Index Funds

Are stock index funds, which have had a great two-year run, pushing up the price of blue-chip stocks? Or are the largest companies simply outperforming everything else and, in doing so, driving up the prices of their shares and, as a result, the performance of index funds?The answer appears to be the latter. The top 50 stocks on the Standard & Poor's 500-stock index seem to be pulling the train, with maybe a little push from index mutual funds that have to buy them.Consider that the 500 S&P stocks have a total market capitalization of about $5.7 trillion, according to S&P officials, and that the index fund, pension and other money tied to the index totals about 8 percent of that, or $475 billion.

There will be a raft of exchange-traded funds opening the rest of this year, but chances are that investors should ignore most of the new issues. The expected creation of hundreds of new funds is the logical outcome of two rules proposals, and one rule change, approved by the Securities and Exchange Commission last week. If passed, as expected, after a comment period, the rules will streamline the approval process for ETFs, turning something that was tedious, time-consuming and difficult into a walk in the park.

Investors smitten with mutual funds that mirror the Standard & Poor's 500 index are in for a shock. After spoiling shareholders with five consecutive years of stellar returns, these funds are on pace to lose in excess of 10 percent this year and teach investors the painful lesson that not everything goes up forever - not even the S&P 500, which has seemed invincible despite market swings over the years. Managers who oversee funds that track the S&P, which is made up of 500 large companies that represent all major industries, are already seeing the damage.

Many investors see no shame in being average. That is why more than $548 billion is invested in 287 index mutual funds, according to Lipper Inc. These funds seek to mirror the performance of a given stock or bond index. Nothing more, nothing less. Building a personal portfolio of index funds can be easy or complicated. You can own two or three broad-based funds, or get fancy, owning up to a dozen that track regions or specific investment styles. The passive investment strategy began 36 years ago when Wells Fargo launched the first equal-weighted New York Stock Exchange portfolio for the Samsonite pension plan.

New York -- The most sure-fire stock market investments I know are having a bumpy ride. I'm speaking of "index" mutual funds.For most of the 1980s, the index funds outperformed at least two-thirds of all stock-owning mutual funds that invest for growth, said Morningstar Inc. in Chicago. Last year and the first quarter of this year, though, indexed investments lagged.They can still be fine buys, says John Rekenthaler, editor of Morningstar Mutual Funds. But for certain investments, indexing isn't the way to go.An index fund makes no effort to pick winning stocks.

Go with the flow.That's the logic behind an index fund. Rather than getting fussy with individual stock picks, this increasingly popular instrument seeks to replicate performance of a particular market index by buying representative stocks.Computers make the process happen.Individual investors are jumping on the indexing bandwagon as they seek to diversify holdings. So are large pension funds disgruntled by the fact that only a select portion of portfolio managers consistently beat the market averages.

When 31.7 percent total return of the Standard & Poor's 500 Index topped four-fifths of all equity mutual funds in 1989, many investors decided they could do better by getting into funds that were designed just to match the index, not try to beat it.As they invested millions of dollars in index funds -- especially Vanguard's 500 Portfolio, the oldest and largest -- in hope of doing as well as "the market," other sponsors, such as Dreyfus and Fidelity, started...

What are the top S&P 500 index funds? -Lilya H. Lilya is a woman on a mission: She wants an index fund, and she wants the best. Index funds that share the same benchmark invest in the same stocks. In theory, then, they should deliver nearly identical returns. There are a couple of factors, however, that can push index funds ahead or drag them behind. The most important factor separating the best index funds from the worst is cost. Plain and simple, the index funds with the smallest expense ratios have an automatic advantage over their more expensive counterparts.

Some news stories on index funds make them sound like a one-decision investment. Once you've decided to invest in index funds, you're done. But there are hundreds of index funds to choose from, and they invest in different asset classes. You've still got your work cut out for you after you've decided to go the index route. With that in mind, I've prepared a few simple rules to help you pick the right one. Before you start picking a fund though, you should know what asset class you need.

MUTUAL FUND managers should hang their heads in shame.Last year, only 17 percent of them beat the Standard & Poor's 500 stock index, which tracks the performance of 500 large-company stocks. Worse, less than 5 percent of the fund managers beat the index over the past five years that ended in August 1998, according to a recent study by Morningstar FundInvestor, a publication owned by the Chicago-based mutual fund ratings company.No matter if the managers invested in small-company stocks, real estate investment trusts, bonds or gold, they were whipped when stacked up against the S&P 500.That's why investors have been pouring billions into index funds, specifically the ones that mirror the S&P 500. Last year, they pumped $46 billion into index funds, up nearly 40 percent from the $33 billion they put into these funds in the previous year, and nearly double what they invested in 1996.

