Active inactivity: the discipline of indexing.

By now, you’ve had a chance to weigh the evidence and have seen all that index investing has to offer. You understand better that choosing the right direction for your investments, through a passive strategy, can greatly improve their ending values. It sounds almost mystical but the truth is, passive investing is one of the best in-actions you can take.

How do I get started indexing?

First, you must decide on your 'timeframe' or how long you have to let your investments grow and then get a good idea on how much risk you are comfortable with. This leads to an appropriate 'asset allocation' decision or how much to buy of stocks, bonds, cash, etc.

Second, you’ll need to choose an index that best represents each asset class. Finally, you’ll need to monitor your portfolio and when an asset class grows or shrinks beyond your determined mix, buy or sell enough shares to 'rebalance' back to your original allocation.

There are online resources that can help you, but you might also consider seeking the advice of a registered investment advisor in your area. They have access to programs and resources that might not otherwise be available to you.

Finding your Asset Allocation Contrary to what you may have heard, indexing is more about asset allocation than it is “buy and hold.” The success of indexing as a strategy doesn’t come from blindly holding an index-based investment for years and years. For most people, that would be assuming far too much stock market risk. Indexing works best when used to spread out or allocate your investment dollars over several asset classes. This is because of non-correlation: when one asset class has fallen in value, another has likely grown. Index funds also provide diversification: This follows the common-sense adage of not putting all your eggs into one basket. To see the most success with your passive investments, determine how much market risk you can be comfortable with and build an asset allocation model accordingly.

Rebalancing, not 'activity' Beware: not all indexing strategies are passively managed. Some will try to add value by layering on their own holdings criteria or using some type of predictive market timing. These strategies, known as "active" or "tactical" or "strategic" indexing don’t just straddle the fence between active and passive; they increase your risk because their subjective decisions may not pan out as planned. They also carry higher costs. True passive management eliminates such risks and reduces your costs. This type of activity contrasts with portfolio rebalancing. To maintain the risk level of your portfolio, when the amount held in an asset class has changed too much from the desired allocation, you must periodically make the required buy or sell trades to correct it.

Choosing an index fund

Investors have the choice between several types of index investments. Index Mutual Fund: Available for purchase directly from the fund company or through a financial advisor. Mid to low fees. Exchange Traded Fund or ETF: Available for purchase only through a stock exchange, using a brokerage account. Low fees. Choose your ETF carefully: many 'speciality' funds should be avoided. This recent article explains why: Bogle Denounces Narrowly Focused ETFs Index Annuity: An insurance company issued retirement vehicle, that pays a tax-deferred rate of interest based on index performance, without investing your money in the market, by using options. Low to no fees, but has restrictions on access to funds.

[1. Why indexing?] [2. Inside an index] [3. Evidence it works] [4. Making the choice]