Funds that do `only' as well as the market shouldn't be sneezed at

Many investors have grown weary of reading magazines, newspapers, and newsletters, trying to find a mutual fund to ``beat the market.'' Now some of these investors aren't trying to beat the market anymore. A small but steadily growing number of people are turning to a small but steadily growing variety of mutual fund known as index funds. These funds are almost entirely invested by computer in the same stocks - and in the same proportion - as one of the widely followed stock indexes.

``So if IBM represents about 3 percent of the S&P [Standard & Poor's] 500, it will be 3 percent of our fund,'' says Brian Mattes, a vice-president at the Vanguard Group in Valley Forge, Pa. Vanguard has three index funds, including Vanguard Index Trust, which mirrors the performance of the S&P.

This no-load fund has been in operation since 1976, making it one of the older such funds. Eight new ones were introduced by several companies just last year.

Index funds are popular with the sponsors and managers of corporate and private pension funds. Rather than take undue risks with retirement portfolios, these money managers accept what many call the ``mediocre'' performance of index funds to make sure they don't underperform the market. Individual investors have been slower to embrace the idea.

``Index funds don't fit in with the American psyche, says Michael Lipper, president of Lipper Analytical Services. ``People seem to feel they can beat the averages in life as well as in investing.''

James Stack, publisher of InvesTech, a newsletter in Kalispell, Mont., agrees.

``Investors will always have the hope that they're going to beat the averages, or that a top-rated fund will fall less than any other,'' he says. ``But history shows that's false, and until that perception gets wiped out, index funds won't do as well.''

The argument for funds that promise to do no better - or worse - than the market becomes stronger when the recent performance of other funds is examined.

In each of the last four years, most equity funds have not done as well as the market, as measured by the S&P 500. Last year, for instance, the S&P posted a 19 percent return, while the average mutual fund was up just 13 percent. (Still, sales of all equity funds doubled last year.)

Clearly, a fund that gained 19 percent in 1986 didn't disappoint too many people. But what if you're in a fund that does as poorly as the market when the bears come out of hibernation?

``In a bear market, two-thirds of the stock funds will end up losing more than the Dow,'' Mr. Stack says.

An index fund, then, won't do any worse than the market, and if you figure that stocks will continue upward over the long term, you'll be comfortable in an index fund.

``If I had a choice of an index fund in a bear market or a top-rated mutual fund, I'd like the index fund,'' Stack adds. ``They're going to lose less.''

Then why not put all your money in an index fund and forget about reading the financial pages? Why not take the completely passive, or ``no brain'' approach, as some have dubbed the index fund strategy?

``All your money shouldn't be'' in an index fund, says Gary Greenbaum, a financial planer in West Orange, N.J., and a strong proponent of index funds. ``Asset allocation is very important.''

You could allocate your money among different types of index funds. In addition to its Index Trust, Vanguard has a bond index fund, and a fund that takes about 3,500 stocks, pares them down to 300 or 400 to make up an index, which the company feels will beat the S&P by a couple of percentage points.

The Colonial Group in Boston has three index funds. Each imposes a 4 percent sales charge. Along with a fund that copies the S&P 500, Colonial offers a small-stock fund that follows the bottom fifth (by size) of the stocks on the New York Stock Exchange, and an international fund that follows the EAFE (Europe, Far East, Australia) index.

``An index fund is a good core investment,'' Mr. Mattes at Vanguard says.

If people still want to try to beat the averages with part of their money, they might invest in various stock or bond funds, or even individual stocks, while half the money is in an index fund. The proportions would depend on your financial needs, the amount of risk you want to take, and how comfortable you become with index funds.

Or you could spread the risk among different index funds, says Mr. Greenbaum. ``Once you pick the asset allocation you want, then find the right index fund that matches each risk factor.''

Since it was introduced a decade ago, Vanguard's Index Trust has grown to $612 million in assets. It picked up more than $200 million of that amount last year, Mattes says.

Colonial's three funds were introduced last July, Art MacPherson, a spokesman, says. By the end of last month, the fund had nearly $37 million in assets.

The growth these companies have experienced has attracted a number of competitors. Dimensional Fund Advisors in Santa Monica, Calif., has three index funds. One tracks the smallest fifth of the stocks on the Big Board, while the two others follow segments of stock exchanges in Tokyo and London.

Another firm, Fund for Government Investors in Bethesda, Md., has two no-load funds under the Rushmore name. One fund follows the S&P 500 index; the other matches the NASDAQ index of 100 over-the-counter stocks.

If you have a question that would make a good subject for this column, please send it to Moneywise, The Christian Science Monitor, One Norway St., Boston, MA 02115. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.

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