Trying index funds? Ask three questions


Monday, July 10th 2000, 12:00 am
By: News On 6


Before you invest in an index mutual fund, ask these questions, said Peter Di Teresa, a senior analyst at Morningstar.com (www.morningstar.com), which follows mutual funds:

How much does the fund cost?

Indexing is an investment approach that seeks to match the investment returns of a specified index, such as Standard & Poor's 500 stock index, by holding all or a representative sample of the securities in the index.

This cuts down on portfolio trading in the fund, which cuts down on trading costs. High costs hurt fund returns.

"I bring up fund costs all the time, and it isn't just repetition-compulsion disorder," Mr. Di Teresa said in a recent article on Morningstar's Web site.

"I do it because costs matter so much. All other things being equal, they determine whether one fund will be better than another."

Expense ratios of S&P 500 index funds range from 0.18 percent to 1.38 percent, according to The Vanguard Group, which pioneered index funds.

The ratio reflects the fund's cost of doing business and is expressed as a percentage of its assets. You can find the expense ratio in the fund's prospectus, the official document that describes a fund.

How closely has a fund followed the index?

"Some S&P 500 index funds have done a less-than-impressive job of tracking their chosen index," Mr. Di Teresa said.

There's more to tracking an index than just buying the stocks it holds, he said.

"The fund has to put new money to work and meet redemptions when investors cash out," he said. "These things affect how consistently the fund is invested in the index. If they have a lot of cash lying around, that's going to impede it or if they have to sell, it can throw things off."

How tax-efficient is an index fund?

"This is the issue many index fund investors overlook at the peril of their returns," Mr. Di Teresa said. The tax efficiency of a fund refers to how good a fund is at minimizing the tax impact on your investment return when it makes income and capital gains distributions.

Financial planners offering pro bono work

One question I've always had about financial planners is whether enough of them are reaching out to consumers who aren't worth millions and can't afford their services.

The planning profession recently addressed the issue of serving the underserved in an article in the Journal of Financial Planning, a trade publication.

Many planners said doing pro bono work is important.

"Giving back has always been important to me," said Spring Leonard, a certified financial planner at SBL Financial Enterprise in Norfolk, Mass. "You get and you give, and you give and you get."

Industry officials said planners are doing pro bono work not for the fame but because they believe they can help.

"They are motivated in the very best way," said Robert P. Goss, former president of the Certified Financial Planner Board of Standards in Denver, which sets professional standards for planners.

But while the desire to help is there, the industry is debating whether pro bono work should be required of planners. Most planners said it shouldn't be, because the work might be seen as simply another way for planners to market themselves. At the same time, planners said their industry should encourage pro bono work.Pension plans making a comeback

Traditional pension plans, which have been overshadowed by the popular 401(k) retirement savings plan, are making a comeback among small businesses, according to a specialist at brokerage firm A.G. Edwards in St. Louis.

In 1997, mutual fund assets in traditional pension plans totaled $39 billion, compared with $7 billion in 1990, said Kristin Wagner, a retirement planning specialist at A.G. Edwards.

Traditional pensions are coming back for several reasons, Ms. Wagner said:

Baby boomers realize they haven't saved enough for retirement and pensions enable them to catch up in the few remaining years they have before they retire.

Younger workers are concerned about the health of Social Security.

Some companies are establishing traditional pension plans alongside 401(k) plans in order to attract workers.