ve seen indexes compared over time to other funds — it was the fees that actually made indexes come out on top.

The systemic effect of this is that most asset classes are now correlated. Diversifying from 1 to 100 assets isn’t worth much if those 100 assets behave in pretty much the same way as the first one.

Because my money is in separate funds, I can sell whatever’s high when I’m withdrawing (sort of re-balancing via withdrawal).

I do have a few individual stocks, but don’t have any confidence that what I think is good is any better than average.

I’m dollar-cost averaging right now, but my extra money’s going to paying off my house (for a guaranteed effective interest rate of 5.63%). I hope that by the time that’s paid off in a year or two, something out there will seem like a bargain. Stocks don’t seem all that cheap to me right now, and bonds, CDs, and savings accounts are all jokes.

@retirebyforty – since you have the numbers, try assuming that you retired on the starting date and instead took out $100 each month. What would be the result of that? What you’re really arguing for here is dollar cost averaging; not indexing per se.

Hi, I downloaded the historical price of VFINX from July 1 2008 to Oct 1 2010. If I put $100 in on the first day of every month. I would have spent $2800 and have 30.65 shares which is worth about $3400. That is a 21% gain so I don’t see a problem with index investing if we combine with cost averaging. Perfect for 401k.

But I don’t think it is fair to criticize indexing for the weaknesses of the Buy-and-Hold strategy. Indexes provide huge diversification at a tiny cost. What’s not to like?

It’s entirely possible to index without engaging in a Buy-and-Hold approach. That is, you can invest in an index but lower your stock allocation when prices rise to insanely dangerous levels.

I agree with the Charlie Munder comment quoted above. Buy-and-Hold Investing is Get Rich Quick Investing. All rational investing strategies consider value propositions. There is no reason why indexing cannot be done intelligently. People mix indexing and Buy-and-Hold/Get Rich Quick together because Bogle pushes both concepts heavily. He’s right to push indexing. He’s wrong to push Buy-and-Hold/Get Rich Quick.

Rob