Archive for Sunday, July 8, 2001

The Motley Fool

July 8, 2001


Name that company

I was founded in Rochester, N.Y., as Paymaster, with one employee and 40 clients. My goals have been to offer companies (especially small ones) payroll, tax, 401(k) and other services. I opened my Taxpay division in 1989. Four years later it had 50,000 clients and double that by 1995. I serve hundreds of thousands of clients in more than 100 nations, raking in more than $750 million annually. More than 5 million Americans receive paychecks through me. Who am I? (Answer: Paychex)

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In recent years, "exchange-traded funds" (ETFs) have grown in popularity, and for some good reasons. They're funds that trade like stocks, and they're worth investigating.

The ETFs available today are index-based. By investing in one, you're simply putting your confidence in the companies in that index. Here are nicknames and ticker symbols for some ETFs of some indexes: S&P; 500 (Spiders, SPY), the Nasdaq 100 (Cubes, QQQ), Total Stock Market (Vipers, VTI), Dow Jones Industrials (Diamonds, DIA), Russell 2000 (iShares Russell 2000, IWM), MCSI Japan Index (WEBS Japan, EWJ).

With very low fees and tax-efficient, infrequent trading, ETFs provide diversification among groupings of large businesses. They're also among the least time-consuming of all investing strategies. If you want to manage some or all of your money passively (not cherry-picking individual stocks), ETFs provide significant advantages.

They're also flexible. An ETF may be traded any time the exchanges are open. Further, ETFs can be shorted, optioned and margined. This actually provides the greatest criticism for ETFs. They're almost too easy, and, as a result, they have been used extensively as short-term investments, the complete antithesis of index investing. John Bogle, the father of index investing, likened ETFs to a shotgun in a recent speech, saying, "They can be used for self-defense, or they can be used for suicide." Trading in and out of ETFs eats up any cost benefit by piling on trading costs.

There's another group of investors for whom ETFs would not be appropriate: those who dollar-cost average. Since there are no direct investing plans ("DRIPs") for ETFs, dollar cost averaging would rack up trading costs that would far outweigh any cost benefit over a traditional index fund.

For people who are adding small systematic amounts to build up a portfolio, a more efficient route would be to find a no-load, low-expense index mutual fund or to dollar-cost average into individual companies.

There's more to learn about these interesting beasts. For more on ETFs, head to and type "ETF" into the search box. Or visit For more on index and mutual funds, click to

Not so great

Our next-door neighbor lost his job selling sandwiches, so he became a stockbroker. One of his sophisticated, tax-savvy investments was a real estate limited partnership. It featured a two-part strategy. Part 1: Buy commercial real estate and operate it at a loss, generating income tax deductions. Part 2: Sell the property at a significant profit, taxed as capital gain. After all, real estate prices only go up. Part 1 worked great. My 1982 investment of $7,000 has generated $13,300 in losses. Part 2, not so great. Quoting this year's annual report, "Investors are expected to receive, in total, substantially less than one-fifth of their original investment" when the partnership terminates next year. John Waller, Norman, Okla.

The Fool Responds: No matter how convoluted our tax code has become, you still cannot make money by losing money. Taxes may be one important consideration, but taxes alone are seldom a good reason for investing. Beware of convoluted investment schemes and any proposition that sounds too good to be true.

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