Indexing in Investment Strategies and Behavioral Finance Essay examples

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The aim of this report is to evaluate and validate passive investment strategies and advantages of having index funds in the portfolio. The importance of passive investment strategy is initially justified with the help of theory on efficient markets. The report then provides evidence that indexing still is a vital aspect of investment strategy and is not influenced by the efficient market theory. The report also gives a brief overview on how investors utilize indexing to minimize transaction cost by replicating the market index in their portfolio. Further, the success of indexing in US, UK and bond markets is highlighted with the help of evidence from past research on passive investment strategies. The later section of the report provides …show more content…
A common practise involved in passive management is indexing. Since our security markets are exceptionally efficient in digesting and adjusting to new information, indexing can prove to be very sensible strategy (Malkiel, 2003). An important issue faced by most of the investors are the transaction fees and other operating expenses. The investors have to pay special attention to these expenses because they can have significant effect on the returns of the investor. John Bogle, founder of Vanguard an investment management company estimates that 2.5% points incur as expense for actively management funds; when all expenses are properly accounted for (Jones, 2009). Obviously, that strongly contrasts the expenses incurred by the index funds which perform as well as the actively managed funds. This is because the index funds imitate the performance of a broad-based index of stocks (Bodie, Kane and Marcus, 2006). The best example for index funds is Vanguard’s Index 500 fund which holds stocks in proportion with the S&P 500. Thus index fund enables an investor to hold a diversified portfolio with minimal management fees. The fees can be kept minimal because Vanguard does not have to pay the analyst to monitor the stocks and does not incur transaction costs from high portfolio turnover (Bodie, Kane and Marcus, 2006). To support the above argument further, Malkiel (2003) in his study proves the efficiency of passive management not only in

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