COLUMN-Choosing an index fund when the indexes are sky-high

Reuters

By John Wasik

CHICAGO, Nov. 18 (Reuters) - When stocks are on a roll - asthey have been thus far this year - you want to go big or gohome.

Quite naturally, most investors want to take advantage ofthe market's healthy gains this year. Yet with so many 401(k)offerings and a plethora of stock-index mutual andexchange-traded funds (ETFs) out there, which ones will give youthe most bang for your buck?

The answer is surprisingly complicated because there are somany similar options. Many of the best funds are either ignoredby investors who insist on owning individual stocks or are notoffered in retirement plans. You may have to hunt them down orrequest that your employer add them.

"Total market" funds are one way to spread your bets. One ofthe most popular funds is the Vanguard Total Market Index Fund, which is offered through five other share classes,including an ETF. Investors have stashed more than $300billion in Vanguard's various total-market funds.

This mutual fund (investor shares) samples the entire U.S.stock market, covering the stocks of large, midsize and smallcompanies. Its annual expense ratio is a relatively low 0.15percent of assets.

As with all total-market funds, there's no need to guesswhat sector or size of stock is hot at the moment. You get apiece of nearly every listed company. Reflecting the market as awhole, the Vanguard fund is up 37.62 percent for the yearthrough Nov. 15, which beats the smaller subset of Standard &Poor's 500-stock index listings by almost two percentage points,a wide margin in the index-fund business.

But index-fund aficionados are never satisfied. They want toknow: Can you cover the entire market in a better way bychoosing a different index with a lower cost?

The SPDR Russell 3000 ETF tracks the 3,000 largestU.S. companies, fewer than Vanguard's 3,600 companies. Althoughdifferent from an open-ended mutual fund, the SPDR fund charges0.10 percent annually. Vanguard has an ETF version of its totalmarket mutual fund that charges 0.05 percent annually.

While these similar ETFs should move in lockstep - they bothtrack a broad-based total-market index - their performances havenot been identical. The SPDR fund is up 36.87 percent for theyear through Nov. 15, lagging the Vanguard fund by a0.75-percentage-point margin.

Over time, this difference widens, with the Vanguard fundholding a 0.85-percentage-point return advantage over the SPDRfund during a five-year annualized period though Nov. 15. That'sa two-horse length in the world of index funds.

If you had invested $100,000 over 20 years, earning a 10percent annual return, you would have paid almost $6,000 in feesin the SPDR fund, compared with about $3,000 for the Vanguardfund, which would have yielded roughly $7,000 more in the totalbalance at the end of the period, according to the FINRA FundAnalyzer.

The differences are the total expenses and the underlyingindexes - or baskets of stocks - chosen to anchor the funds.Vanguard uses an index from the Center for Research in SecurityPrices, while the SPDR fund uses the Russell 3000 Index.

Both hold more than 70 percent of their portfolios in largecompanies with an average market capitalization of more than $36billion. That list includes household names such as Apple, Exxon-Mobil and Microsoft.

"Big index funds and ETFs don't track the same index," saysDan Wiener, chief executive officer of Adviser Investments inNewton, Massachusetts. "Find the cheapest fund tracking the fouror five biggest indexes."

CASTING A WIDER NET

Given the recent returns in U.S. markets, it would be easyto focus on U.S. companies to the exclusion of global markets.But don't you want to tap into growth in Africa, Asia, Europeand South America?

For that purpose, a world index is more of a proxy forglobal growth than a fund that exclusively holds U.S. stocks.The iShares MSCI ACWI Index fund gives you the mostpopular U.S. stocks plus a sampling of 1,300 companies fromacross the world. It costs 0.34 percent annually.

If you're concerned about non-U.S. global diversification,the major drawback of the iShares fund is the dominance ofAmerican stocks, which are nearly half of the portfolio. Butperformance-wise, it's still a strong choice - up about 30percent for the year through Nov. 15 - beating its underlyingworld-stock index by three percentage points.

You could drive yourself crazy by splitting hairs to findthe best indexes and funds. The best way to nail it: Avoidexpensive broker-sold index funds and choose ETFs that have notrading commissions.

Since most of the largest fund groups aren't charging ETFbrokerage fees for their major index funds, you could own aworld of stocks, bonds and real estate funds, all withbargain-basement expense ratios.

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