Q. Are you aware that Vanguard is changing the methodology for the Vanguard Total Stock Market Index? With the majority of my retirement money in this fund, I am very concerned. What is your interpretation of this? After trying to get more information from their web site, I remain unsure if it is indeed a better methodology. Worse, they are forewarning all shareholders that fund expenses will be temporarily increasing as they transition to the new index. What do you think?

---J.R., by email from Houston, TX


A. Don't lose any sleep over this change. Between now and year end Total Stock Market Index fund will shift from the Wilshire 5000 index to the MSCI U.S. Broad Market Index. While the Wilshire 5000 index tracks 100 percent of the U.S. equity market, the MSCI U.S. Broad Market Index covers 99.5 percent, eliminating the smallest and least liquid stocks. You can get an idea of the concentration in the U.S. stock market by considering that one component of the MSCI U.S. Broad Market Index is the Investable Market 2500 index which represents 98 percent of all domestic market value.

The index change will incorporate an operational change that index investors will celebrate once its benefits are understood. Traditional stock indices are constructed by taking the total number of shares outstanding, regardless of ownership. That figure was multiplied by the price of the shares to get the total market capitalization. Then the value of the stock as a percent of the entire index was calculated.

If the total market capitalization of the stock amounted to 1 percent of the index, that's how much of the fund it accounted for.

For most stocks this isn't a problem because their shares are widely distributed. There are a number of stocks, however, where the founding owners continue to own a substantial portion of the shares--- think Bill Gates. This reduces the "free float"--- the number of shares that trade in the market. The net result is that market capitalization based indices can put excessive buying pressure on stocks with limited share float, causing regular overpricing of the shares.

The same additional pressure on share prices also means that the bid/ask spread tends to widen, increasing the transaction costs of the fund. As a consequence, moving to free float indexing will help index funds track their index with less error and reduce costs.

Another thing to remember: index funds operate at a small fraction of the costs incurred by most managed funds. The temporary increase in expenses you see in your Vanguard fund will be minuscule.


Q. I have been told numerous times that mortgage rates are tied to the yield on the 10-year T-bill. Is this true? If so, where do I find this information? I'd like to be able to gauge where rates will go on a daily basis. What is the relationship between the yield and mortgage rates? If the yield goes up, do rates go down?

---C.W., by e-mail from Dallas, TX


A. If you can figure out where interest rates will go on a daily basis, you'll be heading for a new job with a 7-figure paycheck. Until then, let's start with the basics. In the United States all interest rates are keyed off the yields on government securities because our government is a gigantic borrower with perfect credit. Other borrowers will pay more depending on the risk they represent, the period of time they wish to borrow the money, and whether the interest rate is fixed or variable.

Recently, for instance, the 10 year Treasury bond was priced to yield 4.17 percent while the average 30 year fixed rate home mortgage was priced to yield 5.32 percent. You pay more because you're borrowing for a longer period of time. Also, you can't print money to pay your bills the way our government can.

You'll pay less for a 15-year fixed mortgage, about 4.90 percent.

You'll pay still less for a variable rate mortgage whose interest rate is set for a still shorter period of time. According to Banxquote.com, a website that provides financial information, the average "5/1" adjustable rate mortgage will cost you 4.75 percent for the first 5 years and vary annually with an index after that. The average one-year adjustable mortgage will cost 4.51, with some vendors providing initial rates as low as 3.38 percent. It is also possible to have a mortgage that adjusts every month.

Adjustable rate mortgages are usually priced by way of an index such as the Treasury bill average (short term maturities) plus some amount of "margin." This is typically an additional 1.8 to 2.5 percent. A monthly adjustable mortgage based on the Treasury bill average index, for instance, would now cost 2.5 percent plus the margin, say 2.4 percent, or 4.9 percent.

Rates do change daily so it's a good idea to become familiar with websites like www.banxquote.com and www.bankrate.com.