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Is investing in index funds for you? Don't be fooled - not all these funds are alike.

From the outside looking in, running an index fund looks like the investment world's version of a nobrainer. First, you choose an index, that is, a group of stocks whose ups-and-downs are used to monitor the stock market's health (more often than not Index funds are tied to the S&P 500). Next, you buy all of the stocks in the index. Finally, and this is the hard part, stand back and watch the money you've invested grow.

Sounds easy? It is. In the world of mutual funds, one where there are endless choices and innumerable investment styles, index funds remain amazingly uncomplicated. Whether a "normal" fund carries the name growth, growth and income, value, or value and growth you can rest assured its management spends hours scouting for new deals. It constantly examines the shares it holds and, as a result, trades in and out of dozens of stocks a year. With index funds, however, a different philosophy -- hold and stand pat -- is at play. The index fund's bare bones, no-frills portfolio stays set, and goes through little if any turnover during the course of a year. And since the stocks the funds hold remain virtually the same over time, management fees and trading costs are minimal.

As simple as it sounds, the performance of index funds is no laughing matter, particularly in the eyes of many mutual fund managers out there. That's because in the past, stock indices (and index mutual funds) have all too often worn out a portfolio manager's research and investment acumen. According to statistics compiled by Lipper Analytical Services, only 27% of the actively managed mutual funds did better than the S&P 500 last year up to the end of October, while only 16% surpassed the same index in 1995. True, that figure balloons to 45% over a five-year horizon, but moving out to 10 years, it plummets to a disappointing 21%.

It's a mistake, however, to think that all index funds -- even those tied to the same index -- are alike. Even though the 56 funds tracking the S&P 500 soak up $59 billion of the $169 billion invested in index funds, there's a great deal of variety out on the market, covering everything from foreign stock markets to bonds. And within ranks of funds mirroring the S&P 500, you'll find a wide gap in results. For example, Vanguard and Fidelity Equity Index funds posted gains of around 16.5% on a load-adjusted basis through the end of October of last year. However, such rivals as the One Group Equity Index A, the Kent Index Equity, and Mainstay

Equity Index A, lagged in excess of five percentage points, compared with similar index funds that tracked the S&P 500 more closely, according to Morningstar, the Chicago firm that follows mutual fund results.

Experts tie such a large gap to just how lean a fund's management is, more specifically the expenses and fees charged to your gains. The larger the load your fund charges, the wider the gap you'll see between the index's results and your fund's load-adjusted total return. Remember, index funds need a minimum amount of management compared with growth or income funds, simply because index funds buy and hold stocks and don't engage in frequent portfolio shuffling. Jon Teall, a spokesman with Lipper Analytical, says that the best gauge of what your index fund is charging you is the fund's expense ratio, which you can get from Morningstar sheets or from your financial planner. A lean .2% ratio posted by the Vanguard Group (800-205-6189), which invented the first index fund in 1976, is widely touted as the industry standard. Much above that figure, and your fund will stray from the index and fritter away your returns.

Is index investing for you? Teall says your first consideration should be the stocks in the index. "The S&P funds do best when large capitalization stocks have gotten a boost from the economy, and they'll lag behind other funds in years when small companies are doing better in the market." Teall also recommends looking for fund families such as Vanguard and Fidelity (800-544-8888) that allow you the opportunity to switch out of an index when you feel market factors call for it. They also offer you a wide variety of funds to choose from.
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Title Annotation:Mutual Fund News
Author:Anderson, James A.
Publication:Black Enterprise
Date:Mar 1, 1997
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