It’s often noted that a company’s stock gets a bump in value when the company is voted into the Standard & Poor's 500 index, because index fund managers have to buy it. If a company gets booted out, the same managers must sell. Standard & Poor’s announced that Google was being admitted to the S&P 500 index after the U.S. market closed on March 23, 2006.  Google went up 7.3% in after-hours trading.

Now, a new study argues that S&P 500 index companies are overvalued, tracing the effect of more money flowing into the index over the last 20 years. Co-author David Nanigian from The American College will present the paper at the New York Stock Exchange next Wednesday, June 29, 2011.

Along with co-authors Eric Belasco from Montana State University and Michael Finke from Texas Tech University, Nanigian also says in the paper that the problem can’t easily be hedged away.

According to Allan Roth, founder of Wealth Logic in Colorado Springs, there’s a simple remedy: buy Vanguard’s Total Stock market fund. “Owning the total stock index fund is a much better way to index, for several reasons. It hedges what I term the “Google Effect,” gives far more diversification and is much more tax efficient since trading isn’t determined by the S&P committee or anyone else,” he told Financial Planning.

So what says Vanguard’s Jack Bogle, who made index investing so popular?

He wrote Roth that he agrees with the main point: stock prices are affected by the index. But he points out that the S&P 500 has slightly beat U.S. stocks overall since 1928.


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