Wednesday, January 20, 2010

Strategies for the successful investor part 6 :Index the market

Like i said in my previous post trying to outperform the market is a waste of time. The way to go is through index fund or mutual fund since it is rare that someone can outperform the market consistently.

So what would you do if you are investing in traditional assets like stocks and bonds. You have to try to index the market.

What you should do is to invest in companies that are of different sectors of the economy. You will thus select a number of different companies to invest in. What you would do is to add the market capitalisations of all the companies that you want to invest in.

Then if you want to invest in a company X you will have to invest  money in company x acording to the equation below

Money invested = (Market capitalisation of x/total market capitalisation) * money that needs to be invested

You might want to create a spreadsheet to help you determine how much to invest in each company.

Now the indexing will not be similar to a professional index fund but it will approach it if you

1. Choose a large number of sectors of the economy to invest in such the companies you invest in will make your portfolio representative of the economy.

2. in each sector of the economy that you invest in you select a few companies that will be representative of that economy. You will thus invest in a series of mega cap, large cap and small cap companies.

Similarly you will invest in bonds such that you will invest in securities with a wide range of maturities and issuers. Hence your bond portfolio will be spread across municipal bonds, corporate bonds and government bonds. You will also have to invest in the money market and capital market bonds so as to spreads your exposure to different maturities of bonds.

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