A Smart Strategy For Most Investors

As most of our clients at Fund Advisors of America already know, we believe that index funds should be a part of most long-term, investment strategies. An index fund is a mutual fund whose portfolio, tracking that of a broad-based market segment, tends to mirror a specific index.

For example, the selection of mutual funds in a specific index fund might mirror the funds in the Dow Jones Industrial Average, or the Standard & Poors 500 Index, or the Wilshire 5000 Equity Index, or specific mid- and small-capitalization stock indexes, or specific foreign stock indexes.

Why have index funds been so successful? What do you do if index funds are not available in your employer's retirement plan? What if you prefer to have more of your portfolio invested in sector funds? Here are some thoughts on all these issues and why index funds deserve a place in your portfolio.

Low portfolio-turnover-percentage rates

Index funds have low portfolio turnover rates which means, lower management fees. Index funds have closely monitored and carefully defined investment styles. Their trading costs are miniscule when compared to those of more actively managed funds whose managers are constantly buying and selling stocks. The stock selections are already made for these funds by the composition of the indices they are tracking, reducing the need for high-priced analysts.

Tax-efficient

Index funds are good choices for investors who are in taxable accounts, because of the low portfolio turnover rate. Fewer stocks sold within a mutual funds portfolio translates to more modest capital gains than is the case with more actively managed funds, that is, funds that change holdings annually by 50% or more. If you are investing in such a fund, make certain that you are aware of the ramifications of active trading to your taxable accounts. Portfolio-turnover percentages should be stated in the funds annual report or in the Morningstar analysts' assessment of the funds at www.morningstar.com.

High degree of predictability

Index funds consistently deliver what the broad market produces. More active funds focus on narrower niches or sectors, which have more volatility. If you choose to invest in active funds or if you do not have index funds available in your employer's retirement plan, look for funds offering the broadest possible coverage and those which have performed with the most index-like consistency.

For example, if you are interested in a large-company technology fund, compare the number of stocks in its portfolio and its year-to-year performance to those of other funds investing in the same market segment. Morningstar's Web site can assist you in your analysis.

Diversify beyond index funds

Do not construe our advice to mean that your entire portfolio should be indexed. Those investors with ten or more years before retirement can afford to be more aggressive with at least 50% of their portfolios. Actively managed funds give you an excellent chance of beating the overall market returns of the indexes.

If you have already locked in the market's total return by investing in index funds, you might consider looking next for well-managed funds whose managers are not afraid to take a bet on a particular sector or on a small number of carefully selected stocks. In these areas, we like funds such as Janus Growth and Income, the Oakmark Select, and the Third Avenue Value, among others, for our managed accounts.

Be sure to include index funds, whenever possible, as a cornerstone for your portfolio. However, do not be afraid to aim for higher returns through carefully selected, actively managed funds.

For assistance in both of these areas, consider investing in a professionally managed account with Fund Advisors of America, the recommended alliance of http://www.TheMoneyExpert.com.

-John Wagner, Ph.D. is Senior Asset Manager at Fund Advisors of America, a recommended expert alliance of http://TheMoneyExpert.comm

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