Archive for Sunday, August 24, 2003

The Motley Fool

August 24, 2003

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Last week's answer

My first store was opened by a pharmacist in Illinois in 1901 who differentiated me with wide aisles, bright lighting, friendly service and a broad assortment of goods, including pots and pans. I often amazed nearby customers who called in orders by delivering their goods before they hung up the phone. I soon began selling ice cream and hot foods, too. One of my proudest claims is having invented the milk shake. I had 500 stores by 1930, and today I'm the nation's largest drugstore chain, with more than 4,000 units and annual sales around $30 billion. Who am I? (Answer: Walgreens)

Consider index funds

Investing via mutual funds is appealing, but it's not without drawbacks. For starters, the majority of stock mutual funds tend to underperform the overall stock market average. Making matters worse, many funds charge excessive loads, or sales fees, of 5 percent or more. On an investment of $5,000, that's $250 gone at the outset.

Another issue is size. As funds grow bigger (and their managers usually try to grow them so they can collect more in fees), it becomes much harder to deliver strong results. The more money a fund has to invest, the more likely it is that significant sums will be invested in less promising companies, as the managers have to spread the money around.

That's the bad news. Here's the good: There's a simple solution. Instead of seeking those few funds that do tend to beat the market average, you can choose to match the market average. Invest your long-term moolah in index mutual funds that are designed to track the performance of a broad market index. Two good options are S&P; 500-based index funds and "whole market" index funds that track the Wilshire 5000 index. The S&P; 500 is an index of 500 leading companies in America, while the Wilshire 5000 is the broadest market index, tracking all U.S.-based stocks "with readily available price data."

While the average mutual fund typically charges you well over 1 percent per year, index funds usually sport extremely low fees -- sometimes just 0.16 percent. There's little turnover within index funds, too, minimizing commission costs and taxable distributions. Best of all, investing in index funds is simple, taking very little time or energy. Once you've invested in them, you can forget about them, though ideally, you'll keep adding money periodically. However the stock market performs in the coming years, your index fund won't be far behind.

Even superinvestor Warren Buffett advised, "Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees."

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