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Mutual Funds
The Real Deal on Indexing
By Eric Weiss, CFP®
Financial Planner, Chadwick Financial Advisors
If you can’t beat them, join them. That’s the approach many new stock investors take. The stock
portion of their investments consists of only an S&P 500 Index mutual fund. And why not? In
past years, mutual funds based on this popular measure of the U.S. stock market have
outperformed many actively managed diversified stock funds.
Buying the Market?
Like other index funds, an S&P 500 Index fund invests in a majority of the same stocks, in
virtually the same proportions, as the market index on which it’s based. The goal of an S&P 500
Index fund is to mirror the performance of the S&P 500 Index, which is widely considered to
include a representative sample of top U.S. companies in leading industries.
So, if you buy an S&P 500 Index fund, you’re buying the market and shouldn’t need other stock
investments — right? It’s not quite so simple, the S&P 500 is weighted so that a significant part
of its return is derived from the stocks of the top 50 or so largest companies. A much lower
proportion of the index’s performance comes from smaller company stocks. An index fund based
on the S&P 500 would be similarly weighted and, thus, not be representative of the total U.S.
stock market. The S&P 500 Index is considered a reflection of large capitalization U.S. stocks.
The performance of an unmanaged index is not indicative of the performance of any particular
investment. It is not possible to invest directly in any index. Past performance is no guarantee of
future results. Rates of return will vary over time, particularly on long-term investments.
Risk - Another Factor
If you invest in an S&P 500-index fund in a declining market, you won’t have returns that
deviate much from the underlying indexing. But that doesn’t mean index funds are risk free or
that an index fund is appropriate for your personal risk tolerance. When compared to an index
fund, an actively managed fund may be less volatile.
Actively managed funds hold some of their assets in cash, which can help steady returns during a
declining stock market. They also can be more diversified by including small, medium, and large
company stock — and sometimes foreign stocks, as well. In addition, actively managed funds
can have different, specific investment objectives that may more closely match your objectives.
For example, some funds are managed primarily for growth, while others are managed
principally for income. On the other hand, an actively managed fund might not perform as well
as an index fund because of certain investment decisions by the investment management.
Not the Whole Answer
None of this means that an S&P 500 Index fund isn’t a good investment, only that it probably
shouldn’t be your only mutual fund investment. Investing in a single index fund is no substitute
for developing a long-term financial plan that addresses your individual investment requirements
and tolerance for risk. An investor should carefully consider the investment objectives, risks,
charges and expenses of an investment company before investing. Index mutual funds are offered
by prospectus, which contains more complete information on the style of the investment
objectives you should expect in addition to the charges, expenses and risks that the fund may
incur. You can obtain a free prospectus that contains this and other information from a financial
services professional or the sponsoring fund company. Read the prospectus carefully before
investing. As well, a professional financial advisor can review your personal financial situation
with you and develop an investment strategy that will help to meet your particular needs and
goals.
Eric C. Weiss is a registered representative of Lincoln Financial Advisors, a
broker/dealer, and offers investment advisory service through Sagemark Consulting, a division of
Lincoln Financial Advisors Corp., a registered investment advisor.
This information should not be construed as legal or tax advice. You may want to consult a
tax advisor regarding this information as it relates to your personal circumstances.
CRN# 200505-1001191
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