65 | In Defense of Indexing: Capture the Upside

Indexing is a style of investing in which, instead of intentionally selecting a subset of companies from a group, you decide to own the entire group.

Groups of companies come in all shapes and sizes - a group could be all of the big companies in the United States, all of the energy companies in the world, all of the small companies in developing countries, or any other combination of geographies, industries, or company sizes.

Indexing knows that capturing the upside is more important than avoiding the downside.

It's easy to think that avoiding companies that struggle or under perform is the most important part of successful investing.

The reality is that the bigger risk is missing out on owning the companies that out perform.

While psychologically this might seem backwards. Mathematically it is pretty simple.

If you own a company that fails, the maximum amount that you can lose in that single investment is 100%.

On the flip side, if you own a company that is wildly successful you can gain 100%, 200%, 500%, or 1,000%+ on that single investment.

It's pretty easy to see that one successful company can offset and totally wipe out the under performance of one or multiple struggling companies.

Indexing ensures that you own all the companies in a given group and, even though you might include a few companies that struggle, it ensures that you also hold all of the companies that exceed expectations.

Additional Reading

Tails, You Win by Morgan Housel

Portfolio thinking by Seth Godin