A new government regulation (1994) now requires mutual funds must provide information for at least 10 years or the life of the fund if shorter and compare it against the returns of an index fund.

Some indexes are fairly known such as the S&P and Dow Jones. Your basic growth funds can be compared against those. However there are many other indexes that can be used for the specific funds investment criteria. Here is a review of many (Founders Funds Focus):

Dow Jones Industrial Average: this tracks the prices of 30 widely traded, blue chip companies traded on the New York Stock Exchange. They represent only about 2% of the total number on this exchange but comprise about 25% of its value. The DJIA is price weighted- that is that a high priced stock moves the average more than a low priced stock. Considering stock splits, dividends, etc., it really is not considered a true barometer of the movement of the marketplace- though it does get fairly close. But since it is the most well known, at least for now, all newspapers, analysts, commentators and the general public want to hear its movement first.

S&P 500: This is one of the best leading indicators of what the economy is expected to do in the future. It covers the 500 industrial, utility, transportation and financial stocks of the New York and American exchanges and the NASD Over the Counter Market. It represent about 80% of the value of the NYSE. The S&P is capitalization weighted- each stock's price is multiplied by the number of outstanding shares. This gives better capitalized blue chip stocks more weight in the index regardless of share prices. It is most applicable as an index to growth funds- particularly those investing in large blue chip companies.

NASDAQ COMPOSITE: This index covers all the roughly 3,500 stock traded over the counter. It uses capitalization weighing and better reflects smaller and less well capitalized stocks on the NYSE or AMEX.

VALUE LINE COMPOSITE: It is an index of about 1,700 NYSE, Canadian, OTC, regional exchanges and NASDAQ stock that is unweighted. The component is simply an average of their prices. This increases the value of the composite in monitoring small and mid cap stocks since they are not overshadowed by large cap stocks. It is considered a good barometer for aggressive growth funds.

RUSSELL 2000: this is a capitalization weighted index of the bottom 2,000 of the 3,000 of the largest capitalized U.S. securities. Average capitalization of $300 million. It is one of the most widely followed indexes for small capitalization stocks. Two sub indexes measures the performance of growth or value stock within the Russell 2000 giving growth or value investors the opportunity for even tighter comparisons.

WILSHIRE 5000 EQUITY: This is the broadest based indicator. It's capitalization weighted index includes literally all the actively traded U.S. issues- NYSE, American exchanges plus NASDAQ. The Wilshire 5000 capitalization is about 81% NYSE, 2% AMEX, and 17% OTC.

International Indexes

There are two Morgan Stanley Capital International (MSCI) benchmarks.

The MSCI WORLD INDEX is a value weighted global average of 1,472 securities listed on the exchanges of U.S., Europe, Canada, Australia, New Zealand and the Far East.

The MSCI EAFE INDEX is a market value weighted average but it omits U.S. securities and represents the stocks of Europe, Australia, New Zealand and the Far East. Covers about 1,100 international issues and is a good benchmark for international investing.


Lehman Bros has six broad indexes. They include all investment grade (BBB and above) issues with at least one year to maturity and outstanding par value of at least $100 million (US Government) and $50 million for all others. Each index is market value weighted and includes the value of accrued interest. The indexes range from those measuring a particular bond market sectors such as Corporate Bond Index or Treasury Bond Index to indexes created by combining the various sector indexes. For example, the Lehman Brothers Aggregate Bond Index comprises the Lehman's Government/Investment Grade Corporate, Mortgage Backed Securities and Asset Backed Securities Indexes. It is most applicable for funds that invest in domestic, corporate or U.S. Government bonds.

MORE INDEXES: (Mutual Fund Forecaster) People are familiar with the S&P, Dow Jones and possibly the Wilshire and a few others. Here are some more definitions

1. Total Return Index is an equally weighted index of all NYSE listed stock. The TR index is updated each day by adding to its value the average percentage change of every NYSE stock during the day. It's available on Quotron.

2. Trend Change Index measures whether the market's performance today is better than it was yesterday. For example, if the Total Return index was down yesterday but up today, then the trend change index would be positive

3. Final NYSE Tick indicators whether the last price change of a stock was up or down. If, for example, the most recent change for 1,000 NYSE stock was up while 600 were down, then the net index would be a positive 400. Positive readings at the end of the day tend to be followed by a positive market the next day.

4. DJIA last hour change. This is similar to the above- though it involves far fewer stocks overall.

5. DJIA Close/Range Index is an analysis of the Dow's daily high and low. If the Dow closed the day in the upper half of the high low price range for that day, then it should carry over to the next day.

6. Advance/Decline ratio measures the performance of every stock on the NYSE. However, it is only interested in whether the stocks rise or fall- not the magnitude.

7. Up/down volume is similar to the advance decline. But instead of whether stocks went up or down, it simply shows whether the volume of stocks trading up was greater than the volume of stocks trading down.

8. Short term trading index relates the average trading volume of declining stocks to the average trading volume of advancing stocks.

