Broker Check

Forbes Magazine Article Endorses Index Funds

Dear Clients and Friends,

It is always gratifying when a respected publication in the financial press issues an article that effectively endorses the fundamentals of our investment strategy.  The article, entitled “Beating the Broad Market,” was written by Michael Maiello and James M. Clash and appeared in the February 3, 2003, issue of Forbes magazine.  The highlights of that article appear below and each of these points will be very familiar to our clients and to those who understand our investment strategies.

1. INDEX FUNDS, IN MOST CASES, ARE SUPERIOR TO MANAGED FUNDS.

The first index fund, offered by Vanguard’s John Bogle in 1976, was designed to replicate the performance of the S&P 500.  The concept was not popular in the beginning, but over time it became obvious to investors that this passive strategy was, in the words of the authors, “beating the majority of actively managed funds.  As a group, of course, the active managers could not beat the market because they pretty much were the market.  And since they were spending lots of money trying to beat it, they would eventually fall behind.  History has proved out this theory.  Only one in three actively managed funds in operation since 1976 has beaten the Vanguard 500.”

2. INDEX FUND INVESTING, RATHER SIMPLE IN THE BEGINNING, HAS BECOME MUCH MORE COMPLEX.  

In 1976 there was just one index fund; now there are well over 300 such funds and the number is growing rapidly.  “Now there are choices to make. What index should you track, and who has the best vehicle for tracking?  There are funds to track the 500, funds to track a broader market basket and funds to track narrower ones, such as S&P 500 ‘growth’ stocks and S&P 500 ‘value’ stocks.”

3. ONE SOUND APPROACH TO BUILDING A PORTFOLIO IS TO COMBINE BOTH INDEX (PASSIVE) AND MANAGED (ACTIVE) FUNDS.

 “A good strategy, used by many a large pension fund, is to blend active and passive stock portfolio management.  Make one or more index funds the core holdings in your portfolio and plan on holding them through thick and thin, bull and bear markets, for many years.  Then take another chunk of your stock market money and invest it actively, either seeking out fund managers with superior records or creating your own portfolio of stocks.”
 
4. ADD SMALL AND MEDIUM-SIZE COMPANY STOCK FUNDS TO YOUR PORTFOLIO.

 “There are going to be times when the S&P 500 beats the broader market and times when it lags.  In the go-go 1990s the 500 index was on top, as overpriced technology favorites like Lucent kept getting overpriced.  In the market collapse since then, small and medium-size companies have held up better and you would have been better off in index funds for them.” 

5. ADD INTERNATIONAL STOCK FUNDS TO YOUR PORTFOLIO.

 “You should put 10% to 25% of your money abroad.  Index funds exist that just track mainstream European markets or Pacific ones, and a combo from Vanguard that tracks the Morgan Stanley EAFE index. You might want to put a sliver of your net worth in an emerging markets fund.”

6. THE PROPER BLEND OF INDEX FUNDS HAS THE POTENTIAL TO BEAT THE MARKET.

 “Final question:  Can a market index fund—or rather, a blend of them—beat the market?  Paradoxical as it seems, the answer is quite possibly yes.  This intriguing discovery comes from Craig Israelsen, a professor of consumer economics at the University of Missouri.  He compared returns on the Vanguard Total Stock Market Index fund with those on a hypothetical mix of three narrower index funds:  the Vanguard 500, the Dreyfus MidCap, and the Vanguard Small Cap.  Beginning in 1993, the mix would have averaged…a full point (1%) better than the performance on the single broad-based fund.”

We are very proud of the fact that all of the principles described above were incorporated into our investment strategy long before they appeared in Forbes magazine.  And in the future, we will remain committed to staying on the cutting edge of all issues regarding investments and portfolio construction. 

Sincerely,

Val G. Stephens 
President