Investment Bench Mark

A better bench mark for evaluating the skill of individual investors in picking stocks would be a combination index of stocks listed on the New York Stock Exchange and American Stock Exchange. A still better index would include the over-the-counter stocks. A still better one would include bonds and other things. Unfortunately, the official index of the American Stock Exchange is not a value-weighted index, and the index of the over-the-counter stocks is not inclusive or necessarily representative.

Investment Bench Mark

 

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 without major error by using one of the value-weighted indexes for the New York Stock Exchange.

Investment Bench Mark

An argument can be made for using an index in which each stock receives equal weight. In computing the tables of rates of return on common stocks listed on the New York Stock Exchange, Fisher and Lorie gave equal weight to each stock. Such an index provides perhaps the simplest nai’ve model with which to compare the performance of actual portfolios of common stocks. It is the model which corresponds to the dramatic and implausible picture of a man picking stocks by throwing darts or by some more rigorous random process. An index based upon equal weighting shows the results of an investment policy based on random selection with equal probabilities of selecting each stock; the value-weighted indexes correspond to an investment policy based on random selection with probabilities of selection proportional to market value.f

Investment Bench Mark

It is impossible to state categorically which kind of index provides the best bench mark, but it is worth noting that the choice can have practical consequences. The study of mutual fund performance by

Friend 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 percent for the period January 1960 through June 1968. This was inferior to the annual rate of 12.4 percent based on portfolios of stocks with equal weights and was superior to the annual rate of 9.9 percent based on indexes of stocks with weights proportional to market value.2 The margins of inferiority and superiority were probably not so great as to justify a confident conclusion that managers of mutual funds picked stocks better or worse than a random process with either equal probabilities of selection or probabilities proportional to market value. Most observers would probably conclude that mutual funds demonstrated neither superiority nor inferiority during the period under study. Nevertheless, it is worth keeping in mind that the choice of index can make a difference and that occasionally it might even be important.

 

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