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As we look back on that black hole of the past few years in U.S. equities markets, the question arises: to index or not to index.
Index funds mirror the performance of an underlying stock index, such as the S&P 500 or the Wilshire Total Market Index. But after three bruising down years, many are questioning the value of investing in a fund that will mimic the market: Why in the world would I want to sit back and passively invest in a fund that is going to lose money? Why not do my homework to try and identify active portfolio managers that have used strategies to beat the market, and preserve some of my hard-earned money?
That begs the question: Does indexing only work in up markets? And what about the costs of buying an index or exchange-traded fund for investors that invest/save a little bit each and every month? Can they measure up against the costs of no-load mutual fund?
They're issues that even twins can disagree on. Gary Gensler is a co-author of The Great Mutual Fund Trap, a book whose title largely speaks for itself. His identical twin brother, Rob Gensler, runs T. Rowe Price's $363 million media and telecommunications fund, which was ranked number one in its category in 2001; the T. Rowe Price fund lost just 7 percent that year, while its peer group plummeted 36 percent.
Obviously, Rob can pick stocks and make his clients money; that's why he was a guest on Wall $treet Week with FORTUNE's Dec. 27 broadcast. But brother Gary may have doubts about Robert's ability to beat the market in the long run. Gary is in a position to know all about investing perils; he's a Wall Street veteran who made partner at Goldman Sachs before he was 30 years old, later worked as a Treasury official in the Clinton administration, and was one of the behind-the-scenes authors of the much-ballyhooed Sarbanes-Oxley Act passed last year to spur corporate reform.
In The Great Mutual Fund Trap, Gary argues that index funds are better for investors than actively-managed accounts. In his view, actively-managed accounts lead to a lack of diversification, trading too frequently and assuming too much risk.
Gary thinks an alternative to actively managed accounts is the exchange-traded mutual fund. With clever names like Spiders (tracking the S&P 500), Qubes (that track the NASDAQ 100) and Diamonds (following the Dow), ETFs are a relatively new product, one that has been growing rapidly over the past 10 or so years, but still accounting for just 2 percent of total industry assets. They're too new to have a long-term track record, but Gary believes that returns will mirror the indices, just as traditional index funds.
Investors are susceptible to four traps in mutual fund investing, Gary says:
- We're too optimistic.
- We are ignorant with respect to how the markets work.
- We are seduced by the message of the media and the financial industry.
- We focus on returns instead of overall costs.
Rob and Gary can hash out passive versus active investing on Friday, when they're scheduled to appear our program; it will be the first appearance for Gary, and second for Rob. If you have trouble telling them apart, just remember that Rob is left-handed and parts his hair on the right, while Gary is right handed and parts his hair on the left.
They take different stands on many ideas as well. Gary's Democratic Party credentials are well-established, while Rob is labeled a Libertarian. Gary says he doesn't invest in his brother's fund, while Rob says he hasn't read Gary's book.
Diversification and long term time horizons play into both brothers' investment strategies, which is a good thing, since it's one of the basic principles of investing. And neither brother seems to be a big fan of day trading, though many financial news shows are based on minute-by-minute moves of stocks and funds on a given day. Gary takes some of that financial media to task, saying in effect that they should be viewed as entertainment only.
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