Research from academia has shown that while indexing is an excellent way to invest, the research didn’t stop with the advent of index funds. It has continued to this day and we know that there are certain kinds of stocks that appear to have higher returns than other kinds of stocks.
DAVID BELINKIE: Hello, I'm David Belinkie, a financial planner here at Spaugh Dameron Tenny. I'm joined today by Pat Sweeney, partner and co-founder at Symmetry Partners.
PAT SWEENEY: Hi, David.
DAVID BELINKIE: Welcome.
DAVID BELINKIE: Symmetry is one of the partners we work with to provide you with diversified portfolios. So, Pat, can you tell me more about why we shouldn't just invest our clients into a fund that tracks the S&P 500?
PAT SWEENEY: Well, the S&P 500 is an index or a basket of stocks that tracks the price movements of the let's just call it the 500 largest companies in America. And that's a good place to start. But it's one asset class. It's just one small segment that's part of a global market.
So investors should consider there are large company stocks in Europe, in Asia. There are companies that are merging markets. And they all do the same thing. Essentially, they all offer a percentage of their profits to shareholders. So why would you just stop at large companies in the U.S.? It's just one sliver of a very large pie.
DAVID BELINKIE: I guess my question Pat, would be, So what? It seems like it's it's a great place to be.
PAT SWEENEY: The S&P 500 has been an excellent place to be for the past several years. But if we look back over a longer time period and any investor in stocks should consider 7 to 10 years or more, as a financial planner, I'm sure you would agree that the short term really doesn't mean a whole lot, right?
So if we look back from 2000 to 2009, we saw that the S&P 500 had a 0% return, actually slightly negative. So diversification is important, but we don't know what market is going to lead when. So we want to have exposure to international stocks, both large and small, emerging market stocks, large and small, as well as U.S. stocks, because we never know what the best place to be in the world will be.
U.S. companies have led lately. They've been leading for quite some time. This is a bull market when stocks have been going up. And this is a market that's kind of long in the tooth. So we don't know how much longer it's going to go on. Diversification is there for when any market goes into a correction or a bear market. Something else in the world should be doing better and that'll boost your returns in the long run.
DAVID BELINKIE: That's a great point. And we certainly do believe in historical performance and diversification. I guess the next question I would ask is then why not just invest in a diversified portfolio of index funds?
PAT SWEENEY: Well, that's certainly a good place to start. I think indexing, simply buying mutual funds that track those baskets of stocks, is a great place to start. Costs are low. It tends to be a tax-efficient way to invest. So it's a great place to start. But the research on indexing goes back to really the late 1960s, early 1970s, and the first index fund was launched in the early seventies for a big institutional pension plan. New York telephone, I believe. And so this research has been around for a long time.
And to simply say, well, why don't we just use index funds is really looking at it as though the research stopped a long time ago and it hasn't. In fact, it's continued and it's been expanded upon to the point where we now know that there are ways to index that are an improvement upon the original indexing.
DAVID BELINKIE: That's very interesting. Thank you for sharing your thoughts on diversification with us.
PAT SWEENEY: My pleasure.
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