Watching the stock market stumble, as it did late last month when the Dow Jones industrial average sank more than 585 points in a week, is unsettling. In one day that week, the year-to-date return on the Dow went from 10.6 percent to 8.1 percent, casting a pall on even the brightest of summer afternoons. It's not uncommon to react to these events: Should you pull your money out of the stock market? Should you search for funds with managers who can find stocks moving up instead of down or opt for low-cost index funds that mirror market benchmarks?

Attention, retirement savers: Your 401(k) menu may be changing. Investment firms are pitching employers on more exchange-traded funds, target-maturity funds, annuities and index funds based on new benchmarks as competitors vie for the $2.4 trillion 401(k) market. Two recent examples: ETF provider WisdomTree Investments formed a new business unit for the 401(k) market, and Schwab Funds launched a suite of index funds based on new benchmarks that will be targeted in part for corporate retirement plans.

The financial adviser was on the air and on a roll, telling anyone listening why he likes actively managed mutual funds and dislikes index funds. Out came the statistics about how, since the stock market peaked, a large percentage of active funds have beaten their indexed peers. And in listing a few of his favorite funds - including a couple with alarmingly high expense ratios - he brought out the big guns. "Yes," he said as his voice rose to a crescendo, "index funds are much cheaper, but it's the same thing in mutual funds as it is with everything else in life, and I learned from my father 30 years ago that `You get what you pay for.'" Actually, in mutual funds, about the one thing of which you can be certain is that you get what you don't pay for, since the money you don't pay in higher costs stays in your account.

If you've ever been the parent of a teenager, you know that it's a bad idea to read too much into any single day. When your normally angelic kid has a devil of a day, it's important not to overreact and to see if the behavior is an anomaly or the start of a trend. That same kind of thinking typically can be applied to the stock market and mutual funds. So when the market had its biggest down day since September 2001, and the eighth-biggest point drop in the history of the Dow Jones industrial average, the standard advice was to push on. But just as a watchful parent looks for clues during those peak days for what sets their children off, so should the diligent investor look at the market's move last Tuesday to see if it holds any hints that could lead to long-term happiness or disappointment.

Most people shouldn't have credit cards. They allow you to spend money you don't have. Supposedly they are good for emergencies, but what is an emergency? That plasma TV is on sale and you don't have the money? About a year ago, I paid off all credit-card debt and now use only a debit card. I am much more aware of how much I spend and think twice about unnecessary purchases. Before, I got in the expensive habit of carrying a balance. About 85 million Americans, or nearly 60 percent of all card users, carry a balance, according to recent industry estimates.

I've made my list and checked it twice, and because picking on the naughty is always so nice, here is the second installment of the 2006 Lump of Coal Awards. Lumps of Coal go to mutual fund managers, executives, firms, watchdogs and others who deserve nothing more than an inky chunk of carbon in their Christmas stocking this year. They earned that distinction in 2006 as a result of action, attitude, performance or behavior that is offensive, disingenuous, duplicitous, reprehensible or just plain stupid.

Sometimes average is beautiful.Index funds, which try to duplicate the performance of a given set of stocks such as the Standard & Poor's 500, appeal to investors who simply want the market's average.This "no-brainer" approach is gaining in appeal.Over the past decade, the Vanguard Index Trust 500 Portfolio turned in an average annual return of 15.5 percent, compared with the average growth and income fund's return of 12.90 percent.That's not to say some of the better growth funds didn't do even better, especially when the market was hot, but index funds never do much worse than average either.

INDEX mutual funds are the easiest answer for those overwhelmed by investment choices or too busy to keep a frequent eye on their portfolio. These funds basically imitate the performance of an index. So, if you buy an S&P 500 index fund, you can count on getting returns similar to the benchmark for the 500 largest U.S. companies. When the market goes up, or down, your fund shares go right along. But even this simple choice has become increasingly complicated, and financial experts advise investors to do their homework before buying an index fund.

If you like the ease of index investing, you would think investing throughout the world would be a snap. Instead of worrying whether you had too much or too little exposure to developed countries or emerging countries, you'd pick one index for the entire world and be done with it. That single fund would give you everything you needed - one investment that would allow you to partake in the world economy. But international investing has been more complicated than that. Unlike the U.S., where you can invest in the Dow Jones Wilshire 5000 index or MSCI Broad U.S. Market index and have the full array of U.S. stocks in one mutual fund or exchange-traded fund, international investing with indexes doesn't allow one-stop shopping.

Imagine hedge funds without brainy managers maneuvering artfully through short-lived market opportunities day in and day out. You might think the flashy hedge-fund arena could never evolve into this. But with about $1.2 trillion in assets, the industry is maturing. And as it does, analysts are looking for ways to capture the advantages of hedge funds without the tremendous fees and egos that go with the territory. Attention is turning to what is known as passive investing. That's the term that applies to index mutual funds, and that means setting up a portfolio and keeping it intact without human tinkering day to day. What's envisioned for hedge funds tends to be somewhat different than mutual funds.