---R. P., by e-mail from Houston, Texas
A. First let me make an important distinction. I advocate passive investing using index funds. The Vanguard 500 Index fund pioneered this trend for individual investors in 1976. I write about other index investments, including Exchange Traded Index Funds, regularly.
There's a reason the equal weighted S&P 500 index does better than the cap weighted index: it distributes investment money equally to all 500 stocks. The consequence is much greater investment in the smaller companies in the index. This means more money is invested in stocks with faster growth. It also means more money is committed to stocks likely to be acquired by the larger companies on the list.
There is a difference between reporting the performance of an index and reporting the performance of a fund designed to track an index. While there are now hundreds of conventional (capitalization weighted) index funds, there is only one equal weighted index fund. It is the Rydex S&P Equal Weight ETF.
The fund, ticker RSP, was launched in May, 2003. It currently has about $277 million in assets. According to the MSN MoneyCentral website, it has provided a total return of 41 percent since then. The iShares S&P 500 ETF has provided a total return of 28 percent over the same period. The Rydex ETF has an annual expense ratio of 0.40 percent.
Many investment advisors use conventional index investments to achieve broader diversification into mid and small cap stocks. The iShares Russell 3000 ETF, for instance, provided a total return of 31 percent over that period. The iShares Russell 2000 ETF provided a total return of 51 percent.
There may be a reason there is only one equal weighted index fund but I have never seen the subject discussed in research. My speculation--- and it is just that--- is that an equal weighted index fund is more difficult to manage than a capitalization weighted fund. General Electric, the largest company on the S&P list, had a market cap of $311 billion at the end of 2003. That's more than 300 times as large as the smallest company on the list. Given the difference in the liquidity of the small stocks vs. the larger stocks, there would probably be a lot more "tracking error" in an equal weighted index fund than in a cap weighted index fund.
Q. My mother has just turned 91. She needs more income. She has a stock portfolio with a total value of $1,621,406 with about $1.2 million in equities and $400,000 in American Funds Washington Mutual. The problem is she only gets about $3,000 a month from all this. She needs to double it. About half of the money she has in individual equities is in Bank of America and Janus Capital Group shares, neither of which seems to be doing much and which I think might be better invested.
Can you make some suggestions that would give her a higher monthly income?
---B.W., by e-mail
A. Your mother's dividend return from her investments calculates to about 2.2 percent. That's pretty good these days. It would probably be lower without that big slug of Bank of America stock, which yields 3.9 percent.
There are several things you can do. One is to simply liquidate $3,000 of assets each month. Let her spend the money. It will raise her withdrawal rate to 4.4 percent. She will not run out of money. Indeed, her estate will probably continue to grow.
I'd sell the Janus Capital Group shares first since they pay no dividends and the group has suffered significant outflows of client assets.
Before making any major changes you need to examine the portfolio for unrealized capital gains, which are probably quite large. Remember, these tax liabilities disappear at death but would be realized in any big-time selling purge.
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