I’ve posted Entry #172 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Most Investors Should Be in Index Funds, But Not for the Reason Usually Given.
Juicy Excerpt: Fund managers face enormous competitive pressures not to pick the stocks with the best chances of performing well in the long term for their funds. That’s why most fund managers do not pick stocks effectively. Fund managers are not paid to produce results for their investors. They are paid to sell shares in their funds. The actions that generate sales are very different from the actions that produce good long-term results for investors.
Imagine that there are two stocks that a fund manager can add to her fund. Stock A has been doing poorly for five years. It is highly undervalued. The price is likely to rise dramatically as investors come to realize the true value of the underlying company. Stock B has been doing well for five years. It is highly overvalued. The price is likely to fall dramatically as investors come to realize the true value of the underlying company.
Which stock is the fund manager more likely to add to his fund?
If his primary goal is to serve his investors, he is likely to add Stock A.
If his primary goal is to make money in the short term, he is likely to add Stock B.