Cruise-control investing

By , Staff writer of The Christian Science Monitor

Who says it's dangerous to be asleep at the wheel?

Certainly not investors in funds indexed to the Standard & Poor's 500. In the past four years, funds that blindly mimic the index have ripped up the road in just one speed: overdrive.

Indeed, the S&P 500 Index has reigned as the stock market's "Plain Jane" queen over four years: up 34.1 percent in '95, 20.3 percent in '96, 31 percent in '97, and 26.7 percent last year.

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No other kind of fund has demanded so little from the cranium while delivering so much to the wallet.

The S&P 500 Index seems especially alluring in light of last year's average 7 percent return for actively managed funds - those whose managers actively buy and sell stocks.

But before you load with index funds, take a close look under the hood. You might see some potential weakness, both for the S&P 500 and the broader market.

The S&P 500 - a measure of 500 stocks - raced ahead on the backs of just 10 of them. This high-flying elite accounted for nearly half of the index's surge in 1998, according to Salomon Smith Barney.

That concentration narrowed even more last quarter. Just five stocks in the S&P 500 - Dell, Lucent, Microsoft, Pfizer, Wal-Mart - generated 52 percent of the index's return, according to Merrill Lynch.

So investors flourished last year not so much by buying into the S&P 500, but by shopping from among a select group of high-priced stocks. "Focus" or "select" funds that follow such a strategy - building their portfolio on 20 or so stocks - were among the few fund types that easily beat the S&P 500.

But this superoctane action hides weaknesses in the broader market.

Most stocks faltered in 1998. In the S&P 500, 7 out of 10 stocks last year lagged behind the index, according to Salomon Smith Barney.

Analysts say that any market standing on so few legs is wobbly. Declining profits and record-high prices make it all the more shaky.

Investors who seek the simplicity of indexing would do well to look at smaller stocks, say analysts. "Funds that invest in small- and mid-cap stocks offer much more attractive valuations," says Amy Arnott, editor of Morningstar Mutual Funds in Chicago.

The Vanguard fund family, which manages the largest index funds, has cautioned investors for more than a year against blindly investing in blue-chip index funds like its own Vanguard 500 Index Fund.

Investors haven't listened. At current rates of growth, the Vanguard 500 Index Fund later this year will surpass Fidelity's Magellan Fund as the nation's largest mutual fund.

"It's a great concern to us that investors continue to pour money into the 500 portfolio," says Brian Mattes, Vanguard spokesman. "The stocks are selling at unusually high valuations and this can't continue for very long," he says. "But," he adds, "I've been saying this for nearly two years."

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