The Daily Dow Approach, 07/08/97: The Daily Dow

The Daily Dow
Tuesday, July 8, 1997
by Robert Sheard

LEXINGTON, KY. (July 8, 1997) -- If you've read through our 13 Steps To Investing Foolishly, you know that our baseline investment strategy is investing in an index fund that mirrors the S&P 500. We feel that if you're not going to choose individual stocks (or can't because of limitations on your retirement fund), then at least you'll keep pace with the industry benchmark index by investing in a mutual fund.

There was an interesting article in the April issue of Forbes magazine (which a reader pointed out to me this week), listing some dangers on index-fund investing. The columnist (Gretchen Morgenson) rightly explains that the index isn't the market itself, but a market-cap weighted index where the top fifty stocks or so are the real concentration of any investment in such a fund.

But she makes a few claims I feel need elaboration. First of all, she claims that the statement that the index beats most money managers is a myth. Forbes includes a couple of charts to support the contention, but I have to ask who these managers are that are beating the Index. I'll tell you one thing, over the last decade, they weren't managing mutual funds. I recently posted the results of a survey of stock mutual funds where, of the funds in existence for a full decade, 82% failed to keep pace with the S&P 500 Index. That's no myth; I counted the funds who beat the index myself. Perhaps she's talking about private money managers, but the article doesn't say. But if we're comparing funds versus funds, it's no myth: the S&P 500 Index beat all but 18% of all stock funds over the last decade.

The part of the article I had the biggest problem with, though, is the implication that index fund investing is a risky proposition. It does, of course, carry risk in the sense that any equity investment carries risk, but she's characterizing it as momentum investing as if the stocks dominating the fund were micro-caps with 60% swings overnight. The example she used that seemed to crystallize the stretch she was having to make was that during the crash of 1987 the S&P 500 lost 32.1% while the average general equity fund fell slightly less than 28.7%. It's hard to take that seriously as an indication of high volatility and risk. A little over three percentage points in a single three-month stretch?

I agree with her general premise that too many investors are piling into index funds without really knowing the mechanics of the funds or what they represent, but I can think of a lot worse places they could be looking. But her claim that the naïve investors are just looking at last year's return, or the return over the last three years, is without merit. The same story holds true over the entire last decade: actively managed funds consistently lose to the S&P 500 Index. For the mutual fund investor, where else should they turn?

[Rankings Note: After posting better-than-expected earnings today, INTERNATIONAL PAPER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IP)") else Response.Write("(NYSE: IP)") end if %> priced itself out of the top ten yielders, opening up a slot for CATERPILLAR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAT)") else Response.Write("(NYSE: CAT)") end if %>.]

(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. ________________________________

1997 Foolish Four Model

Stock  Change   Last
--------------------
T    -   3/16  36.44
GM   +   1/8   56.69
CHV  +   1/4   75.75
MMM  +1 15/16  103.25

                Day   Month    Year
        FOOL-4   +0.39%   2.48%   4.70%
        DJIA     +1.32%   3.66%  23.48%
        S&P 500  +0.72%   3.80%  24.03%
        NASDAQ   +0.98%   2.98%  15.03%

    Rec'd   #  Security     In At       Now    Change
   1/2/97  120 3M            83.00    103.25    24.40%
   1/2/97  153 Chevron       65.00     75.75    16.54%
   1/2/97  179 Gen. Motor    55.75     56.69     1.68%
   1/2/97  479 AT&T          41.75     36.44   -12.72%


    Rec'd   #  Security     In At     Value    Change
   1/2/97  120 3M          9960.00  12390.00  $2430.00
   1/2/97  153 Chevron     9945.00  11589.75  $1644.75
   1/2/97  179 Gen. Motor  9979.25  10147.06   $167.81
   1/2/97  479 AT&T       19998.25  17453.56 -$2544.69


                             CASH    $767.60
                            TOTAL  $52347.98