9. Seasonality indicator relates to three specific trading days during the year. If they are positive, then the prognosis for stocks may be go. First, the market tend to rise across a five consecutive trading day period each month, consisting of the last trading day of the month plus the first four trading days of the ensuing month. Second, the market has a upside bias in both of the two trading sessions preceding a market holiday closing- Christmas, New Years, etc. Third, the market rise on a Friday at a greater frequency that any other day. . If any one of these components are in effect tomorrow, then the seasonality indicator is favorable. If none of these three conditions is in effect tomorrow, the odds are less than 50-50 that the market will be up tomorrow.

The supposed odds are

Bullish Forecast

Daily Indicator Indicator Today Probability of rise tomorrow

Total Return up 68%

Trend Change positive 66

Final NYSE positive 74

DJIA Last Hour up 64

DJIA close/range upper half 67

Advance/decline above 1.0 69

Up/down volume above 1.0 69

Short Term Trade below 1.0 67

Seasonality favorable 63

Bearish Forecast

Daily Indicator Indicator Today Probability of drop tomorrow

Total Return down 63%

Trend Change negative 55

Final NYSE negative 58

DJIA Last Hour down 56

DJIA close/range lower half 59

Advance/decline below 1.0 60

Up/down volume below 1.0 64

Short Term Trade above 1.0 64

Seasonality unfavorable 53

INDEXES: (Kiplinger's) Here are some indexes as of August, 1995. The Dow is included since it is what a lot of people focus on, but primarily you look to the S&P.
One year Three years Five years
S&P 500 26.0% 13.0% 12.0%
Dow Jones 29.2 14.4 13.0
Russell 2000 20.1 16.5 12.9
Russell 3000 24.9 13.5 12.5
Morgan Stanley EAFE* 2.0 13.0 5.0

* International Funds (Europe Australia Far East)

AVERAGE MUTUAL FUND: The average mutual fund does not do all that well when compared against the S&P 500 index. For 10 years through 1991, a U.S. diversified stock fund did 15.69% versus the S&P 500 at 17.52%. Admittedly 15.69% isn't shabby, but if you had $100,000 in a kitty at the beginning of the period, the diversified portfolio would have returned $429,495 (compounded annually) versus the S&P at $502,479. That's $72,983 more.

S&P 500: (1996) Is the S&P 500 index- the most commonly used index for gauging other fund returns- and, old staid and stodgy index? Not quite. The committee that oversees the index has made 46 changes in this component stocks since the start of 1995, many due to mergers and acquisitions. Standard and Poors says it chooses companies not because they are the largest companies in terms of market value, sales or profits. The companies that are chosen tend to be the leading companies in the leading industries. One analyst noted that the S&P 500 is less cyclical and more diversified- both sectorially and geographically than it was a generation ago. Back then it was cyclicals, energy and utilities and today its global consumer brand franchise companies that predominate.

So does that mean that the average S&P 50 index fund changes its stock portfolio frequently? Nope, because few funds buy all 500 stocks? They buy maybe 50 stocks that mirror the index overall and simply adjust those. Therefore, the lack of changes make it (and many index strategies) a good "taxable" fund for the long haul.

ENHANCED INDEX FUNDS: (Ibbotson Associates) There are about eight funds that have attempted to show that the returns of the basic index fund could be greater if one was able to eliminate the obviously weak stocks or by using derivatives. But Ibbotson's study said they didn't do all that well- and didn't mirror the index that well either. Three actually did beat the index, but it was impossible to determine whether it was luck or skill. The kicker was they also had more risk. This is a very worthwhile study that was buried in minutia in a financial magazine. I had considered using these funds in the past but couldn't really determine if they were worth while.

S&P 500: (Forbes 1997 ) Standard & Poor's estimates that up to 8% of the U.S. stock market's $9 trillion in total capitalization is indexed as of 1997, up from 7% of $4 trillion five years ago. Most of that money is in institutional funds like pensions, but a lot of individuals have bought these funds during the last few years. Apparently, about 20% of the money going into mutual funds up through March of 1997 went into indexed funds. That's up from less than 3% in 1994.

The S&P 500 is an index weighted by market capitalization rather than weighted equally among all 500 stocks. That means the most popular stocks account for the bulk of the index. Though there are 500 stocks in the index, the stocks at the top — Coca-Cola, Philip Morris, Microsoft — have a weighting several hundred times that of stocks at the bottom such as Alexander & Alexander, Armco and Giddings & Lewis. The standard deviation of the index, measured by the Vanguard 500 index fund, was 10.2% over the past five years. That translates into a normal daily movement of 0.6%. Over a more recent period- the past three years- the standard deviation has climbed to 11.6%. In 1996 the S&P 500 moved up 1% or more on 21 trading days and down 1% or more on 17 trading days. That's three times the number of days experiencing a 1% move in 1995.

That said however, one must realize that the deviation in the 90's has been considerably less than the historical averages and that we may be simply returning to the mean.

