A personal finance blog dedicated discussing such topics as budgeting, asset allocation, 401K, IRA, cash flow, insurance, financial planning, portfolio management, and other areas in personal finance.


Monday, January 10, 2005

A Twist on Index Investing

I'm a spreadsheet kind of guy. In the spirit of spreadsheet madness, I did a little study using the Dow Jones Total Market Index from 1992 - 2004. The purpose of the study was to see if there was a way to index and still beat the index. Huh?

Before I get into the nitty gritty it is important to know a little about the Dow Jones Total Market Index (from now on I'll simply call it the DJTMI). The DJTMI is a market-weighted index, meaning larger companies (based on market value) make up a greater percentage of the index than do smaller companies. This is not unlike other indexes like the Standard & Poor's 500 Index. But, the cool thing about the DJTMI is that it is composed of the following ten sector indexes:

Basic Materials
Consumer, Cyclical
Consumer, Noncyclical

For my study I put together a portfolio putting equal dollar amounts in each of the ten sector funds and rebalanced them at the end of each year. Here are my results:


Annually DJTMI
9.30% 8.74%
1993 10.97% 9.78%
1994 1.54% 0.21%
1995 36.14% 36.62%
1996 18.77% 22.08%
1997 30.01% 31.75%
1998 23.19% 24.90%
1999 18.30% 22.72%
2000 1.63% -9.23%
2001 -10.27% -11.95%
2002 -17.81% -22.08%
2003 26.03% 28.44%
2004 12.53% 10.16%
Average 12.33% 11.70%
Geometric Average 11.28% 10.24%

NOTE: I used Geometric Average instead of the simple arithemetic average because it is a more accurate measure of return. Just trust me on this! Also, I used the index returns for my calculations because the corresponding Exchange Traded Funds have not been around long enough. So, that means actual returns would have been less due to brokerage fees and Exchange Traded Fund expenses. Even so, this strategy would have still outperformed the DJTMI in 2004.

So, if you want to increase your returns but still want to index, consider this method. For those interested in learning more, send me an email using the link following this post. I'll send you an Excel 2003 Spreadsheet of my study.

Until next time...