FOOL'S EYE VIEW
Bookies Buy Trackers!

By James Carlisle
January 14, 2002

You don't need to spend long on this website to be told, probably quite forcefully, that you should be saving hard for your retirement. (Please accept our apologies for constantly banging on about this, but it is very important). Almost as uncontroversial is the notion that shares provide the best means of doing this over the long term (although you can find some alternative opinions on our Communion of Bears discussion board). After all, if shares, and the underlying companies, did badly for long periods of time, then where's the money going to come from to pay the interest on those bank accounts?

The arguments really start getting fresh, though, when the discussion moves onto which, and what type of, shares to buy. Most people make their investment decisions by balancing the opinions of a vast army of financial advisers, journalists, Motley Fool posters, City analysts, and blokes down the pub. After all, if we hadn't the faintest idea about football, but wanted to know who was most likely to win the Premier League, then we'd ask the opinions of those people we thought had a clue. If half of our football gurus said Man Utd, and a third each Arsenal, Leeds and Liverpool (with due respect to fans of Newcastle and Chelsea) then, depending on the force of the views, we'd probably surmise that Man U was most likely. That would be a perfectly sensible way of going about things.

The stock market, however, is very different, precisely because it is a market. It would be more like asking our football cogniscenti which team we should bet on to win the Premier League. This is much more difficult. The more people say that Manchester United are likely to win, then the more expensive it becomes to have a bet on them. So our tipsters become less useful. That's how it is with shares. If everyone is shouting at you to jump into a particular share or sector, you can expect them to have already become expensive enough to remove the attractions.

It goes further than this, though, because the stock market sometimes displays lemming-like tendencies. For some reason people seem to think that the more a share goes up, the more likely it is to go up some more. That would be like saying that the shorter the odds on Man Utd winning the Premier League, the more it's worth betting on them. Presumably it has something to do with human greed and the ease with which shares are traded, but clearly it's nonsense. Anyway, whatever the reasons, it suggests that the more people are shouting about something, the less likely it is to make a good investment.

So, following the suggestions (aka tips) of our journos, gurus and stock jocks doesn't help us and, in fact, may well be harmful. That leaves us back at the beginning: without a clue what to invest in. Thankfully there is an answer to this conundrum, but it involves stretching our footballing analogy to breaking point.

Betting on who's going to win the Premier League will, on average, lose people money, because the bookies have to make a profit over the long-term. Otherwise there wouldn't be any bookies. The stock market, on average, tends to make people money. When investors buy shares, they're indirectly providing companies with capital for their businesses and there has to be an incentive for doing this. Otherwise, there wouldn't be any investors and there wouldn't be any businesses.

So, being the investor in the stock market is more like being the bookie than his punter, because there is an overall profit to be made. It's a good position to be in, except that we have no way of telling where the profits are to be made. The bookies have been managing this situation since Roman chariot racing and before, so why not take a leaf out of their book? Their approach, the ones that stay bookies for a long time anyway, is to accept bets on every team in the league, in the right balance to the odds, creating a balanced book. The upshot is a smug bookie that goes home happy whether Man Utd wins at evens or Fulham come in at 200-1.

In the investing world, the equivalent of the bookie's balanced book is an index tracker. It basically involves buying a little bit of every share in the index, in the same proportions as everyone else, so you'll end up with the average return of the index (less a little for costs), whoever ends up winning the individual races. So, take a tip from the bookies and invest in an index tracker.

More: The Fool's Index Tracker Centre | Which index, though? | Beating the Odds - Investing Vs Gambling