| > | | | | fullyinvested in the market and potentially |
| Index Funds - Are they right for you?by Gabriel | | | | corrective actions are nottaken. Accordingly they |
| Nijmeh | | | | may be regarded as a riskier option forsome |
| Indexing is an investment approach that seeks to | | | | investors during market declines. |
| match theinvestment returns of a stock or bond | | | | It can also be argued that when you invest in an |
| index. An investmentmanager tries to duplicate | | | | actively managedmutual fund, you are paying a |
| the target index by holding all thesecurities in the | | | | professional to research and pickwinning stocks. |
| index. This is what is called a passivemanagement | | | | You are not paying them 2 or 3 percent a year |
| approach which emphasizes broad diversification | | | | topark your holdings in cash. If that were the |
| andlow portfolio turnover. | | | | case, you would bebetter off putting your money |
| There are a variety of indexes to suit each | | | | in your savings account. It reallydepends on |
| investment style. Thelargest and well known index | | | | market conditions and the fund's investment |
| is the S&P 500. This index isdominated by the | | | | philosophyand how it matches with your |
| largest blue chip companies and accounts forclose | | | | investment goals. |
| to 75% of the U.S. stock market value. Other | | | | Another common thought is why shoot for an |
| indexesinclude the Nasdaq, Wilshire 5000 Total | | | | average return whenyou can try and beat the |
| Market Index, S&P MidCap | | | | market. Well, it is very difficult evenfor seasoned |
| 400, Morgan Stanley Capital International Europe, | | | | money managers to consistently beat the index |
| Australasia, | | | | yearover year. |
| Far East (MSCUI EAFE) and various bond indexes. | | | | Taxes are another aspect of investing that needs |
| Since 1926, the stock market has an average | | | | to be consideredcarefully. Every time an active |
| rate of return of | | | | fund manager sells a profitablestock, a taxable |
| 11.3%. Investors have earned more or less | | | | capital gain is triggered. Anytime some of |
| depending on the typeof investments and risks | | | | aninvestment is taxed away, the magic of |
| taken. It is very important to note thatthis return | | | | compounding iscompromised. Index funds on the |
| is before costs have been factored. Therefore, | | | | other hand are considered taxefficient |
| thoseinvesting in actively managed mutual funds | | | | investments because very few stocks are bought |
| may have a net returnlower due to these costs | | | | and soldand therefore few capital gains are |
| and thus will earn significantly lessthan the market | | | | distributed to investors. Youchoose when to sell |
| average. | | | | your investments and therefore have a bitmore |
| These costs include: | | | | control over the tax consequences. Index |
| - Management expense ratio (including advisory | | | | investing was onceonly available to institutional |
| fees, distributioncharges and operating expenses) | | | | investors who take tax deferralseriously. |
| - Transaction costs (brokerage and other trading | | | | Indexing is a strategy that can be applied in many |
| costs) | | | | differentways. It is an efficient and low cost way |
| Index fund expense ratios are typically 1 percent | | | | to investment acrossvarious markets and asset |
| and usuallyeven less, compared with 1.5 to 3 | | | | classes. You can build a core holdingof index funds |
| percent for actively managedfunds. Fund | | | | and add a well managed mutual fund that |
| expenses and transaction costs for a typical | | | | enhancesyour portfolio's return. |
| mutualfund can take a big bite out of your net | | | | What appeals to me about indexing is that I can |
| investment returns. Addsales commissions to | | | | have a broadbasket of stocks that moves |
| your purchases and even more of your | | | | lockstep with the market so at thevery least I |
| returnsare swallowed. Typically, index funds can | | | | am guaranteed a market return. In addition, I |
| be purchased on a no-load basis thus saving you | | | | canpurchase individual stocks or other mutual |
| sales charges. | | | | funds that will addvalue and enhance my overall |
| Of course, there is always a caveat... during | | | | rate of return. |
| periods of marketdecline, index funds can be | | | | Do index funds fit in your portfolio? This is |
| expected to suffer somewhat largerdeclines over | | | | something you needto determine based on your |
| actively managed funds. A fund manager can | | | | investment goals and philosophy. Overthe long |
| makeadjustments in anticipation of market | | | | term index funds should provide competitive |
| declines by selling stocksand also has the option of | | | | returnsrelative to actively managed mutual funds |
| holding a cash reserve. This is notsomething that | | | | while keeping yourcosts down. |
| occurs within an index fund because you are | | | | |