<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (Mar. 3, 1998) -- A number of readers have asked me recently to explain the difference between an S&P 500 Index fund and the relatively new Standard and Poor's Depositary Receipts (SPDR), more commonly called Spyders, which trade on the American Exchange under the ticker symbol SPY. And just as importantly, which one is better in what circumstances?

Both investments are designed to mimic the performance of the S&P 500 Index and do so generally through passively owning the stocks in the index itself. Within a few basis points either way, whatever the S&P 500 Index does, the index funds and the Spyders will do as well.

But there are some important differences that may make one or the other more attractive to you if you're employing this base-line Foolish stock investment -- indexing.

The big difference is in the structure of the investment. An index fund is a common pooled interest (a mutual fund), managed by a single manager (the fund company). When the manager buys and sells a stock as a result of a change in the index or a redemption in mutual fund shares requiring a cash payment to shareholders, the capital gains triggered by those sales are apportioned to all shareholders according to the number of shares they own. Furthermore, when you buy shares in a mutual fund, you're buying into the unrealized gains the fund portfolio is sitting on and you'll pay taxes on those gains, even if they become realized only a day after you invest in the fund. If you buy at the wrong time, you can get stung with a tax liability that you didn't profit from.

The SPDR is a trust rather than a mutual fund, and while the management of the portfolio is approximately the same, your responsibility for taxes is different. With the SPDR, your tax liability is only tied to the shares you buy and sell and the holding period you choose. So when the index changes and the manager of the trust has to sell a stock, you don't inherit a portion of the capital gains because of that individual sale. Likewise, if the manager has to sell stocks to meet a cash outflow because a large number of other trust shareholders sell out, you're not stuck with the capital gains liability then either. Your only taxable events with the SPDR are when you sell your own shares. The sale is treated as any other stock sale then.

The management fee on the SPDR is also very low. Coming in at just above 18 basis points (0.18%), the SPDR's management fee is even a shade lower than the low-cost champion Vanguard's expense ratio for its S&P 500 Index fund of 0.20%. Fidelity's Spartan Market Index Fund, by way of comparison, has an expense ratio of 0.44%.

So the Spyder is always better, right? Well, no.

The one drawback to the Spyder is that, since it trades as any other stock, you pay a brokerage commission for every purchase or sale. With the index mutual funds, of course, there's no sales load and most have no redemption fee.

So for the investor who's depositing $25, $50, or $100 a month into the S&P 500 Index, it's more cost effective to use a no-load index fund, despite the other minor drawbacks to funds in general. But for an investor who's primarily a stock investor and is just looking for an easy parking place for cash before his next stock purchase, the SPDR will at least keep your slush fund working at the same pace as the index.

So if you're still approaching the first line of Foolish stock picking -- the Foolish Four -- keep your index alternatives clear and choose the one that's most cost-effective for you, either the index fund or the SPDR.

Fool on!

[Want to be the first Fool on your block to get a copy of Robert Sheard's forthcoming book? Click here to pre-order your copy of The Unemotional Investor.]

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 UK   +   1/4   47.38 
 IP   -   1/4   48.00 
 MO   +   3/8   43.75 
 EK   ---       67.50 
 
            
                    Day   Month    Year 
         FOOL-4   +0.19%   2.17%   7.43% 
         DJIA     +0.40%   0.46%   8.56% 
         S&P 500  +0.41%   0.26%   8.41% 
         NASDAQ   -0.09%  -0.75%  11.89% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  206 Eastman Ko    60.56     67.50    11.46% 
  12/31/97  289 Int'l Pape    43.13     48.00    11.30% 
  12/31/97  291 Union Carb    42.94     47.38    10.33% 
  12/31/97  276 Philip Mor    45.25     43.75    -3.31% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  206 Eastman Ko 12475.88  13905.00  $1429.13 
  12/31/97  289 Int'l Pape 12463.13  13872.00  $1408.88 
  12/31/97  291 Union Carb 12494.81  13786.13  $1291.31 
  12/31/97  276 Philip Mor 12489.00  12075.00  -$414.00 
  
  
                              CASH     $77.19 
                             TOTAL  $53715.32