SAug 1, 2002
Where To Find The Broadest Market Index Investments
Q. I agree with your recent column about the destruction of trust. Personally, I have Merrill Lynch accounts that I want to close because I have lost faith in them. However, I don't know what I should do next. I like the couch potato model, but do you still think an S&P 500 fund is right? Should I send a message to Wall Street by getting out of stocks altogether, or is that cutting off my nose to spite my face? Should the other 50 percent go into a government, not corporate, bond fund?
D.F., Irving, TX (by e-mail)
A. In early February (2/10/02, The Stock Vigilantes), I suggested all of us should become "stock vigilantes" and send a message to Corporate America. We'd send it by reducing our commitment to equities.
When the column was published my mailbox quickly filled with angry messages. Many declared I was an irresponsible jerk who wanted people to "cut off their noses to spite their face."
Since then the S&P 500 Index has lost about 26 percent of its value , indicating that some reduction would have been great plastic surgery. Growth oriented funds have done worse. The devastation in technology and telecom is still worse. Today, technology stocks account for only 14 percent of the value of the S&P 500 index. That's less than its long-term average of 17 percent. At the height of the bubble technology was 34 percent of the index according to Leuthold Group research.
If you use the size of the decline as a measure, it is reasonable to believe we are close to a bottom. Unfortunately, Bear markets, like bull markets, tend to exceed what anyone thinks is reasonable.
The Standard & Poor's 500 Index represents about 75 percent of the market value of all publicly traded stocks. That's why it has served as a proxy for "the market" for so many years. Other indices represent still larger portions of the market:
• The Russell 1000 Index, for instance, represents about 90 percent
of all market value. The Russell 2000 Index represents an
additional 8 to 9 percent of all market value beyond the Russell
• The Russell 3000 Index is the combination of the 1000 and 2000
indices and represents 98 or 99 percent of all domestic market
• The Wilshire 5000 Index, the largest, represents virtually all
traded equity in America.
Today's Couch Potato should use a broader index. The Russell 3000 Index, ticker IWV, works if you are buying exchange-traded funds. If you use mutual funds, Vanguard, Fidelity, Schwab, and T. Rowe Price offer Wilshire 5000 based "Total Market" funds. Either way, you are "buying the market."
On the bond side, the return advantage for corporate bonds is small. According to Ibbotson Associates figures, the long term annualized return on corporate bonds is 5.8 percent. The comparable return on government bonds is 5.3 percent. Net of inflation, the returns are only 2.7 and 2.2 percent, respectively.
In the current market, Inflation indexed Treasury obligations yield as much or more--- Bloomberg figures range from 2.08 percent for 5-year inflation protected notes to 2.77 and 2.99 for 10 and 30-year obligations. A low cost fund that invests in inflation protected government securities is a good way to get those returns. Vanguard, American Century, and PIMCO have such funds. Fidelity launched one last month.
Q. I am in my early sixties. I plan on working about 3-4 years. My investments are about 60/40 equity/bonds. I took a five-year payout from my company retirement from my previous employer and am now starting my second year with my new employer. Obviously, my timing sucks. My question is this: two different people have told me they are getting 9 percent on corporate bonds.
What is your opinion of setting aside a certain amount of money on corporate bonds?
---R.M., by e-mail
A. Corporate bonds are one thing. Corporate bonds that yield 9 percent are another. The yield on bonds rises with their credit risk. The higher the risk, the higher the yield.
In the current market, according to Bloomberg.com, a 10-year Treasury yields only 4.43 percent. High quality corporate bonds yield about 1 percentage point more. According to Morningstar the average junk bond portfolio has an SEC yield of less than 9 percent.
Bottom line: your friends are getting 9 percent because they own junk. Envy them from a distance.
Filed Under: Income Investing, Q&A (from print)
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