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Diamonds and SPDRs!
For Market Returns

by Ann Coleman
([email protected])

Alexandria, VA (November 20, 1998) -- What has eight legs, a fused cephalothorax, spinnerets, and has beaten Foolish Four two falls out of three?

No points for guessing RP just because you were wondering what the mysterious RP is. (If you don't know, click that blue link!)

It's SPDRs, affectionately known as Spiders, but more properly as Standard and Poor's Depositary Receipts <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: SPY)") else Response.Write("(AMEX: SPY)") end if %>. Spiders are a new idea in investing that has proven immensely popular. They were created in 1994 by the American Stock Exchange (which needed something to sell, with most new issues opting for Nasdaq and most bigger companies migrating to the NYSE).

Technically a Unit Investment Trust, for practical purposes they provide an alternative to an index fund for individual investors. SPDRs let investors purchase a single security that represents all the stocks that make up the S&P 500 Index. The American Stock Exchange creates units of SPDRs by purchasing the underlying stocks in the proper proportions so that the value of each unit mimics the index, not perfectly but darn close.

The price of a single SPDR share is 1/10 the S&P index, so when the index is at 1,162.84, as it was earlier today, the price of a single SPDR would be $116.28.

This year the AMEX created Diamonds <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: DIA)") else Response.Write("(AMEX: DIA)") end if %>, which do the same thing for the Dow that SPDRs do for the S&P 500. (Who comes up with these names? This one is just brilliant -- Dow [Jones] Industrial Average = DIA = Diamonds. Oops, sorry 'bout that, Mr. Jones.) Since the Dow and the S&P usually track each other very closely, picking one over the other is probably just a matter of taste. (Last year was a big exception, with the S&P beating the Dow by 10 percentage points, and this year the S&P is also outperforming, but over the long term the returns are very close.)

Why would a Foolish Four investor care? Well, we can't get away from it. Right now SPDRs are beating our beloved Foolish Four, and last year they beat both the Foolish Four and the RP variation. (This year the RP is ahead. See 1998 Dow Returns.)

Now, I don't think that this is any kind of death knell for Dow investing strategies. There have always been years where the S&P beat up on everything in sight. Unless you can predict those years in advance, however, I think it's safer to pay more attention to the long-term averages than to the most recent year. Still, this is a good time think about index investing either through SPDRs, DIAs, or the ol' index mutual fund.

There are two main differences between SPDRs and index funds. First, SPDRs are purchased through brokers and so incur the same kind of commissions as stocks, but most index funds can be purchased commission (load) free. Second, index funds can create small capital gains on which you must pay the capital gains tax, while SPDRs do not. With SPDRs, capital gains are only realized when the security is sold. The gains are usually small, around 1% per year (on which you pay a 10% or 20% capital gains tax), but that does reduce the return slightly and you do have to do the Schedule D thing.

Both types of securities have annual expense fees. The expense fee for SPDRs is a low 0.1845%, comparable to the 0.18% fee for DIAs and the 0.19% expense ratio for the Vanguard 500 Index fund. Most other index funds have higher expense ratios, by the way.

What it boils down to is that SPDRs or DIAs may be better for an index investor who has a large chunk of money to invest in "the Market" all at once, while index funds may be better for someone who wants to build an investment through frequent small contributions. The advantage of being able to add to a fund without incurring commissions or worrying about purchasing a certain number of shares makes the index fund more attractive than SPDRs in that case, even if you do have to report capital gains.

Fool on and prosper!

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Current Dow Order | 1998 Dow Returns

11/20/98 Close
Stock  Change   Last
--------------------
UK   +   3/4   44.50
IP   +   3/4   46.00
MO   +   7/16  55.75
EK   +   1/2   76.69

                   Day   Month    Year
        FOOL-4   +1.14%   5.53%  17.04%
        DJIA     +1.14%   6.60%  15.82%
        S&P 500  +0.95%   5.90%  19.90%
        NASDAQ   +0.44%   8.85%  22.79%

    Rec'd   #  Security     In At       Now    Change

 12/31/97  206 Eastman Ko    60.56     76.69    26.63%
 12/31/97  276 Philip Mor    45.25     55.75    23.20%
 12/31/97  289 Int'l Pape    43.13     46.00     6.67%
 12/31/97  291 Union Carb    42.94     44.50     3.64%


    Rec'd   #  Security     In At     Value    Change

 12/31/97  206 Eastman Ko 12475.88  15797.63  $3321.75
 12/31/97  276 Philip Mor 12489.00  15387.00  $2898.00
 12/31/97  289 Int'l Pape 12463.13  13294.00   $830.88
 12/31/97  291 Union Carb 12494.81  12949.50   $454.69


               Dividends Paid YTD  $1092.81
                            TOTAL  $58520.94

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