by Cian Callaghan
You’ve been hearing me harp on about the stock market for a few blogs now. In fact, if you are a client you are probably sick to death of me going on about the wonders of the great companies of the world. It might come as a surprise to you then that we really do not like when our clients invest in individual stocks (companies).
What are you going on about?
We love the global stock market, simply because we know in the long term it will give our clients the returns they need to live the life they want, assuming we help them manage their investor behaviour. There is no guarantee that one company, or even a handful of companies, will stand the test of time.
There are plenty of reasons why I don’t like investing in individual stocks and some of these are covered in other blogs I have already written (see ‘Do markets always go up in the long term?‘ for reference). Today, I’m just going to focus on one area – indexing.
Capturing the market
There are lots of different ways, methods and philosophies on how an index fund might work. But for the purpose of today, we are talking about any fund or ETF that attempts to track an index and does not attempt to beat it by picking individual stocks.
It’s important that we understand what an index fund does and how it works.
Essentially, an index fund will buy and sell stocks on a regular basis in order to mirror the current make-up of a particular market (index). In this case we are only looking at the global stock market.
The obvious reason why this is so important is diversification – we can mitigate the risk of permanent capital loss. What might be less obvious to people is that the process of indexing allows us to capture the real value and wealth created by human innovation over a multi-decade timespan.
Market movers and shakers
Take a look at the chart below from Charlie Bilello (he is going great by the way – you should follow him).
This looks at the largest US Companies each decade since 1960. It’s pretty clear that there’s significant turnover here every year, as we see human innovation create and invent new ways of doing things. Even creating things we couldn’t even have imagined before they were invented!
Let’s take Google (Alphabet) for example. They weren’t even on the largest 10 companies in 2010. Can anyone reading this honestly say Google hasn’t had a profound impact on the way you live your life right now? And yet 20 years ago most of us didn’t even know we might need or want some of the solutions Google offers us today.
In fact, the research shows us that on average companies really start to struggle or plateau after they get into the top 10.
The “Next Big Thing”
The point here is that it’s impossible to tell what the next big thing will be. The next biggest company in 2030 might not even have been founded yet. It might be for a product or service that hasn’t been invented or even conceptualised yet.
The idea that large companies are too big to fail is a myth. Buying a handful of companies and hoping they are going to capture the sum total of human innovation is a fool’s errand. The beauty of indexing is that you already bought Google in your portfolio many years before it became one of the biggest companies in the world.
So, why would you bother taking a bet or speculating on a handful of companies when you can ensure you capture the next google or Tesla just by buying the market? By investing in the entire market you ensure you are going to capture the sum total of human innovation over your investment timespan. Now that’s innovative.
Cian Callaghan is the Head of Financial Planning and a Private Client Manager at Metis Ireland.
Metis Ireland Financial Planning Ltd t/a Metis Ireland is regulated by the Central Bank of Ireland.
All content provided in these blog posts is intended for information purposes only and should not be interpreted as financial advice. You should always engage the services of a fully qualified financial adviser before entering any financial contract. Metis Ireland Financial Planning Ltd t/a Metis Ireland will not be held responsible for any actions taken as a result of reading these blog posts.