500 INDEX: (1997) Of the 500 stocks in the S&P 500, 100 of the largest accounted for 75% of the entire index's return. (Top 100 returned 23.4%, next 400 returned 15.2%) A total of just 6 stocks provided 1/5th of the indexes total 20.1% return through June. The average S&P stock managed "just" a 17% increase. The average stock equity fund earned a much lower 13% return

S&P 500: (BW) (1998) The companies represented in the index do not have as much impact today as they  did years ago. "In 1998, the S&P 500 companies represented 67% of the total U.S. stock market capitalization and the top 20 companies accounted for 29% of the index. In 1964, the S&P comprised more than 90% of the market's capitalization and the top 20 made up almost 50% of the index. In 1964, GM was ranked number 2 with 7.3% of the S&P's market capitalization. Microsoft is now number 2 but with only 2.4% of the S&P."

MANAGED FUNDS: From 1971 to 1995, approximately 65% of all managed funds underperformed the S&P 500. Now the pundits of managed funds say that their funds will lose less in a down market than the S&P 500 because they can shift into other asset classes and their portfolios include some cash holdings to temper losses (actually the cash was one major reason why, everything else being equal, they also earn less in an up market- they are NOT invested in stocks!). So how did they do in the terrible market of 1973 and 1974 when the S&P 500 lost 42.5%? Managed funds lost even more at 47.9%. And guess what? The same thing happened in this most recent down market. So actively managed funds do poorer overall in an up market and poorer overall in a down market. That is NOT to say that you cannot/should not use them. But you have to understand their place and the return ramifications.

There is some more commentary regarding index versus actively managed mutual funds that comes from Dow Jones Investment Adviser, April 1998.

One had to do with the style shifting of actively managed bonds. Managed funds have a tendency of investing in various classes of stock-say for value, growth, large cap, small cap, etc.-"in the quest for market beating performance". The article specifically referenced the last ten years of Fidelity Magellan. Apparently "some asset classes entirely disappeared from its holdings while other showed significant percentage fluctuations". That certainly was clear during the tenure of Jeffrey Vinik who had invested heavily in bonds at a time when they simply did not produce. The new manager sold most of that position. The article elaborated "that actively managed portfolios often experience significant and predictable shifts in their investment style or composition. It is therefore extraordinarily difficult to estimate the risk in return levels of an actively managed portfolio."

The article concluded that index funds are the best choice for implementing an asset allocation portfolio. The factors noted were

1. Low portfolio turnover and this can be reviewed by simply going to Morningstar site and checking the statistics. Most of the index funds will have a turnover rate of around 5%- some even less.

2. You have a relative certainty of achieving the expected return of an asset class since an index fund will not change its asset class. You know exactly what you are invested in at all times (with minor revisions as the index is changed annually to reflect new stocks that mirror the index better). Managed funds- as stated above- drift in their categories. (Yes, I am aware that the prospectus says what a fund "supposedly" will be. But if you read the extended commentary therein, you will find an exceptional latitude that the manager has.)

3. The costs for managing an index portfolio is universally significantly less than anything else offered by managed funds. Again I refer you to Morningstar where you can check the fees of thousands of funds. Then go to Vanguard's site and compare.

4. Index funds maintain full diversification of their portfolio-meaning that they will have far more than 15/20 stocks in the portfolio- sometimes from 50 to 100 or more. While most managed funds also maintain reasonable diversification, many newer funds have been noted for utilizing few stocks with very similar correlations. That does not make them bad in their attempt on trying to "hit a home run", but you need to recognize that the risk is significantly greater in a non-diversified portfolio.

5. Index funds are almost always fully invested versus many managed funds which universally maintain a cash position- sometimes fairly large in order to pay off investors or because they're attempting to market time the stock market. But as defined initially, such activity has not statistically nor consistently beat the S&P 500.

THE QUARTER DOESN'T MAKE ANY DIFFERENCE: (1998) "Bloomberg News reports that only 19% of actively-managed stock funds beat the S&P 500 Index in the first quarter of the year. That makes 4-1/2 years during which most active fund managers haven't kept pace with the S&P index." Another quote indicated that only 90 out of 1022 U.S. diversified mutual stock funds beat the S&P 500 over the last 5 years.

What's missing from that report is that they are not even talking about the SAME managers. So a manager might beat the S&P once, but never do it again or so infrequently that it would be statistically impossible to depend on.

Further, such managers must do it time and time again if they want to keep their jobs in this highly "What have you done for me today?" reporting. For example, the John Hancock Special Equities averaged 18.5% over the last ten years but had moved wildly in doing so. It returned a negative return in the beginning of the year and the manager was fired. And remember what happened with the Von Waggoner funds? He starts his own firm after considerable success elsewhere and then burns his funds terribly. Such volatility is not for the feint of heart- but I bet a lot of conservative people bought these thinking they could always best the market averages. As one analyst put it with high volatility funds- "you either have to buy them and forget about it, or actively trade it. Most people can't trade funds and make money at it." Read that again- Most people can't trade funds and make money at it.

HOW TO EARN MONEY IN A LOSING MARKET: (1998) The top 50 stocks of the S&P 500 were what was driving the market (through 7/8/98, the top 50 returned 29.5%). The next 450 earned just 10.4%. The smallest of the 500- numbers 401 to 500- actually lost money (remember this was before the major market drop). So why not pick just the top 50? Because many of the top 50 that were, ain't. It's always changing. So it's just best to pick the whole bunch and go for the ride.

