Insurance companies licking their chops
- Alan Lavine and Gail Liberman
Although reports have indicated that some actively managed funds have outperformed index funds in recent years, we still like index funds.Reason: They're a low-cost way to invest and you don't have to do much thinking to be successful.
They sport among the lowest annual expenses because they generally keep invested in the same basket of stocks. By not trading much, they can't generate too much in the way of hefty commissions. Also, taxes tend to be low.
There are index funds that track the following stock indexes:
S&P 500. This is an index of 500 large companies traded on the New York Stock Exchange.
Wilshire 5000. This is an index of the broad stock market, including large, medium size and small company stocks.
MSCI EAFE. This index tracks the Europe, Australasia, and Far East (EAFE). It is a common barometer for international stock markets.
The Russell 2000 tracks the small company stock market.
Historically, index funds have outperformed the vast majority of actively managed stock funds. That's because actively managed funds charge more than 1 percent in annual expenses. By contrast, you can pay expenses as low as, say, one-quarter of one percent with certain Vanguard Group index funds. This, over time, can mean a lot more cash in your pocket.
The great drawback to index funds: There is nowhere to hide when the markets decline. You're always fully invested.
Actively managed funds, however, may change holdings based on indicators to reduce a fund's losses in down markets. In addition, actively managed mutual funds typically keep about 3 percent to 5 percent in cash investments.
So how can you get the most mileage out of your index funds?
- Keep in mind that the most popular indexes are for stock funds. Be sure you also own index funds that invest in bonds, or other investments that will cushion the blow of a stock market decline.
- Practice portfolio rebalancing. Every year make sure you have the same percentage mix in different types of index funds you hold.
- You might consider some tactical or strategic asset allocation. Have a system in place that tells you when to invest different index funds. For example, a system may tell you that U.S. small company stocks have higher expected returns in the future. As a result, you should put more money in U.S small cap funds.
- Consider hiring a money manger that has a good long- term track record managing index funds. But keep in mind that this action will add at least another 1 percent annually to your expenses.
- Beware that not all index funds alike. Some may charge significantly more in annual expenses than others. Also other terms, such as exactly when a stock or bond gets replaced from an index, may vary.
- When you calculate how much you have invested in a particular index fund, don't exclude your retirement accounts.
Spouses Gail Liberman and Alan Lavine are syndicated columnists. You can purchase Alan Lavine & Gail Liberman's latest book Quick Steps to Financial Stability (QUE Publishing 2006) online at www.moneycouple.com or at your local bookstore. E-mail them at MWliblav@aol.com.
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