A better bench mark for evaluating the skill of individual investorsÂ in picking stocks would be a combination index of stocks listed onÂ the New York Stock Exchange and American Stock Exchange. AÂ still better index would include the over-the-counter stocks. A stillÂ better one would include bonds and other things. Unfortunately, theÂ official index of the American Stock Exchange is not a value-weightedÂ index, and the index of the over-the-counter stocks is not inclusiveÂ or necessarily representative.
Investment Bench Mark
Someone would do the financial community a great service by constructing a value-weighted index that included stocks not on the New York Stock Exchange. In the meantime, investors seeking a bench mark can probably struggle along withoutÂ major error by using one of the value-weighted indexes for the NewÂ York Stock Exchange.
Investment Bench Mark
An argument can be made for using an index in which each stockÂ receives equal weight. In computing the tables of rates of return onÂ common stocks listed on the New York Stock Exchange, Fisher and Lorie gave equal weight to each stock. Such an indexÂ provides perhaps the simplest nai’ve model with which to compareÂ the performance of actual portfolios of common stocks. It is the modelÂ which corresponds to the dramatic and implausible picture of a manÂ picking stocks by throwing darts or by some more rigorous randomÂ process. An index based upon equal weighting shows the results ofÂ an investment policy based on random selection with equal probabilities of selecting each stock; the value-weighted indexes correspondÂ to an investment policy based on random selection with probabilitiesÂ of selection proportional to market value.f
It is impossible to state categorically which kind of index provides the best bench mark, but it is worth noting that the choice can haveÂ practical consequences. The study of mutual fund performance by
FriendÂ et al shows that their sample of 136 mutual funds on the aver age had an annual rate of return compounded monthly of 10.7 percentÂ for the period January 1960 through June 1968. This was inferiorÂ to the annual rate of 12.4 percent based on portfolios of stocks withÂ equal weights and was superior to the annual rate of 9.9 percent basedÂ on indexes of stocks with weights proportional to market value.2 TheÂ margins of inferiority and superiority were probably not so great asÂ to justify a confident conclusion that managers of mutual funds pickedÂ stocks better or worse than a random process with either equal probabilities of selection or probabilities proportional to market value. MostÂ observers would probably conclude that mutual funds demonstratedÂ neither superiority nor inferiority during the period under study.Â Nevertheless, it is worth keeping in mind that the choice of indexÂ can make a difference and that occasionally it might even beÂ important.
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