INDEXES: (1999) (FED Board of Boston) The Dow Jones 30, S&P 500 and the Wilshire 5000 have high correlations among themselves and all have a beta coefficient less than one relative to the market, indicating that these indices represent relatively conservative investments with lower volatility. The NASDAQ composite and the Russell 2000 have higher correlations with each other than with the other three indices had have beta coefficients greater than 1.0 indicating that they represent relatively aggressive investments with above average volatility.

TOTAL RETURN VERSUS CAPITAL APPRECIATION: (1999) (BOSTON FED) When you look at the return of an index, you almost focus exclusively on that current number without addressing the total return available over time. You should add in any dividends are being paid. The Federal Reserve Board of Boston addressed the issues noting that, "each of the indices examined is an index of prices allowing one to determine the rate of capital appreciation , BUT NOT TOTAL RETURN. Over long periods, cash dividends are a significant component of the value of stocks. While it is true that attention is drawn to the rapidly moving hare of stock prices, the slow but steady tortoise of reinvested dividends is a very important component of wealth." (paraphrased)

"According to the Frank Russell Company (1998), the median dividend for the Russell 2000 was zero while the median dividend yield for the S&P 500 was 1.36%. The focus of indices on prices rather than accumulated values (the inclusion of dividends) can distort our view of relative performance!"

MANAGED FUNDS: (1999) Morningstar found that 273 out of 294 actively managed equity funds underproduced the S&P 500 index. That's why it is awful tough not to consider its use. That, however, is not to say you do not use managed funds. Some have lower levels of risk- hence, traditionally, a lower return. Some focus on an area of investing- say technology- where greater returns might be possible (though I am not a fan of Internet stocks which are WAY overpriced). But people get carried away by their supposed innate capability of choosing the best funds a the right time in concert with economics. You are just kidding yourself. Read the first sentence again. The key word is underproduced.

INDEXES: (1999) There are index funds and then there are index funds. The S&P 500 did 21.83% for 1998 (WSJ)
Index 1 Year Tax Adjusted Expenses
Blackrock Index Equity 20.11 19.90 1.38
Dreyfus S&P 500 21.16 20.88 0.50
Mason Index 21.13 19.46 0.85
Morgan Stanley S&P 500 20.15 21.05 1.50
Scudder S&P 500 21.50 21.05 0.40
Stagecoach Equity 20.01 18.91 1.45
Vanguard S&P 500 21.81 21.10 0.18

S&P 500: (1999) Market value of all 500 companies= $10.7 trillion

Average market value- $21.4 billion

Median Market Value- $8.7 billion

Biggest- Microsoft at $440 billion

Smallest- Foster Wheeler at $560 million

Portion of Index represented by the 25 largest companies- 38%

Technology and telecom companies among the 25 biggest  S&P stocks- 10

Portion of Index represented by the 50 smallest stock- 20.3%

Largest U.S. company NOT in S&P- Berkshire Hathaway

Number of  Nasdaq listings in S&P 500- 39

Number of American Stock Exchange in S&P 500- 1 (Hasbro)

ACTIVE MANAGED EMERGING MARKET FUNDS: (Burton Malkeil 1999) Active management is considered viable where there are enough inefficiencies in the market (or section of the market) so that an astute manager can find the stocks to use. He, however, says that the added costs of finding such stocks in an emerging market situation clearly overwhelm any benefits and that one should still use an index.

"The 164 actively managed emerging-market funds tracked by Morningstar Inc. fell 26.9% last year, far more than the 18.2 % loss by the Vanguard Emerging Markets Stock Index fund, the only emerging-market index fund tracked by Morningstar "The real question is not whether the market is inefficient or not, it's whether you can overcome any inefficiency and add value beyond the costs of obtaining information and the bid-offer spreads. That is probably why active managers fail in the emerging markets," said financial author Larry Swedroe. "In aggregate, active managers can't get out of the market. For everybody who gets out, there's somebody who must get in."

Probably true in many time frames, but consider this. The Asian indexes universally included Japan. And because Japan has been in recession for years, your return with such funds has been abysmal.

S&P 500 Returns (1999)  

Date Return(%)12/88 1.745%      01/89 7.323%         02/89 -2.492%

03/89 2.333%    04/89 5.192%       05/89 4.046%     06/89 -0.567%      07/89 9.029%

08/89 1.955%     09/89 -0.406%    10/89 -2.322%    11/89 2.039%       12/89 2.401%

01/90 -6.714%    02/90 1.288%     03/90 2.650%     04/90 -2.495%      05/90 9.751%

06/90 -0.675%    07/90 -0.321%     08/90 -9.039%    09/90 -4.867%  10/90 -0.426%

11/90 6.464%    12/90 2.786%      01/91 4.355%      02/91 7.152%      03/91 2.422%

04/91 0.237%      05/91 4.314%    06/91 -4.581%     07/91 4.661%     08/91 2.369%

