What is a stock index fund or an indexed bond
fund? I want to open a Roth IRA and need to decide where to put
I wonder if the T. Rowe Price Mid-Cap Growth Fund
would be a good idea for my Roth? Is it a stock index fund? What
about the T. Rowe Price Capital Appreciation fund? Is it a hybrid
fund? Thank you. -- Martha Markets
The stock market and the bond market have dozens of indexes, or
groups of investments, that are used as benchmarks to measure how
well a segment or sector of the financial markets is doing.
Most investors are familiar with the Dow Jones Industrial
Average (DJIA) or the Standard & Poor's 500 (S&P 500) because
the changes in these indexes are widely reported every business
Well, investors can invest in funds that buy what
is in the index and earn a return that approximately equals the
index's performance -- less any expenses associated with owning
that fund. Instead of trying to beat the market, you own the market,
or at least that part of the market represented by the index fund.
For example, the Fidelity Spartan US Equity Index
(FUSEX) is a stock index fund based on the Standard & Poor's
500 Index. An investment in FUSEX will approximate the return of
the S&P 500 over the same holding period less the mutual fund's
annual expense ratio of .17 percent.
The Dow Jones Industrial Average is an index of 30
US stocks, while the Standard & Poor's 500 is an average of
the 500 largest capitalization stocks of US based companies selected
by the Standard & Poor's Index Committee.
The DJIA is an simple average of the prices of the
30 stocks in the index, adjusted for stock splits and stock dividends
while the S&P 500 is a capitalization weighted index that not
only considers the price of the stock but also considers the number
of shares outstanding. Over a trillion dollars is invested in S&P
500 indexed investments.
The Vanguard Total Bond Market Index (VBMFX) approximates
an investment in the Lehman Brothers Aggregate Bond Index. In this
case the mutual fund doesn't actually own the more than 6,700 bonds
that comprise the index, just a grouping of bonds sufficient to
capture the average risk and maturity of the index to provide investors
with a return that is close to the return on the actual index less
annual expenses of .22 percent.
The T. Rowe Price Mid-Cap Growth fund (RPMGX) isn't
an index fund. The fund manager selects stocks based on their size
and their growth prospects. Market capitalization is the size of
the firm based on the stock price times the number of shares outstanding.
The growth emphasis relates to the companies' expected future earnings.
The T. Rowe Price Capital Appreciation fund (PRWCX)
is a hybrid fund. That means that the portfolio manager invests
in both stocks and bonds. This fund is not an index fund but you
can invest in a hybrid fund that indexes its stock and bond investments.
An example of an indexed hybrid fund is the Vanguard Balanced Index
Index funds will typically have much lower annual
expenses than an actively managed fund. Index investors aren't trying
to beat the market, just keep pace with the market index. A broad
based approach to investing can keep the investor from taking speculative
risks in an industry or sector.
I can't tell you whether an index fund investment
will outperform the T. Rowe Price funds that you're considering,
or any other actively managed fund for that matter. I like index
funds for core holdings that will be held for long periods of time
because of their low expense ratios and diversification.
You could always select the T. Rowe Price Equity Index
500 fund (PREIX) or another index fund from that fund family, but
the annual expense ratio for PREIX, at .35 percent is roughly twice
that of the Fidelity Spartan US Equity Index or Vanguard 500 Index.
An alternative to indexed mutual funds for your Roth
IRA is to open a brokerage account and invest in Exchange Traded
Funds (EFTs) like the SPDR Trust Series 1 (SPY) for the S&P
500 and others.
for a complete review of the various investment indexes and the
different mutual funds and ETFs available to invest in an index.
Editor's Note: Dr. Don holds
investment positions in Fidelity Spartan US Equity Index
and Vanguard 500 Index funds.