What is index investing?
In short
Index investing is a passive strategy in which you use a single purchase to follow an entire stock market index (such as the AEX or S&P 500), with the goal of achieving the average market return. You simply buy the whole market: both fundamentally strong companies and the very expensive, overvalued hype stocks. Because index investing does not make selections based on price or quality, and therefore offers no safety net during market crashes, we at Mpartners consciously choose a grounded, selective value-investing approach.
Index investing is a form of passive investing in which you do not try to beat the market, but simply track an existing stock index (such as the AEX or the American S&P 500) exactly. You buy a basket containing all the shares in that specific index, so your performance is always an exact reflection of average market sentiment.
How does Index Investing work exactly?
Where an active investor performs fundamental analysis to pick the best opportunities, an index investor takes a passive approach. This usually happens via an ETF (Exchange Traded Fund) or an index fund. If the S&P 500 index rises by 2%, your investment rises by 2%. Does the index fall by 5%? Then your portfolio also blindly falls by 5%.
With this method, no attention is paid to the intrinsic value of individual companies. A computer or algorithm simply buys the shares in the same proportion as they appear in the index. So you ride along with the overall growth of the economy, but you are also completely at the mercy of daily market sentiment.
Index Investing in Practice
Most major indexes are 'market-cap weighted'. This means: the higher a company's share price and market value, the heavier that company weighs in the index.
Suppose the market becomes obsessed with a handful of tech companies. The share prices of these companies skyrocket and they become heavily overvalued. Because their market value rises, they take up an ever-larger place in the index. As a passive index investor, your money is automatically put into these overvalued companies at the absolute peak price. Instead of buying low and selling high, the index structurally forces you to keep buying the most expensive shares.
Opportunities and Risks
For the beginning retail investor with limited capital, index investing certainly has advantages, but for substantial wealth management it comes with significant blind spots:
Opportunity: Low costs and convenience. Because no expensive analysts are needed to assess companies, the management fees of index funds are very low. In addition, you are broadly diversified in one go.
Risk: You buy the bad apples. When you buy a haystack, you also buy the weeds. You are forced to invest in companies with sky-high debt, failing management, and shrinking markets, simply because they are in the index.
Risk: No Margin of Safety. If the market is irrationally expensive, then as an index investor you are too. There is no financial buffer (margin of safety) built in to protect your capital against a severe market crisis.
Mpartners' vision: no standard index
At Mpartners Vermogensbeheer, we firmly believe that successful management of larger assets (from € 300,000) is all about risk management and capital preservation. That is why we consciously do not engage in index investing.
As Value investors, we refuse to blindly follow the market. We want to invest only in quality companies, and only when they are available at an attractive discount. Index investing forces you to participate in every market hype and accept every overvaluation. We prefer to use common sense. By actively selecting shares based on their fundamental value and long-term resilience, we avoid the value traps and overvalued hype stocks that fill the index. That gives our clients peace of mind, clarity, and protection against unnecessary risks.
Do you choose to blindly follow the crowd, or for a sober and thoughtful policy? Contact us to discuss how we can protect your assets through active value investing.