09/91 -1.673%     10/91 1.344%     11/91 -4.029%    12/91 11.437%   01/92 -1.863%

02/92 1.295%     03/92 -1.945%     04/92 2.936%      05 /92 0.490%   06/92 -1.488%

07/92 4.085%      08/92 -2.047%     09/92 1.175%    10/92 0.345%    11/92 3.405%

12/92 1.227%      01/93 0.836%      02/93 1.363%    03/93 2.110%     04/93 -2.417%

05/93 2.675%      06/93 0.293%     07/93 -0.402%     08/93 3.794%    09/93 -0.767%

10/93 2.069%      11/93 -0.953%   12/93 1.209%0       1/94 3.400%   02/94 -2.714%

03/94 -4.360%      04/94 1.282%    05/94 1.641%      06/94 -2.451%  07/94 3.284%

08/94 4.100%      09/94 -2.445%     10/94 2.247%     11/94 -3.642%  12/94 1.483%

01/95 2.593%      02/95 3.897%       03/95 2.951%       04/95 2.945%   05/95 3.997%

06/95 2.323%      07/95 3.316%       08/95 0.251%      09/95 4.220%   10/95 -0.357%

11/95 4.390%      12/95 1.926%    01/96 3.404%        02/96 0.927%   03/96 0.963%

04/96 1.474%      05/96 2.579%    06/96 0.381%       07/96 -4.418%    08/96 2.109%

09/96 5.628%      10/96 2.758%    11/96 7.559%      12/96 -1.981%     01/97 6.248%

02/97 0.784%      03/97 -4.109%   04/97 5.970%       05/97 6.088%      06/97 4.480%

07/97 7.957%       08/97 -5.602%  09/97 5.477%    10/97 -3.340%     11/97 4.629%

12/97 1.717%      01/98 1.106%    02/98 7.212%      03/98 5.121%      04/98 1.006%

05/98 -1.719%     06/98 4.062%     07/98 -1.065%    08/98 -14.458% 09/98 6.406%

10/98 8.134%      11/98 6.061%    12/98 5.762%       01/99 4.182%   02/99 -3.108%

03/99 4.001%      04/99 3.873%    05/99 -2.361%      06/99 5.550%    07/99 -3.122%

08/99 -0.495%     09/99 -2.741%   10/99 6.328%        11/99 2.033%

S&P 500: (NY Times 2000) Not too long ago, two out of three funds beat the S&P 500- though that still does not say they repeat. One analyst suggests that it is due to how the S&P 500 index has changed

"... research shows that since 1994 the S&P 500 has become dominated by "new-economy" stocks, those in health care, technology, telecommunications, financial services and consumer services companies. While such companies made up roughly 60 percent of the index in 1994, they made up almost three-quarters of it at the end of last year."

So you now have the index far more heavily weighted in technology and consumer services rather than transportation and utilities- about 75% most recently. The MidCap 400 however is only about 56% in these type stocks.  

"Because of its market capitalization weighting the S&P is an index that day by day owns more and more of the stock market's stars and fewer of its duds."

"In the first quarter the top 18 stocks accounted for 100 percent of the S&P's 5 percent rise. That means the remaining 482 stocks added nothing to the index's return. Sixty percent of the stocks in the 500 underperformed the index's 5 percent return in the first quarter, while 55 percent lost ground in the period."

Another comment from Morgan Stanley is worth noting- " Money managers do not typically weight their holdings based on market capitalization, as an index does, and therefore are unable to mirror the index's performance; and even large-capitalization fund managers are likely to have larger holdings of slightly smaller-capitalization stocks than the S&P index holds. This means that even those managers who have been investing in large-company stocks recently have been tarred by the investor bias against smaller companies."

In the first quarter of 1999, 73% of the $24 billion that Americans put into equity mutual funds flowed into index funds. It's slowed recently, but still vibrant.

Will this last forever? No. But I will warn you once again regarding the fact that if a manager does beat the index, you need to ask if it was due to a higher risk overall. Secondly, and most importantly, can it do it again and again and again and again? The answer is almost always NO. That does not mean you need to use index funds exclusively since sometimes they can put you into a bad situation. (Think about Far East indexes that had to use Japan while it was sinking.) Nonetheless, the changing economic scenario and the fact that the S&P 500 index is now more on the cutting edge of technology gives it an impetus that may bode well for many years yet. Large companies are no longer neither staid nor slow.

