A Random Walk

Indexing is one of my favorite blogging topics when it comes to investing, so this article about Burton Malkiel caught my eye. Malkiel is a Princeton Economics Professor who literally wrote the book on index investing. Here is a notable blurb from the interview:

We have a lot of information about how index funds have done, as well as the typical actively managed mutual fund. I find that consistently two-thirds of active managers are beaten by the indexes, and those that beat the index in one year are not necessarily the ones who beat it the next year.Over a very, very long period, sure, there are a few people who have outperformed the index. But you can almost count them on one hand. I still believe -- even more strongly than I did in 1973 -- that most investors would be much better off having at least the core of their portfolio in a low-cost index fund.

And on the most frequent criticism of indexing:

There is no question that it is a rap on indexing -- that at the peak of the market in 2000, you had more Internet stocks than you should have had, in retrospect. But active managers had an even a greater proportion than did the index funds.

Similarly, you could say that with an index fund at the end of 2007 and the beginning of 2008, you had too much in financial stocks, absolutely. But that's what killed all the value managers who had done so well for so long.

So you are quite right that, with an index fund, you will be invested in what turns out to be the most overvalued part of the market. But you will also be invested in what turns out to be the most undervalued part of the market.