Myth #4: Risk Reduction
Myth: Owning just an S&P indexed fund is enough to spread your risk around.
The Truth: Aside from sector weighting, it also omits crucial asset classes.
Yes, an S&P 500 index fund like the SPY is diversified in regards to large-cap equities. But aside from the previous point of sector weighting, it’s important to understand there are whole segments of the market that don’t get included here.
While there is a global flavor via multinationals, the lack of foreign-based companies is one blind spot. And by definition, the large-cap index omits smaller companies with bigger growth potential and faster snap-back in a recovery. Also, REITs — a huge dividend-generating sector — don’t play into the S&P at all.
And if you really want to get technical, a fully diversified portfolio should include bonds, and many investors also advocate exposure to commodities or other physical investments like real estate. So the S&P 500 is not a one-stop shop.
Myth #5: Fund Costs
Myth: All S&P 500 Index funds are cheap and perform the same.
The Truth: Read the fine print!
Yes, many S&P 500 Index funds do have low expense ratios. And you might think that it’s academic to shop around. After all, the SPY ETF isn’t that much more “expensive” with a 0.1% cost vs. the Vanguard S&P 500 ETF (NYSE:VOO) and its 0.05% cost. And the Vanguard 500 Index (MUTF:VFINX) mutual fund’s 0.17% expense ratio is hardly breaking the bank, even if the Spartan 500 Index (MUTF:FUSEX) fund is lower at just 0.07%.
But guess what? There are some greedy funds out there.
The DWS S&P 500 Index C (MUTF:SXPCX) fund, for example, has an expense ratio of 1.4%. And it’s not even a no-load fund! So read the fine print, especially for front loads or deferred loads that can hurt your performance.
Because of these expense ratios, performance is naturally affected. But other trading costs also factor in. After all, you can’t “buy” the S&P — you still have to rely on a manager buying individual component stocks. There’s no guesswork since the fund must follow the rigid rules of the indexing committee, but remember: There is real trading going on here in real stocks.
As such, you’ll see some index funds might underperform (or even outperform) the S&P 500 based on the particulars of how they buy and sell component stocks. Consider that while the actual S&P 500 is up 15.1% in the past 12 months (as of Friday’s close), the Vanguard ETF is up 15.5%, the iShares S&P 500 ETF (NYSE:IVV) is up 15.1% and the Vanguard VFINX mutual fund is up 14.9%. That’s a range of 0.6 percentage points.
You might not think that’s substantial, but compounded over decades, that kind of difference adds up.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.