Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, October 30, 1995 TAG: 9510300008
SECTION: MONEY PAGE: 8 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Long
The Institute of Certified Financial Planners said index funds generally match the performance of a specific market index by buying all, or a representative portion, of the securities contained in that index.
This passive approach, used by only about 100 mutual funds, contrasts with the many more actively managed funds that try to sort out the winners from the losers according to the fund's specific investing style: for example, the best of the fast-growing small companies.
James Kern, manager of the Roanoke office of Interstate/Johnson Lane, said few brokers recommend index funds because most of them are of the no-load variety, meaning there is no sales charge.
Index funds, he said, appeal to people who are satisfied to do as well as the overall market and at the lowest possible price. That's the basic premise of the funds, he said. They have low management fees because they follow the market in general.
Kern said "a fair amount" of people are willing to accept this premise and have ridden up this year with the overall robust financial market. They are, by and large, conservative investors.
Most brokers, on the other hand, try to put their customers into funds that have a record of outperforming the market.
Kern said Vanguard's index fund is the most popular of that type of fund, and it was recommended recently by Forbes magazine.
However, he likes two American Funds: the Washington Mutual Investor, which was founded in 1952 and has a gain of 30 percent so far this year, and the Investment Company of America, founded in 1934. Both are load funds, but they have outperformed the Standard and Poor's 500 Index while riding out the down market with minimum volatility, he said.
The Institute of Certified Financial Planners said the vast majority of index funds follow the Standard & Poor's 500 Index, which reflects predominately large-company stocks and represents nearly 70 percent of the total market value of stocks in America.
Large-company stocks have done well so far this year, the institute said, and consequently so have most index funds.
But there are index funds that follow a dozen other benchmarks, including the Wilshire 5000 (virtually all U.S. stocks), Morgan Stanley's Europe, Australia and Far East (1,000 international stocks), and the Lehman Brothers Aggregate Bond Index (U.S. government securities, corporate bonds and mortgage-back securities).
Index funds have been around for 20 years, the institute said, and have long been popular with institutional investors.
But they haven't caught on with individual investors until recently, and many investors still avoid them. These people maintain that the idea of investing is to beat the market. Why invest in a fund that is designed to do no better than the market? Why aim at mediocrity?
The institute said proponents of index funds reply that investors should consider adding them to their portfolio for several reasons:
Few actively managed funds outperform the market over the long run. Study after study shows the S&P 500 outperforming 80 percent or more of the actively managed diversified stock funds.
Because index funds are essentially passive funds that don't spend a lot of time and manpower trying to pick winners, their management fees generally are among the lowest of all mutual funds.
Annual expense ratios average about 0.45 percent for S&P 500 Index funds. That compares with an average of 1.4 percent for managed funds. Some run as low as 0.15 percent. Low fees mean you get to keep more of the income and profits.
Because funds don't buy and sell a lot of securities, they don't spend much money in brokerage fees.
Low portfolio turnover (typically 10 percent or less a year) also means less realized capital gains or losses (profits and losses from the sale of securities). This compares with a standard fund that turns over 80 percent to 100 percent of its portfolio in a year. That means lower tax costs for the investor.
Index fund investors know they will at least track the market. They won't have to worry whether the fund is doing better or worse than the market.
However, that doesn't means all index funds are alike. Some do better than others in tracking the index. And some funds have exceptionally high expenses of nearly 2 percent, plus up-front sales charges, both of which eat away at long-term returns.
While index funds have their virtues, the certified financial planners said, investors generally shouldn't rely solely on them.
For one thing, actively managed funds, such as small-company or sector funds, will outperform index funds.
Also, most index funds focus on the stocks of the Standard & Poor's 500, while a well-balanced portfolio typically includes other types of investments such as bonds, cash and real estate, depending on the goals of the investor. And the S&P 500 completely ignores the global stock market.
by CNB