Over the past three decades, index-style investing has moved from the fringes to the mainstream, with an estimated $3 trillion now committed to this simple strategy -- to match broad market returns and give up as little as possible to fees and taxes.
Clearly, indexing has served investors well and is here to stay. But can it be made even better? Wharton finance professor Jeremy Siegel thinks so. The standard index, which gives more weight to stocks of bigger companies, should be replaced by "fundamental indexing" that assigns each stock a role based on factors like corporate sales or dividend payments, Siegel says. "Capitalization-weighted indices are no longer the best ones for investors. Fundamentally weighted indices will give you superior risk and return characteristics."
But many index-investing experts are unconvinced. "I don't believe in new paradigms," says John C. Bogle, founder of the Vanguard Group mutual fund company, which specializes in traditional index investing.
Traditional indexing allows investors to easily match the overall market's performance, and new schemes are destined to run afoul of the law of averages, which says it's near impossible for any investing strategy to beat the broad market's performance over long periods, according to Bogle. Any short-term advantage offered by fundamental indexing would be negated by higher operating costs that come out of investors' pockets, he argues.
Debate about tweaking indexing investing strategies simmers most of the time. But it heated up recently as Siegel and Bogle squared off in dueling op-ed pieces in The Wall Street Journal.
In a June 14 piece, Siegel argued that traditional indexes such as the Standard & Poor's 500 suffered from too much market "noise" -- price distortions caused by speculation, momentum investing and other factors. Investors could get higher returns, with less risk, using indexes built upon stocks' fundamental values, such as dividend payments, he said.
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