LOAD AND NO LOAD FUNDS:  (Dr. Paul B. Farrell 2000) "....the many ways mutual fund returns are overstated by this tacit conspiracy of fund managers, brokers, professional planners, and, unfortunately, by an often unwitting and naive financial press more interested in ad dollars and circulation than their integrity as an advocate of the individual investor:"

1. returns totally ignore sales charges

2. fund returns ignore increasing expense ratios

3. they ignore risk factors between funds

4. they minimize the impact of taxes

5. statistical problems in multi-year comparisons

6. they fail to account for hyperactive turnover

7. they don't reveal gimmicks used by new funds

Then look at the chart below for the verifying numbers.
      1. EQUITY RETURN (1983-1998) 16.9 %    
      2. SALES COMMISSION ON LOAD FUNDS (annual impact) -0.5 %    
      3. CASH DRAG -0.6 %    
      4. FUND RETURN 15.8 %    
      5. TRANSACTION COSTS -0.7 %    
      6. EXPENSE RATIO -1.2 %    
     7. INVESTOR'S RETURN 13.9 %    
      8. TAXES -2.7 %    
      9. INVESTOR'S AFTER-TAX RETURN 11.2 %    

Indexing is not prefect. Being in the wrong index fund- most notable being the Far East indexes with Japan- do not service the client well. But your core funds should be here. Cheap and with very low turnover. The difficulty is not the funds themselves but which ones to use. The suggestion for the Total Market fund is valid if you are willing to accept avenge returns. But none of my clients is "average".

INDEX OR MANAGED: (2000) "Some industry analysts say that the time has long passed when investors could simply choose between an index fund and one that sought to beat the market through smart stock-picking. Now, if they pick the actively managed route, they must choose between funds that hang close to the index or those that theoretically could significantly outperform it -- or, of course, lag behind it by a wide margin."

USA TODAY INTERNET 100 INDEX LINK:  The USA TODAY Internet 100 is a capitalization-weighted index that consists of the E-Consumer 50 and the E-Business 50. It also reflects seven specialized sub-indexes of the Internet economy. The indexes are benchmarked at 100 as of June 30. The components are updated quarterly.

NASDAQ INDEX LINK:   Information on the new- Nasdaq-100 Index Tracking Stock       QQQ

SPDR's, WEBS and more

SPDRS - Standard & Poor’s Depositary Receipts       SPY
Based on Standard & Poor’s 500 Composite Stock Price Index®

MidCap SPDRS - Standard & Poor’s MidCap 400       MDY
Based on Standard & Poor's 400 Mid-Cap Index

Select Sector SPDR Fund
(click on name for components)

Ticker Symbol

Basic Industries Sector XLB
Consumer Services Sector XLV
Consumer Staples Sector XLP
Cyclicals/Transportation Sector XLY
Energy Sector XLE
Financial Sector XLF
Industrial Sector XLI
Technology Sector XLK
Utilities Sector XLU

DIAMONDSSM - Dow Jones Industrials        DIA
Based on the Dow Jones Industrial AverageSM (DJIASM)


Australia EWA
Austria EWO
Belgium EWK
Canada EWC
France EWQ
Germany EWG
Hong Kong EWH
Italy EWI
Japan EWJ
Malaysia (Free) EWM
Mexico (Free) EWW
Netherlands EWN
Singapore (Free) EWS
Spain EWP
Sweden EWD
Switzerland EWL
United Kingdom EWU

Index Name Symbol
Broad Based Index
Morgan Stanley Consumer Index CMR
Morgan Stanley Cyclical Index CYC
S&P MidCap Index Options MID
Institutional Index XII
Major Market Index XMI
International Indices
Hong Kong Option Index HKO
Japan Index JPN
Sector Indices
Biotechnology Index BTK
Morgan Stanley Commodity R CRX
CSFB Technology Index CTN
Disk Drive Index DDX
Pharmaceutical Index DRG
Deutsche Bank Energy Index DXE E-commerce Index ICX
Inter@active Week Internet Index IIX
Morgan Stanley Internet Index MOX
Morgan Stanley High Technology MSH
Airline Index XAL
Securities Broker/Dealer Index XBD
Computer Technology Index XCI E-finance Index XEF
Natural Gas Index XNG
Oil Index XOI

7/10: Can you buy Index Funds for just $25???  (2000)
Minimum Investment
Expense Ratio
1-Year Return
Average Annual Return Since Fund Inception
American Century Equity 500 Index
S&P 500 Index
$50/month automatic plan; min./$10K otherwise.
13.34% (since 2/26/99)
Strong Dow 30 Value
50% assets mirror the DJIA 30 stocks. Other 50% is chosen from Dow 30.
$50/month automatic monthly plan; Regular indiv. Account $2500/ IRA $250
16.61% (since 12/31/97)
Strong Index 500
S&P 500
$50/month automatic monthly plan; Regular indiv. Account $2500/ IRA $250
25.30% (since 5/1/97)
TIAA-CREF Equity Index Fund
Russell 3000 Index
$25/ month automatic plan/ $250 individual account
0.26% (reflects partial waiver through 7/1/2003)
-2.21% (since 4/3/2000)
Transamerica Premier Index Fund
S&P 500 Index
$50/month automatic plan
25.0% (since 10/2/95)
T. Rowe Price Equity 500 Index
S&P 500 Index
$50/month automatic plan; $2500 indiv., $1000 IRA regular plan
18.44% (since 3/30/90)

Indexing?: (NY Times 2000) Russ Wermers, a finance professor at the University of Maryland -- concludes that fund managers have market-beating abilities in picking stocks in that the average stock bought by a fund manager outperformed the market by 1.5 percentage points a year over the 20 years ended in 1994.

