Fundamental indexes worth a look for portfolio
Every so often, a revolutionary idea turns out to be quite true. Most people, for example, now believe that low-cost index funds can often clobber a high-cost, actively managed mutual fund.
Now there's a new twist on indexing, called fundamental indexing, that's rattling the mutual fund universe. Although the jury is still out on fundamental indexing, it does seem promising — and certainly a far better development than the recent spate of highly specialized index funds that have plagued the industry.
The theory behind index funds is fairly simple. It's extremely difficult to outperform a stock index such as the Standard & Poor's 500 with any regularity. It's even harder if you're charging 1.5 percentage points a year for active management. It's like carrying a couple of barbells during a marathon. The guy without the barbells is probably going to win over the long run.
No surprise, then, that the two largest stock mutual funds are index funds. (SPDR S&P 500 and Vanguard Total Stock Market, measuring by single share class.) From a fund company's perspective, however, indexing has one big problem: a relatively limited universe. How many funds do you need that track the S&P 500?
The number of useful, broad-based indexes is relatively small. The fund industry's response has been to create a number of silly — and often expensive — funds based on narrowly defined indexes.
Amid all this fund clutter comes fundamental indexing. Let's start with a little background. Most index funds give greater weight to stocks with the largest market capitalization — number of shares outstanding multiplied by share price. The 10 largest holdings in the S&P 500 account for 18.88 percent of the index.
One criticism of weighting by market cap is that the very largest stocks can be overvalued.
A simple solution would be to weight each stock equally — a strategy that does best when most stocks, rather than a few, are rising.
Fundamental indexing is another way to address the problem. It weights stocks by criteria other than market cap — dividends, for example, or sales or earnings. A few fundamental index funds have five-year records, and the results are mixed.
Charles Schwab & Co. has rolled out five fundamental index funds, using the methodology advanced by Rob Arnott, head of Research Affiliates and a founder of fundamental investing. These funds use a combination of retained operating cash flow, adjusted sales and dividends plus buybacks to weight stocks.
Adding a fundamental index or two to your portfolio might not hurt — and could actually help.
Show commenting policy
TribLive commenting policy
You are solely responsible for your comments and by using TribLive.com you agree to our Terms of Service.
We moderate comments. Our goal is to provide substantive commentary for a general readership. By screening submissions, we provide a space where readers can share intelligent and informed commentary that enhances the quality of our news and information.
While most comments will be posted if they are on-topic and not abusive, moderating decisions are subjective. We will make them as carefully and consistently as we can. Because of the volume of reader comments, we cannot review individual moderation decisions with readers.
We value thoughtful comments representing a range of views that make their point quickly and politely. We make an effort to protect discussions from repeated comments either by the same reader or different readers.
We follow the same standards for taste as the daily newspaper. A few things we won't tolerate: personal attacks, obscenity, vulgarity, profanity (including expletives and letters followed by dashes), commercial promotion, impersonations, incoherence, proselytizing and SHOUTING. Don't include URLs to Web sites.
We do not edit comments. They are either approved or deleted. We reserve the right to edit a comment that is quoted or excerpted in an article. In this case, we may fix spelling and punctuation.
We welcome strong opinions and criticism of our work, but we don't want comments to become bogged down with discussions of our policies and we will moderate accordingly.
We appreciate it when readers and people quoted in articles or blog posts point out errors of fact or emphasis and will investigate all assertions. But these suggestions should be sent via e-mail. To avoid distracting other readers, we won't publish comments that suggest a correction. Instead, corrections will be made in a blog post or in an article.
- S&P 500 reaches new heights
- Social Security spent $300M on ‘IT boondoggle’
- Dick’s cuts PGA professionals as golf business declines
- 10 million Americans sought help to enroll in Obamacare
- Federal appeals courts disagree on Obamacare subsidies
- Amwell wastewater site to be shut down
- Chrysler recalls up to 792K Jeep SUVs for ignition switch defect
- Latrobe’s Ci Medical Technologies transforms to medical device business
- BMW widens recall over air bag concern
- Allegheny Technologies reports 2Q loss despite higher sales
- Microgrid becomes popular option