Also, even if an investor uncovers an attractive small-cap stock, there could be a sizable wait before a significant number of other people also become enthusiastic. Institutions such as pension funds tend to be heavily weighted toward the larger companies, and their charters may preclude them from investing in firms whose stock is valued below a certain amount. 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. 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.