But the average fund delivered annual returns that were eight-tenths of a percentage point below the market's over that period. Taken together, the two facts mean that the average mutual fund frittered away 2.3 percentage points of return annually. The largest single source of fund inefficiency was expenses -- investment managers' salaries and administrative and marketing costs. Roughly 1.1 of the difference of 2.3 percentage points was spent on such costs. The second-largest source is the lower returns of funds' nonstock holdings. The typical fund must hold a significant amount of cash so that it can meet redemptions. Because returns on cash lag behind those of the stock market over the long term, the typical fund has weaker performance than if it had been fully invested. Professor Wermers estimated that these cash and other nonstock holdings cut the average annual return by 0.7 percentage points.

The third reason for the gap is transaction costs. Professor Wermers estimated that transaction costs of all kinds reduced performance by 0.5 percentage points or so a year. The study did not even consider front- or back-end loads, or sales charges.  

Pensions 2000: In 1999, according to Pensions and Investments, 23% of institutional investment cash was indexed.

* Some mutual funds have indeed outperformed indexes over long periods of time, but the number of outperforming funds is no different than what we would expect from random chance. This does not prove that mutual fund performance is random, but it does mean that we cannot disprove that relative performance is based on luck. More importantly, the seemingly random pattern to mutual fund returns indicates that there is no consistent means of selecting mutual funds which will outperform in the future.

Cavanaugh Capital Management


These graphs illustrate the results of Cavanaugh Capital Management Study. The red bar represents the percentage of time a fund improved its ranking the year after landing in the top quartile. The green bar shows the percentage of funds that dropped in the rankings.

The blue bar represents the percentage of funds that did not remain in the top 25%. The yellow bar represents those that did not even remain in the top half.

Index changes: (NY Times 2001) Morgan Stanley Capital International is overhauling its products, from its local indexes for countries from Italy to Indonesia, to its broad international and global indexes, including EAFE (Europe, Australia and the Far East) and the World Index. It is deducting from its indexes the part of a company's stock that is not available to investors, including the shares held by a government and by other companies. The indexes will also be broadened to cover 85 percent of the shares in public hands in each industry, instead of the 60 percent of the old calculation of market cap.

Indexing: (2001) conducted a study of Wall Street analysts by hypothetically carrying out their research recommendations, buying on the upgrades and selling on the downgrades. Investars conducted this experiment on 19 companies. The results?

During the time Investars ran its research (January 1997 to June 2001), the S&P 500 gained 75%. But the best Wall Street firm — Credit Suisse First Boston — returned just 6.45%. Only three banks reported positive earnings (CSFB; A.G. Edwards, 4.41%, and Solomon Smith Barney, 0.99%). The average for the top 10 firms was minus 2.26%.

William Bernstein- (2001) "With index-fund performance over short periods, anything less than three to five years is going to perform very close to the 50th percentile on average. But as one looks at index fund returns over longer periods, "the noise of active manager performance washes out and index funds are left with a considerable advantage,"

Magellan vs. Index- (CBS Marketwatch 2003) Investors pay the Fidelity Magellan Fund (FMAGX: news, chart, profile) $429 million annually to manage their $55 billion. In contrast, investors pay Vanguard $99 million to run the Vanguard 500 Index (VFINX: news, chart, profile), also a $55 billion fund.

Magellan's rationale for charging $330 million more than Vanguard's S&P 500 fund every year is simple: They provide active-management to enhance performance and beat the S&P 500. Here's how Magellan's manager Robert Stansky described his strategy in a Money interview with Jason Zweig a couple years ago:

"How do you beat the S&P 500?" Stansky asked rhetorically: "You beat it by over-weighting some groups, under-weighting others, and by owning stocks that aren't in the S&P. Sometimes I think if people knew how risky I was acting in the portfolio they'd really be surprised. Just go back a bit: I made AOL very big; I made Yahoo very big. I'm not afraid to make any bet."

Magellan isn't beating the S&P 500 or Vanguard! Quite the opposite, Vanguard 500 Index is beating Fidelity Magellan on a one, three and 10-year average basis.

Where does all that money go? Answer: In the owner's pockets. For example, while Magellan shareholders lost over 40 percent in the past three years, the Forbes 400 list of America's richest billionaires reported that the net worth of Fidelity's two owners, Edward Johnson and Abigail Johnson, increased from $11.1 billion to $12.3 billion between 1999 and 2002, making them the 19th and 38th richest people in America.

Index versus managed (Bogle 2003) One study showed that 35% of managers beat the market in any single year. But the percentage falls to 25% over a 10-year period, 10% over 25 years and 5% over 50 years – an investor’s lifetime investing horizon.

Vanguard’s expense ratios (generally, the annual fee paid the fund’s managers) have fallen from an average of 0.73% of an investor’s holding in 1974 to 0.26% today. Over the same period, the entire industry’s average (including index funds) has risen from 0.91% to 1.32%.

In addition to expense ratios, which average 1.6% for managed funds, the typical managed fund must pay 0.8% for trading commissions and other transaction costs and 0.3% in sales charges. By holding 6% of funds assets aside for cash reserve, the typical managed fund passes up 0.2% in investment gains. Miscellaneous costs chew up another 0.2% of assets.

