What is indexing?

 

Indexing is a passive investment strategy that attempts to track the returns of a specific market index as closely as possible by holding all or a representative selection of securities in the index.

 

Indexing as a zero-sum game

The zero-sum-game concept helps explain why indexing can be an attractive investment strategy for your clients. The theory states that at every point in time, the holdings of all investors in a particular market in the aggregate form that market. If one investor outperforms the market, another investor must underperform. Once costs are subtracted, though, it becomes increasingly difficult to beat the market. These graphs help tell the story.

The efficient market hypothesis (EMH): A rationale for indexing

EMH was developed in part by U.S. economist Eugene Fama. The theory argues that it's impossible to beat the market through stock selection or market-timing because stock prices already reflect all relevant information. Therefore, buying and selling securities with the intention of outperforming the market is purely a game of chance.

Most investment professionals—including devoted indexers—do not fully subscribe to the theory of efficient markets. Instead, they believe that there are some inefficiencies in markets where value can be added, despite the many obvious advantages of indexing. However, it is important to note that the zero-sum-game theory applies in all markets, even in efficient ones.

All investing is subject to risk, including possible loss of principal.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

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