Running Water

by Harry Jones

(May 13, 1999) -- Lucinda left the water running too high last night. As summer arrives, she waters by putting the hose in certain places of the garden at night and leaving it on very low. By morning, her garden usually has just the right amount of moisture in the ground. She doesn't water during the day then, because it isn't good for her plants to be watered while the sun is hot on them. (You'd think that it would be.)

This morning the garden was flooded. Her cat was drinking from it. She had the water on too high. Over winter, she forgets how low it should be. Soon she'll have the hang of it again and soon overnight, drip by drip, slowly building up, she'll water the right amount without trying.

Asset Classes

by Jeff Fischer (TMFJeff)

There are three general types of stock asset classes: large cap, mid cap, and small cap. Measures vary, but large caps are typically companies worth $5 billion or more, mid caps are valued at $1 billion to $5 billion, and small caps are below $1 billion. Historically, small companies outperform large ones by a few percentage points annually. Therefore, many investors become interested in small-cap index funds as their investment careers progress.

However, some people argue that investing in small cap managed mutual funds is more attractive than investing in small cap passive index funds. The argument says that small companies are more difficult to invest in and require more thought. Thus, a thoughtless index fund of small caps might hold too many eventual losers compared to a managed fund.

The book Earn More, Sleep Better: The Index Fund Solution, by Richard Evans, shows otherwise. It looks at non-index funds of all asset classes versus an adjusted passive index. ("Adjusted" means that the risk, determined by volatility in this case, of the index is equal to the average risk of the non-index funds.) Consider the five-year period beginning December 31, 1991:

Non-Index Funds Versus the Adjusted Index Fund Average Adjusted Index Index Advantage Large Cap 13% 17% 27% Mid Cap 14% 18% 30% Small Cap 15% 20% 29%
In each class, the passive index fund has outperformed by a wide measure. It outperforms even more with small companies. There are many reasons. One, the market is efficient, meaning that everyone has pretty much the same information at the same time, so it is extremely difficult to outperform others or the index. Two, managers trade too often, trying to predict the unpredictable. Three, fund fees have an impact. Four, costs of high turnover, including taxes and missed opportunity, take another bite from returns.

So we're very lucky that there are small-cap index funds. We'll consider some next week.

Fool on!

 Recent Harry Jones Portfolio Headlines
  08/26/99  Is it a Nifty 500? Part II
  08/19/99  Is it a Nifty 500? Part I
  08/12/99  Illuminating Index Funds, Part Two
  08/05/99  Illuminating Index Funds
  07/29/99  The Foolishness of Index Funds
Harry Jones Portfolio Archives »  

05/13/99 Close

Stock Change Close SPY + 19/32 137.34
Day Month Year History HARRY +0.43% 3.07% 7.62% 7.62% S&P: +0.26% 2.43% 11.57% 11.57% NASDAQ: -0.94% 1.54% 17.75% 17.75% Rec'd # Security In At Now Change 1/4/99 16 S&P Depos 127.63 137.34 7.62% Rec'd # Security In At Value Change 1/4/99 16 S&P Depos 2042.00 2197.50 $155.50 CASH $0.00 TOTAL $2197.50 Yesterday Today Change S&P Depos 136.75 137.34 SPY + 19/32


FoolWatch -- It's what's going on at the Fool today.

Are you a Foolish investor?
The Motley Fool Recommends...
Industry Snapshot
New format! A stock idea, industry overview, top players, and financials -- every two weeks! Get more info or order.

Foolish Eight Stock Screen
Here at Last! Foolish Eight Stock Screen. Get more info or order.

Shop FoolMart!