Hence, said Bogle, the total annual costs for the average managed fund is 3.1% of assets. If annual investment gains averaged 8%, these fees would devour 37% of each year’s return. By reducing annual returns from 8% to 5%, these costs would cut the 30-year return by 57%, so that each dollar invested would grow to $4.32 instead of $10.06.

Indexing: (2003) For the last five years, the S&P 500 outperformed 53.4% of large-cap funds, the S&P MidCap 400 beat 91.4% of mid-cap funds, and the S&P SmallCap 600 beat 69.4% of small-cap funds.

the average 10-year return of domestic stock funds was 8.19% vs. the S&P 500's 10.04%. That's a significant margin of outperformance.

Of the 1,314 domestic stock funds with 10-year histories in the Fund Screener database, 135 no-load (i.e., commission-free) funds beat the S&P 500 by a percentage point or more, 51 outperformed by three percentage points or more, and the top 25 beat it by four percentage points or more. Ironically, the No. 1 fund came from the company that created index investing: Vanguard. Its Health Care Fund posted a 10-year average annual return of 19.98%.

Indexing (Burton Malkiel 2004) In terms of indexing, I prefer the broadest type of index. If you want to buy the U.S. stock market, you should buy the whole U.S. stock market. I would prefer you not just buy the S&P 500, because you don’t just want big companies. For diversification, you want small companies and big companies. And for this, you want a comprehensive index of the total market, like the Wilshire 5000 or Russell 3000. I tend to not prefer the S&P 500 because I want breadth—I want the whole market—and, in part, because if a small company, like a Microsoft, becomes successful and becomes a part of the S&P, I want to have already owned it. I also want to avoid the transaction costs. One of the advantages of indexing is that you don’t do a lot of buying and selling, and the turnover, also, of the S&P 500 is higher than I would like. So I prefer as broad an index as possible.

Do index funds outperform low fee managed funds.  (2004) This is from a doctoral thesis so be prepared.

Indexing: (Lynn O'Shaughnessy 2004) During a recent 15-year period, for example, 91 percent of the investment managers overseeing more than 200 major corporate pension funds underperformed a laughably simple portfolio. Somebody who had put 60 percent of his money into the Standard & Poor's 500 Index, a blue chip proxy, and 40 percent into the Lehman Intermediate Government/Corporate Bond Index, a popular fixed-income benchmark, would have beat the big boys.

Indexing (Journal of Indexes, Professor Martin Gruber ) By most any performance measure, it has been found that funds underperform market indexes. The methodology used here explains 89% of the variability in abnormal fund returns.The study’s major findings include the following:

1. Mutual funds underperform their benchmark indexes by about 65 basis points a year;

2. Fund expense ratios average 113 basis points and exceed the value added by portfolio managers;

3. Index funds outperform managed funds due to smaller expense ratios;

4. Load funds perform worse than no-load funds over any horizon;

5. The author’s methodology forecasts future risk adjusted performance better than do past returns;

6. Funds do not price superior management performance into expenses—top-performing funds have lower expense ratios than bottom-performing funds and increase them more slowly;

7. Investors do chase fund performance, as measured by the relative amount of new cash inflows;

8. New cash inflows follow predictors of performance and earn higher returns than average actively- and passively-managed funds; and

9. After-tax returns of momentum strategies differ for tax-deferred and taxable actively-managed and index funds, but favor active management.

So why do investors stay invested in mutual funds that are predicted to perform poorly? They do, despite the fact that average mutual funds have negative risk-adjusted returns and are outperformed by index funds. The answer is that there are two distinct “clienteles” for mutual funds: sophisticated and disadvantaged.

The “sophisticated clientele” recognizes that future fund performance is partly predictable from past performance.On the other hand, there is the “disadvantaged clientele” that includes: (1) unsophisticated investors attracted by nonrational information, such as advertising; (2) institutionally disadvantaged investors constrained by pension plans to underperforming funds; and (3) tax-disadvantaged investors holding funds with large capital gains that make them inefficient to sell.

Index funds versus many managed funds: (WSJ 2006) "the more funds you pick and the longer the time period, the worse the odds get." Indeed, with a single actively managed fund, the chances of beating an index fund shrink to 31% over five years, 25% over 10 years and 13% over 25 years.

Suppose, instead, that the two sets of competing portfolios consist of five funds. Suddenly, the odds of an actively managed-fund portfolio beating an indexed portfolio shrink to 35% over one year, 18% over five years, 12% over 10 years and just 5% over 25 years.

As you add more funds, it gets even worse. Let's say you own 10 actively managed funds. Your chances of beating an indexed portfolio are 29% over one year, 11% over five years, 6% over 10 years and a scant 2% over 25 years.

It's like gambling in Las Vegas. Yes, you might get lucky on your first few bets. But the longer the night goes on and the more hands you play, the less likely you are to come out ahead. The reason: If you make enough bets in which the odds are against you, eventually mathematics is almost certain to triumph over luck.