AI: Alpha and Index Funds

A current theme among Wall Street wealthcurrent holdings. They will tell you something about
managers is for individual investors to have indexthe correlation and diversification of your portfolio.
funds as their core holdings and to focus theWhere to focus your alpha energy? Investments
remainder of their assets in high alphain real estate, commodities, and energy are less
investments, which will produce returns notcorrelated with the stock market (although I've
correlated with the market.never thought commodities were suitable for
A quick digression for those of you who aren'tindividual investors).
familiar with alpha and beta. In traditional finance,The Wall Street pros also recommend stock fund
return not correlated with a broad market index,mangers who have unique strategies and can
such as the S& P 500, is referred to as alpha.demonstrate a high alpha relative to the market
The return which is correlated to the market is(and, of course, positive relative performance).
beta. An index fund should have the same returnAsk your investment adviser for suggestions. The
(positive or negative) as the index it mimics. (Onealphas for individual mutual funds (and individual
of the controversies surrounding some ETFs isstocks) are available from some brokers and
their performance has not tracked their underlyingonline premium services.
index.)Alpha and index fund investing makes a great deal
The theory behind Alpha and Index Funds is multiof sense. You know what to expect in terms of
fold: 1. the major indices are a good place for anrisk and return when you invest in an index fund.
investor to be, both from a risk and returnHaving a portion of your portfolio in index funds
perspective; 2. you can't outperform the majorleaves you free to concentrate your investment
indices, so don't waste your time; 3. find thosetime and energy (think alpha waves) on those
investment niches with high alphas to increaseinvestments which can make a difference.
your return and reduce the overall risk in yourPicking high alpha investments, which by their
portfolio.nature are less correlated with the stock market,
Even if you don't subscribe to this theory, youshould reduce the risk/volatility of your portfolio
might find it an interesting exercise to review theand, depending upon the investment, provide
alphas -- every investment has one -- of yourabove market returns.