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AI: Alpha and Index Funds

A current theme among Wall Street wealthWhere to focus your alpha energy?
managers is for individual investors to haveInvestments in real estate, commodities, and
index funds as their core holdings and toenergy are less correlated with the stock
focus the remainder of their assets in highmarket (although I've never thought
alpha investments, which will produce returnscommodities were suitable for individual
not  correlated  with  the  market.investors).
A quick digression for those of you whoThe Wall Street pros also recommend stock
aren't familiar with alpha and beta. Infund mangers who have unique strategies and
traditional finance, return not correlatedcan demonstrate a high alpha relative to the
with a broad market index, such as the S& Pmarket (and, of course, positive relative
500,  is  referred  to  as  alpha.performance).
The return which is correlated to the marketAsk your investment adviser for suggestions.
is beta. An index fund should have the sameThe alphas for individual mutual funds (and
return (positive or negative) as the index itindividual stocks) are available from some
mimics. (One of the controversiesbrokers  and  online  premium  services.
surrounding some ETFs is their performance
has  not  tracked  their  underlying  index.)Alpha and index fund investing makes a great
deal of sense. You know what to expect in
The theory behind Alpha and Index Funds isterms of risk and return when you invest in
multi fold: 1. the major indices are a goodan  index  fund.
place for an investor to be, both from a risk
and return perspective; 2. you can'tHaving a portion of your portfolio in index
outperform the major indices, so don't wastefunds leaves you free to concentrate your
your time; 3. find those investment nichesinvestment time and energy (think alpha
with high alphas to increase your return andwaves) on those investments which can make a
reduce  the  overall  risk in your portfolio.difference.
Even if you don't subscribe to this theory,Picking high alpha investments, which by
you might find it an interesting exercise totheir nature are less correlated with the
review the alphas -- every investment has onestock market, should reduce the risk
-- of your current holdings. They will tellvolatility of your portfolio and, depending
you something about the correlation andupon the investment, provide above market
diversification  of  your  portfolio.returns.



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