It started last year when, for the first time in five years, the average domestic equity fund did better than the S&P 500 Index, providing a total return of 28.12 percent and beating the index by 7.08 percent. The last time this happened was in 1993.
The definitive break, however, appears to have occurred in the last few months and weeks. Here's the evidence:
- Lipper Analytical Services, the New Jersey based mutual fund tracking firm, has divided the mutual fund universe into thirteen distinct pieces ranging from small capitalization value to large cap growth. As of last week, every single one of those indices was ahead of the S&P 500 index.
- Figures from Morningstar, the Chicago financial data firm, show that the Vanguard Index 500, after years of having a substantial advantage over the Vanguard Total Market Index, has finally started to trail the broader index. While the Vanguard Index 500 provided a return 20.72 percent annualized over the three years ending August 31, the Vanguard Total Market fund trailed with a 19.61 percent return. But Total Market has beaten the 500 Index over the last 12 months and year to date, as it did in 1999.
|The S&P 500 Index Falls Behind|
|Index Fund||Year to date 8/31||Last 12 months||3 years||5 years|
|Index 500||4.16 percent||16.46 percent||20.72 percent||24.01 percent|
|Mid Cap Index||23.67||40.50||Na||Na|
|Small Cap Index||7.60||27.39||10.19||14.57|
|Source: Morningstar Principia Pro, August 31 data|
I think there are three answers. Which you choose depends on (a) your fundamental faith in the S&P 500 index and (b) how much work you want to do.
- Stay the Course. Since the late sixties a multitude of research studies has shown that about 70 percent of all professional managers will fail to beat the S&P 500 index due to management expenses, transaction costs, and stock choices. From 1994 through 1998 the S&P 500 index stocks--- fueled largely by the incredible rise of the 50 largest stocks in the index--- simply crushed managed funds, beating over 90 percent of them. Such superiority can't be sustained forever, hence the current relatively poor performance. But there is no reason to believe that an S&P 500 index fund won't beat the majority of the managed funds over the long term.
- Bow To a Greater Index. The fastest way to be a complete Couch Potato is to expand your universe and move your equity investment from the S&P 500 Index to a fund that represents the total domestic stock market--- such as Vanguard Total Market Index. This will allow you to capture that last 15 to 20 percent of the market not included in the S&P 500 index. You can accomplish much the same thing by moving 15 percent of your S&P 500 Index investment to Vanguard Extended Market index, a fund that invests in all the stocks that are NOT in the S&P 500 Index.
- Make a Deliberate Reach. If you feel that a larger change is necessary, you can move a portion of your money from the S&P 500 index fund to index funds that invest in small and medium cap stocks, such as Vanguard Small Cap Index and Vanguard Mid Cap Index. Try a 50/25/25 percent mix.
Tuesday: The other market shift