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Do you own a closet index fund? Would you recognize one if you saw it?
Index funds are mutual funds that track the performance of a particular index, such as the Standard & Poor's 500. They have low expenses because there is no need to pay for stock research or a manager with proven stock-picking skills. Computers do a lot of the work required to keep the fund's money invested in the right stocks in the right proportions.
Actively managed funds are different by design. Their managers try to add value by taking less risk or by performing better than whatever index they use as a benchmark. However, in practice, some actively managed funds track the ups and downs of the S&P 500 so closely they aren't much more than index funds with higher expenses.
Jim Lowell, who publishes the independent Fidelity Investor newsletter, labels seven of Fidelity Investments' funds closet index funds. While he notes that the funds could change their approach in the future, he says they've been managed nearly as index funds for at least three years. Those he singles out: Blue Chip Growth, Destiny, Large-Cap Stock, Magellan, Stock Selector, Tax Managed Stock and Trend. The situation is not unique to Fidelity.
I point this out because if you are going to invest in an index fund, it might as well be a real one with low expenses. There are more than 250 from which to choose, according to the fund research organization Morningstar.
If you own any actively managed funds, it is worth looking at this issue when you review your investments; a midyear review would be great timing.
The easy way to research this is to go to www.morningstar.com type in the name or ticker symbol for your fund and click on "risk measures." There, you will see the index that is the best fit for your fund and a number for something called "R-squared," which is the percentage of the fund's movement that can be explained by movements in the index. A fund with an R-squared rating of 95 or higher will track the index very closely. If you want to dig deeper, you can compare your fund's sector weightings with those in the index.
Even if your fund is not a closet index fund (most are not), look at how its performance compares with its most closely matched index over various time periods. If you've been getting chronic underperformance, it is time to consider a switch. If your fund is a high performer, watch it closely. Index-beating performance is something to cheer about, but very difficult to sustain. The odds are best for small-cap funds.
Before selling any fund outside a retirement account, be sure to consider how big your gain or loss will be and its potential tax impact. If you decide to buy an index fund, compare costs and performance. Some index funds track their chosen indexes more closely than others. The Web sites www.indexfunds.com and www.moneycentral.com may be helpful in your research, along with Morningstar's site.
Q. Almost everyone I know lives beyond their means because of credit cards. To me, this means the economy is improving, but we are using play money to do that. How is that really helping our economy in the long run? Eventually those debts have to be paid, and many people can't do that.
The fact that money is borrowed does not eliminate its economic benefit. Can you imagine how many fewer houses would be built and cars manufacturered if people had to save up the money in advance to buy them? Consumer spending creates jobs, which in turn generate more consumer spending.
The economy benefits so long as your friends keep spending and keep making payments on their credit cards. Lenders expect some people to default on their debts, which is why interest rates on credit cards are set so high. If defaults stay within the expected range, they are not a problem. It is when defaults soar that they pose a danger to the financial health of the lender and potentially to the economy.
Consumers hurt their own financial well-being when they spend more than they have and fail to save for the future. If too many of us used up all our credit and had nothing left to spend, the economy would be in trouble.
- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to huntley@sptimes.com or Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.