Fundamental Index Funds for Long-Term Growth

If you're looking to invest in the stock market for long-term growth, fundamental index funds are a great option. They offer a low-cost and efficient way to gain exposure to the entire market.

One of the key benefits of fundamental index funds is their ability to capture the performance of the market as a whole. This is achieved by tracking a specific index, such as the S&P 500. By doing so, you can potentially benefit from the growth of the market over time.

Fundamental index funds are designed to be long-term investments, not short-term trading vehicles. They're meant to be held in your portfolio for years, not months. This allows you to ride out market fluctuations and benefit from the power of compounding.

Index funds are a type of investment that pools money from many investors to buy a small piece of a large number of stocks.

They are often referred to as "set it and forget it" investments because they require minimal maintenance and can be a low-cost way to diversify your portfolio.

Index funds aim to replicate the performance of a specific market index, such as the S&P 500.

This is achieved by tracking the underlying stocks in the index, rather than trying to beat the market through individual stock picks.

Index funds are often less expensive than actively managed funds because they don't have the same level of management fees.

In fact, the management fees for index funds are typically around 0.05% to 0.20% per year.

This low cost can add up to significant savings over time, especially for long-term investors.

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By focusing on the market capitalization of companies, you can create a diversified portfolio that tracks the overall market.

This approach eliminates the need to pick individual stocks, which can be a daunting task even for experienced investors.

The fundamental index fund strategy also allows you to invest in a wide range of companies, including those that are often overlooked by traditional investors.

By doing so, you can potentially capture the returns of the entire market, rather than just a small portion of it.

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The debate between active and passive investing has been raging for a long time, and it's not hard to see why. Proponents of active management claim that skilled mutual fund managers can outperform index investing in the long term.

Research from Research Affiliates shows that smart beta strategies have beaten the market over long time periods, and this outperformance persists even when these strategies are turned "upside down".

However, the evidence points towards indexing. Fewer and fewer mutual funds are outperforming their benchmarks, and billions of dollars have flown out of actively managed funds into index funds in each of the last 10 years.

A good example of a successful passive strategy is the Fundamental Index strategy, which was launched in 2005 and weights securities by four measures of company size rather than market capitalization. This strategy has outperformed cap-weighted broad market and value indices in the US and other markets.

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Here's a comparison of the performance of a hypothetical RAFI index with cap-weighted broad market and value indices:

RAFI Fundamental Index strategies have also shown a history of outperformance during periods of heightened inflation, bear markets, and recessions, which is an attractive feature for investors looking for a stable investment.

It's worth noting that the term "smart beta" has become somewhat controversial, but the concept itself is a significant development in investment management that helped bridge the gap between active and passive investing.

Smart beta strategies have been around for a while, with the Fundamental Index strategy launched in 2005, three years before the term smart beta became popular. This strategy weights securities by four measures of company size: sales, cash flow, dividends + buybacks, and book value, rather than market capitalization.

Research has shown that smart beta strategies can outperform the market over long time periods, even when turned "upside down." In fact, a hypothetical RAFI index, which weights constituents based on their economic footprint, outperformed cap-weighted broad market and value indices from 2007 to 2022.

Fundamentally weighted indexes, like the RAFI Fundamental Index, provide a benchmark for passively managed funds offered to investors seeking exposure to stocks based on fundamental characteristics. These indexes can base their construction on a range of fundamental metrics, such as revenue, dividend rates, earnings, or book value.

A fundamentally weighted index can be a better option than a cap-weighted index, especially during periods of heightened inflation, bear markets, and recessions. Currently trading at low valuation levels, RAFI Fundamental Index strategies have a history of outperformance during these times.

Here are some key characteristics of equity strategies that merit the smart beta designation:

Fundamental index funds are a type of investment that focuses on the underlying value of a company, rather than its market capitalization.

By using a combination of accounting data and economic indicators, fundamental index funds can provide more consistent returns over time, as seen in the example of the Value Line Fund, which has a long-term track record of outperforming the market.

One key benefit of fundamental index funds is their ability to reduce concentration risk, as they typically hold a larger number of stocks and spread their investments across various sectors.

This diversification can help to smooth out returns and reduce the impact of any one stock's performance, making them a more stable choice for investors.

Get International Investing insights in your inbox once per month. In global terms, Vanguard’s FTSE All World ETF (VWRA) plunged 18.11 percent in 2022, measured in USD.

A fundamental index like Invesco’s FTSE RAFI All World 3000 UCITS ETF, which dropped just 8.71 percent in 2022, might be worth considering.

The fundamental index outperformed a traditional, cap-weighted index like Vanguard’s Global Stock Market Index (VT) over the past dozen years. A $10,000 investment in January 2011 would have grown to $20,430 by December 31, 2022, in USD, with Invesco’s FTSE RAFI All World 3000 UCITS ETF.

Here's a year-by-year comparison of the two indexes:

The fundamental index didn't disappoint, even during times of popular growth for cap-weighted index funds.

Growth stocks are all about finding companies on the "up and up", with a new, world-changing way of doing things that will continue to appreciate in value.

Tesla, Netflix, and Amazon are all examples of growth stocks that have made investors fortunes.

In a growth strategy, you're betting on a stock "breaking out" and continuing its upward trend.

Growth investors are often looking for companies with high growth potential, but this approach can be riskier than value investing.

Value investing, on the other hand, is all about finding mispriced securities that will revert back to their intrinsic value over time.

Benjamin Graham and Warren Buffett are famous for their value investing approach, which focuses on finding undervalued stocks.

Value investors are betting on a reversion to the mean, where the market price returns to the stock's intrinsic value.

This approach can be less exciting than growth investing, but it's often considered a more stable and long-term strategy.

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Fundamental index funds have consistently outperformed their cap-weighted counterparts over the last ten years.

Research Affiliates has built fundamental indices that have outperformed their corresponding cap-weighted benchmarks across various asset classes.

World stocks are no exception, with Research Affiliates' fundamental strategy outperforming the benchmark on a real and risk-adjusted basis.

The same is true for large cap U.S. stocks, developed international stocks, and emerging market stocks, all of which saw their fundamental indices outperform their benchmarks over the ten-year period.

Fundamental strategies also offer better risk-adjusted returns, as evidenced by their higher Sharpe ratios compared to cap-weighted benchmarks.

Research Affiliates' fundamental indices have demonstrated their potential for long-term growth and stability in a variety of markets.