Lux Investing

Index Funds: I am in the process of learning about mutual fund investing. I want to make sure I am well ?

diversified. I understand that index funds that follow the S&P are mainly large cap companies. Should I have a separate fund for Large, medium, and small caps? Or maybe just one that follows the S&P. Or maybe one that follows the entire market (wilshire 5000)? There are so many options . Please help. Thanks in advance.

Public Comments

1. Vanguard, for one, has "total stock market" and "total bond market" index funds.
2. You should be clear in your concept of diversification. Whether you choose a large, medium or small cap fund, check the stocks comprising the index and see if they belong to different industry segments. Small and mid-cap funds tend to be riskier - but give higher returns in a rising market. They also fall more when the market tanks. Large cap funds are less risky and give steadier returns. So what you choose will depend on your risk tolerance. Also check the past record of funds. Though it does not guarantee future returns, steady performance over a 3 to 5 year period usually indicates good fund management.
3. in the end, it really won't matter much. the S&P 500 tracks the 500 largest (by market cap) companies in the US. this gives you mid- and large- (and mega-) cap coverage. but the index is cap-weighted, so it does act more like a large cap than an all-cap. the Wilshire 5000 gives you more companies, but it still faces the same handicap of giving better large-cap coverage, though it is a better broad-market index than the S&P 500 hands down. both of the above are only US-based indexes, though, and both are cap-weighted, which is generally not ideal. the NYSE Composite would give you a US-focused index, but it includes considerable foreign issues, as well. 55 of the top 100 holdings in the NYSE Composite are non-US companies. It's also not cap-weighted, but is rather share-weighted. It tends to outperform the other indexes in good periods, and under-perform in weak periods - basically, it's just a bit more volatile than the other indexes due to its foreign holdings. over time, this may actually be a good thing, though, if you've got the stomach for the bit of extra volatility, as it will pump up your return a bit. personally, i prefer the NYSE Composite for an all-market index. but, it's less popular than the S&P 500, so it will generally have higher fees. it might be easier to find than a Wilshire-tracking fund (it's mostly used by academics, not investors), though, so you might save a bit on fees there, though they'd probably be roughly equal. really, i don't think you can go wrong with any broad-market index, though. the most important thing is just to be invested. i wouldn't worry too much about trying to be invested in a bunch of different funds to capture every conceivable market segment. i'd just pick one fund that you like, with a good fee structure, where the company offers you all the service you're looking for. THE MOST IMPORTANT THING TO LOOK AT, THOUGH, IS TRACKING ERROR. IF YOU HAVE A FUND THAT LOOKS GOOD, IS BASED ON AN INDEX THAT YOU LOVE, BUT IT SOMETIMES MISSES THE MARK BY A COUPLE OF PERCENT, COMPLETELY DISREGARD THAT FUND - IT'S POORLY RUN.
4. There are many options, indeed. First of, if you want to merely track an index and if you keep your investments in a non tax deferred account (such as IRA/401/Roth), you might be better of with ETFs rather than mutual funds for tax purposes. See http://www.ameri-financial.com/headline-story/mutual-fund-owners-eyeing-big-tax-hit.html for some tax implications of investing in Mutual Funds. Second, it does matter what market capitalization group you invest into. Generally, small cap offers higher returns and more risk, vs. large cap that usually generates less return but comes with lower risk too. According to http://www.ameri-financial.com/headline-story/your-ideal-obama-portfolio.html, historically small caps perform better under democrats. Finally, the crisis is not over. It might be wise to wait for a while before getting into the game. If you still decide to proceed now, do not invest the whole sum. A third of your intended investment should do.
5. You probably want to start with a mutual fund primer to educate yourself, then try to diversify outside of S&P with WW funds. Asset Allocation would depend on your time horizon. ETF is not bad, but you probably miss some great fund managers.