Q. In a recent column you once again proclaimed the wonders of index funds, especially Vanguard index funds. I have the opportunity to rollover $40,000 in an old 401k into a traditional IRA.   I have a financial advisor and he recommended Templeton Growth and Franklin Small-Mid Cap Growth to compliment the approximate $10,000 in my existing traditional IRA in the Mutual Shares fund (Class Z).   In doing so, I qualified for a reduced load of 4.5%.   I showed him your article and asked if the Vanguard Total Market Index fund or the Vanguard 500 Index fund would be a better investment.

He compared my hypothetical $50,000 Mutual Shares/Templeton World/Franklin Small-Mid Cap Growth portfolio to a $50,000 invested in both the Vanguard funds.   He went back 1,2,5 and 10 years. Even after taking into consideration the sales charges, my hypothetical Franklin Templeton portfolio outperformed both Vanguard funds in each of those time periods.

In looking over the 10-year figures, my portfolio was also less volatile…  

  My advisor mentioned these historical reports were no promise of future returns. However, from my perspective, what else do we have to base our decisions on?   You, in fact, support your recommendations in part based upon past performance.   I bounced this against my CPA who is also a CFP.   She concurred with my advisors' recommendations and referred me to an article on the S&P 500 (http://moneycentral.msn.com/content/P25387.asp). After reading this article, I think you'd have to be a fad following fool to invest in an S&P 500 Index fund.

One last point: (sorry, I found the soapbox) I find it amazing that you and others bash loaded funds and advise people that they can "do it on their own"…

If it is so easy to "do it on your own" why are so many seeking advice from others? I, for one, am very happy with my advisor and don't mind paying a load to get the advice and service…  

----JM, by e-mail


A. A managed fund can beat an index fund. But the odds are against it, whoever makes the decisions. You are citing a particular case, yours. It is a happy case. The case for indexing is about probabilities. Most people don't tell a story like yours.

In the column you mention* I deliberately mentioned the performance of four American Funds group funds that did better over the 20-year period. I said they were a good example of commissioned representatives who served clients well by putting them in funds with low ongoing costs. Your broker picked good funds and considered diversification and risk.

Unfortunately, this is not a common experience. A typical small investor meets a broker with little experience who has to obey the sales directives of the office manager. This means he sells what's being sold. Today, that generally means high expense "wrap accounts."

Indexing is an issue with a long history. In the late sixties and early seventies corporate pension managers learned that 70 percent of professionals regularly failed to beat the S&P 500 Index. They measured against the S&P 500 Index because it was the only broad index with a history at that time . The Wilshire 5000 index wasn't created until 1974   and the Russell indices weren't created until 1979 .

Further evidence came from a major computer exercise done by Media General in the early seventies. They programmed a computer to randomly select portfolios of stocks from three different stock universes--- the 200 largest, the 500 largest, and the 1800 largest. Then they rank ordered the performance of the randomly selected portfolios. Regardless of universe size, managed funds regularly averaged below the 50th percentile of randomly selected portfolios.   

Managed pension funds failed to beat a passive index in the 60's and 70's. Managed mutual funds failed to beat a passive index in the 80's and 90's.

Today it is possible to invest in funds that duplicate the performance of broader indices than the S&P 500 Index. I would not be surprised if future flows went to funds that duplicate broader indices, such as the Wilshire 5000. Wherever the money goes, a broad index will continue to beat at least 70 percent of the managed funds.

  This leaves you with a choice:

•           You can bet your retirement on a 3 in 10 shot with managed funds.

•           Or you can bet your retirement on a 7 in 10 shot.

For retirement, which has no second chances, I'll take the 7 in 10 shot.

Indexing Is Built for the Long Haul