There’s no way around it: At some point, you, as an astute investor, will have to make some pretty educated decisions when it comes to your investment portfolio.
How much money should I invest? What’s the best strategy for me? Can I meet my long-term financial goals? And how can I put myself in a position to properly gauge how my stocks or stock mutual funds are faring?
This last question brings another element of investing into focus. It’s called index investing, and it’s a strategy that savvy money managers have been using for years.
The Dow Jones industrial average is the most widely quoted stock indicator, but it represents only 30 blue-chip stocks. It often says surprisingly little about the day-to-day direction of the entire market. Because the Dow is so narrowly based, it’s usually a poor benchmark against which to compare a portfolio’s performance.
Market analysts have devised dozens of other stock indexes-ranging from the Standard & Poor’s 500, which comprises 500 stocks, to indexes that focus on just one sector, such as autos or restaurants-to get both broader and narrower looks at how the market is behaving.
It’s important for the investor to pick the right index when making a decision to buy or sell any one stock or mutual fund.
Says John Reckenthaler, editor of Morningstar Mutual Funds: “Index investing became popular because the first index funds performed very well during the ’80s. These index funds mirrored the Standard & Poor’s 500 (which, for the 10 years ending in October 1993, rose 15 percent, beating 92 percent of all mutual funds over that time, according to the newsletter Mutual Fund Forecaster). Indexing was, therefore, seen as a very desirable strategy.”
There is a contrarian point of view to index investing, too. A. Michael Lipper, president of Lipper Analytical Services, questions the popularity of index investing for individual investors.
“Most of the S&P 500 index funds are largely for institutions and 401(k) plans,” Lipper explained. “Other than the S&P, there’s even less interest in it. It just doesn’t fit the American psyche.”
And Reckenthaler does point out that index funds “haven’t done so well on a relative basis in the ’90s,” adding that 1993 was the third straight year in which most index funds were outperformed by actively managed funds.
But investors who are interested in the strategy should take the trouble to learn about the market’s many indexes before putting their money down.
For one thing, the Securities and Exchange Commission now requires mutual funds to compare their performance against an appropriate index. Investors should understand the index to appreciate the comparison. If a fund is performing worse than its index, it may be poorly managed or charging overly fat fees.
But a knowledge of indexes can help you decide whether you’re in the right mutual funds in the first place. For example, in recent years small-capitalization stocks have outperformed big ones, a fact that investors who have been comparing the Russell 2000, a small stock index, with the S&P 500 or even the Dow industrials would soon realize.
Indeed, Reckenthaler warns that index investing should not be thought of as a “no-brainer.”
“When you index-invest, you still have an important investment decision to make,” he said.
And that decision for those of you who want to “buy the market,” as index investing is sometimes known, is: Which index should you use?
Many portfolio managers use the S&P 500 as a benchmark because it is a far broader measure of market activity than the Dow Jones industrial average.
But there are other options. There’s the Russell 2000 Index and the Wilshire Small Cap Index, both of which track the stock performance of smaller companies; the S&P 400 MidCap Index, which tracks medium-size stocks; the Wilshire 5000 Index, which tracks all major New York Stock Exchange, American Stock Exchange and NASDAQ stocks; and the Morgan Stanley Capital International Europe Australia Far East (EAFE) Index, the most prominent index used to track foreign stocks.
So, how can you get started in index investing? Obviously, you can’t buy every single stock on the S&P 500 or the Russell 2000, but you can invest in funds whose stocks are chosen to mirror each index.
For example, there’s United Services’ U.S. All American Equity Fund (800-US-FUNDS), a no-load fund that allows investors to track the S&P 500.
The minimum investment is $1,000, or an investor can get started with as little as $100 in its ABC Investment Plan, which allows for investments of $100 or more in the fund each month via a checking or savings account. The fund’s trailing annual return ending Sept. 30, 1993, was 12.48 percent.
Allen Parker, United Services portfolio manager, chalks up the popularity of index investing to “people just like you. We respond to the demand for index funds.”
The Gateway family (800-354-6339) has three funds available: Index Plus Fund, the Capital Fund and the Small Cap Index Fund. Portfolio manager Peter Thayer says that the “Gateway Index Plus Fund is an index offering with a safety net.” The particular fund’s stock portfolio is a market-cap-weighted index of the S&P 100.
The Gateway Capital Fund is similar to Gateway Index, though it is designed for a more aggresive investors. It invests in the stocks that make up the S&P 100, but it does not hedge its positions as much. The Gateway Small Cap Index Fund is a new trading vehicle consisting of the 250 stocks that make up the Wilshire Small Cap Index.
All of Gateway’s funds require an initial $1,000 investment, with $100 minimum investment increments thereafter.
Vanguard (800-662-7447) is the leader in index funds offered, boasting six domestic stock index funds and six international stock index funds, with a few bond index funds to boot.
Its most popular fund, the Vanguard Index Trust 500, mirrors the S&P 500. Some of the other funds it offers are the Vanguard Value Index Fund, Vanguard Growth Index Fund, Vanguard Total Stock Market Fund, Vanguard Extended Stock Market Fund and Vanguard Small Cap Index Fund.
The first three are no-load funds. The others charge a fee ranging from 1 to 2.5 percent.
A LOOK AT SOME MARKET INDEXES.
– The Dow Jones industrial average. Tracks the movement of 30 of the largest blue-chip stocks, such as AT&T and Coca-Cola, traded on the New York Stock Exchange and is the most commonly quoted stock market average. It is the only “price-weighted” index, and thus is most affected by the movement of higher-priced shares.
– The Standard & Poor’s 500. Tracks 500 blue-chip stocks, mostly NYSE issues, and is segmented by industries. It’s the benchmark against which most portfolio managers compare themselves. It is “market-valued weighted,” that is the impact of a stock’s price change is proportional to its overall market value (the share price times the number of shares outstanding.) All of the Dow industrials are in the S&P. The index doesn’t represent small stocks, however.
– The NASDAQ Composite. Tracks all but the smallest companies traded on National Market System. NMS issues tend to be smaller, more volatile companies, though they also include Apple Computer, Intel and Sun Microsystems.
– The Russell 2000. Tracks 2,000 stocks with an average of $250 million or less in market capitalization, which is price multiplied by the number of shares outstanding. It’s considered the best barometer for small stocks. It is market-weighted.
– The Standard & Poor’s 400 MidCap. Tracks medium-sized stocks, those with a median market capitalization of $1.6 billion, compared to $13 billion for the S&P 500. This is the newest index, formed in 1991. It’s probably the best benchmark for a typical growth stock mutual fund, which tends to invest in medium-sized companies. It is market-weighted.
– The Dow Jones utilities. This 15-stock index is an excellent barometer of interest rates because utilities borrow heavily to finance operations. When rates are falling, borrowing costs decline and these stocks rise. Conversely, when rates are rising, as they have been recently, these stocks decline. Utilities pay high dividends. Like bonds, they appeal mostly to income-oriented investors.
– The Dow Jones transportation. Tracks 20 big transportation stocks, and, like the Dow industrials, is highly sensitive to economic prospects. If companies sell more goods, they ship more goods.
– The Wilshire 5000. Tracks all major NYSE, AMEX and NASDAQ stocks. In a way, it’s better than the S&P 500 because it is a good indicator of all stocks, small and large. It is market-weighted.
– The Morgan Stanley Capital International Europe Australia Far East (EAFE) Index. This is the most prominent index used to track foreign stocks. It tracks 1,080 stocks in 20 countries and is market-weighted.
Knight-Ridder/Tribune.
