Pros and Cons of Index Funds?

As a group, I'd think we can compile a pro/con list pretty rapidly.

Pro

*In general, ETFs have low expenses, .10% for the SPY (S&P index) *They are priced during the trading day, not just at the market close as a mutual fund is. *They tend to be tax efficient, a mutual fund can have gains carried forward that have to be distributed and you can't time that, i.e. you may find a nasty surprise at year end. *You may buy into a sector short term if you believe that sector will rise, again, compared to mutual fund that may have an extra penalty for a fast trade (less than 60 days). *You may short an ETF. *Many ETFs are optionable.

Cons

*ETFs trade like a stock, with a commission for purchase/sale. So dollar cost averaging (putting in, say, $250-$500/month) will incur commissions that are a high percent of the transaction. *Liquidity - not all ETFs trade high volume, so the bid/ask can get out of whack, or your order may not fill at one price. *High expense - there are actually some ETFs that have fees well over 2%. Good to do the research and find the expenses..

In the end, ETFs as a group are another choice, neither good nor bad, you have to decide on the particular ETF to make that assessment. The same as with mutual funds.

JOE

Here's some thoughts:

You can also search in google usenet archives, because there have been many discussions already:

Funny, that you think "index funds" means ETF. That never occurred to me. I think of Index Funds as mutual funds. As such, your list of Pros and Cons doesn't apply. I think index mutual funds have been around a lot longer than ETFs.

Elizabeth Richardson

from indexfund.com; "An index fund can be defined as a mutual fund or exchange traded fund (ETF) with a clearly defined set of rules of ownership, that are held constant regardless of market conditions."

I did make an assumption. But the rest of my post compared ETF to the mutual fund equivalent, mostly. And the OP really didn't say compared to what. So I didn't know if she was asking for a comparison to individual stock or other non-index type funds. Funny, is that you make of habit of catching my mistakes but don't offer a reply to the original question. What is your take on index mutual funds?

JOE

Ummm... Joe, the poster asked about Index funds, not about ETFs. They are two entirely different things.

I would recommend the OP find a copy of Bogle on Mutual Funds (isn't that the name of it?)

Elizabeth Richardson

Biggest problem with index funds is the indexes themselves. they tend to be weighted by whatever rose the most and is the highest priced.

If energy is hot the s&p as an example will take on more weight in energy than you want, They are always dominated by what may be over valued and never take advantage of anything undervalued.

NO protection in down markets as they are always fully invested so you have the all the decisions as to what you do next resting soley on your shoulders.

make an assumption. But the rest of my post compared ETF to the

I was thinking of index mutual funds. My minimal understanding is that ETFs are more for folks with a larger amount to invest than I have (which is 8K). Also, I don't want to deal with paying commissions. i was wondering about index funds vs non-index funds - I am not savvy enough at this point or have the time commitment to consider individual stock investments.

all responses have been educational to me though, so thanks.

There are now some ETF's that are fundamentally weighted such as Power Share's PRF. They are designed to avoid this problem. In theory, PRF should mimic the S&P 500 plus about 2%. In practice, it has been doing so. But we only have a

10 month track record so far.

-- Doug

I own some index funds (from Vanguard) in my 401k

I own some managed funds (from Vanguard) in my 401k and some managed funds from T Rowe Price in my Roth IRA.

with 8k, I think mutual funds are a good direction to go.

index funds:

pro low expenses you will get the return of "popular" benchmarks the index tracks. You will not "beat" the market, but you will increase and decrease with the market, knowing that in the past, the market has often gone up for long periods.

con manager of the mutual fund cannot deviate from benchmark (for example, could not sell Enron until it was removed from the index). Even the most popular indexes (S&P 500) are highly volatile over short and medium periods You have no control over what is in the index, and neither does the fund manager.

managed funds pro There is a paid professional buying and selling stocks to TRY and make money The return of the fund is based on the performance of the market AND a person The manager can weight stocks s/he thinks are favorable/increasing and sell (or not own) the stocks which are decreasing. In some people's interpretation, this reduces risk.

con Higher expenses (relative to index funds) Fund managers can change (Fidelity is known for frequent changes in who manages their funds)

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My personal philosophy with investing is I want most of my portfolio to pay dividends. There are many websites which show (as evidence) that the dividends of the S&P 500 account for around 40% of it's past performance. I believe if I overweight in dividend paying stocks I will have better returns than the market, and probably less risk.

The disadvantage is if market shoots up 50%, dividend paying stocks will probably NOT be the reason for the increase, so I should not expect my funds to get this high return. In the past when the market when down, the dividend paying funds I owned at the time did not go down nearly as much as the index.

we were talking index funds not etf's that werent index funds. dvy is one of my favorites

[snip]

• There is little evidence that the number of active managers who can beat their asset class index benchmark is greater than what chance would predict. * And related to that, there's even less evidence that you can pick a winning active manager going forward.

I think some article was right in saying there are "seasons" that are more favorable for indexing and other times/environments better for active management. I think in recent years it been easy for mgt to beat indexes because the high-beta stuff has done well, and that involves inefficient markets such as small cap and emerging market which takes a lot of research and judgement.

We have been promised forever that the return of big cap growth is around the corner, and for that case the markets may be so well known and efficiently priced that bra> They are always dominated by what may be over

Yeah, the cap-weighting is annoying and tends to focus you on bloatware. Etf RSP does equal-weighting for SP500; maybe there are mutual funds doing similar things.

The ability for mgt to pull in/out of the market (or even sell short) is great in theory. But it seems quite rare that they can pull this off to your advantage more often than not. And of course they can hurt you even worse thru stupid blunders. I don't know why they don't succeed better on this...