What’s Wrong with Indexes
Indexes, by design, have major flaws that make them suspect as truly representative of much of anything.- People decide which stocks to include and which to remove and people make mistakes. So, sometimes stocks are included that shouldn’t be and stocks are removed that shouldn’t be; and so on.
In addition, this process repeats year after year, so it is hard to look back and compare the S&P 500 of 1995 with the S&P 500 of 2004.
- By weighting the indexes (except for the Dow) by size, disproportion representation goes to large or giant companies. If one of them has a bad day, it can shake the whole index.
What Should we do with Indexes?
There are a few things investors need to remember about the indexes:- Indexes are not the market. No matter what the big three indexes say, you should stay focused on your stocks or targets for evaluation. Pick any day that all three indexes are down and I can almost guarantee that there will be stocks setting new highs the same day.
- Indexes react to actual trades. If you listen to some of the TV talking heads, you might think the indexes move on emotion.
Investors may trade on the expectation of good or bad news, but indexes are mathematical calculations, not tea leaves.
- Focusing on day by day, hour by hour, minute by minute clicks of an index is a good way to waste time.
- Indexes provide a better historical perspective than forecasting service. They can be especially helpful when viewed over a long period in spotting trends.
