May 25, 201609:08 PMFinancial Perspectives
with Michael Dubis, CFP
When does indexing investments require caution?
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I’m a big fan of index funds. I prefer lower-cost asset class funds (similar to indexes, but more surgically structured to target factors or asset classes), but let’s not nitpick here. Today, the investment world well knows the value of indexing.
Index funds are generally mutual funds or exchange traded funds constructed to match the components of a market index such as the S&P 500, EAFE, or Aggregate Bond Market (among literally dozens if not hundreds more).
Index funds are generally very low cost, relatively tax efficient, fully transparent, easy to understand, and easy to allocate among portfolio holdings, including diversification.
Index funds, generally by design, over-weight the most “valuable” or “largest” companies. This can be good because the most valuable companies can sometimes be the best performers, as well (it’s a circular reference).
This can also be a time for caution because in bond indexes, for example, the most indebted nations or companies can make up the largest allocation in the index.
Today, that’s where some index funds have gotten concerning. Case in point: international bond index funds.
International bond investing has strong supportive evidence of diversification benefits, but if you haven’t read the financial news of late you might be surprised to know that — today — many foreign developed countries are actually paying “negative” interest rates. In other words, investors are paying to hold money! Yes, you read that correctly.