I Love Index Funds

Last week at Fool HQ, I heard that 60% of U.S. households now own stocks. That's up from half at the end of 2005, according to research supplied by the Investment Company Institute. Clearly, we Americans are once again in love with stocks.

But is that good idea? After all, many of us were spurned during the bear market of 2001-2002. These stocks are down more than 20% from January 2000:

Company

CAPS Stars (5 Max)

Total Return

Gap (NYSE: GPS  )

*

(58%)

QUALCOMM (Nasdaq: QCOM  )

***

(57%)

Jabil Circuit (NYSE: JBL  )

***

(29%)

Alcoa (NYSE: AA  )

***

(22%)

Martha Stewart Living (NYSE: MSO  )

*

(21%)

Source: Motley Fool CAPS, Capital IQ

That table alone might spur you to swear off stocks altogether. But before you do, please allow me to introduce you to index funds.

Index funds mimic broad stock indexes such as the Dow Jones Industrial Average, the Nasdaq 100, the Russell 2000, or the S&P 500. As such, they allow investors to own small stakes in thousands of stocks very cheaply. (Sometimes for as little as $1.80 for every $1,000 invested!)

And that confers many benefits, including simplicity. For example, plunk down $100 a month in the Vanguard 500 Index and you'll be immediately granted a stake in every firm in the S&P 500 -- from PMC-Sierra (Nasdaq: PMCS  ) to PepsiCo (NYSE: PEP  ) . You merely collect the monthly statements from your broker.

Second, there's downside protection. Since January 2000, S&P 500 tracking SPDRs (AMEX: SPY  ) have climbed 9.4%, while my list of sourpuss stocks have lagged behind.

Finally, there's the cheap factor. Index funds cost less to produce more. Electric City Value is a good example. Yahoo! Finance says you can expect to pay $2,275 over 10 years for every $10,000 invested in this fund. That's nearly ten times what you'd pay to hold the Vanguard 500 over the same period, yet Electric City Value has historically lost to the indexer.

When it comes to stocks, love is once again in the air. That makes sense; equities are the best-dressed asset class of all time. But buying stocks individually can result in an extreme portfolio makeover of the worst kind. Actively managed mutual funds, meanwhile, watch wealth-destroying fees multiply like rabbits in spring. Only index funds, by offering a diversified portfolio of equities on the cheap, offer the returns of stocks at prices that would make even Ebenezer Scrooge swoon. Maybe it's time you fell for them, too.

What's sending Fools' hearts aflutter? Go back to our intro page to see what else we have a crush on.

Fool contributor Tim Beyers, who is ranked 1,123 out of more than 22,200 in our Motley Fool CAPS investor intelligence database, didn't own shares of any of the companies mentioned in this story at the time of publication. All of his portfolio holdings can be found at Tim's Fool profile. His thoughts on growth stocks, Foolishness, and investing in general may be found in his blog. Gap is a Stock Advisor pick. The Motley Fool's disclosure policy just sent your portfolio flowers.


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