Market Indexes One way to monitor whether stocks are in or out of favor is to compare their stock performance with those of various market indexes. However, there are thousands of additional stocks, most of which, based on the value given to their outstanding shares, would be considered small-capitalization issues. Over long periods of time, small-cap stocks have outperformed those of their larger counterparts. However, investor sentiment tends to move in cycles, which can last for a number of years. These are called index funds.
Many pension funds invest a portion of their assets in index funds.
One advantage is that transaction costs tend to be low because the stocks that make up an index do not change often, and investments that replicate a broad-based index offer extensive diversity. Also, over the long term, due in part to lower costs, broad-based index funds have provided better returns to investors than most categories of mutual funds. At the most passive level, an investor can simply own shares of an index fund for a lengthy period of time, seeking to participate in a continuation of the above-average returns that stocks have historically provided. At a more aggressive level, an investor can try to time the market, to increase the level of stock holdings when the general tide is expected to rise and to sell stocks when a falling market tide seems likely. Successful anticipation of the market's direction benefits owners of index funds, just as it does investors who are choosing stocks on an individual basis.