We've long said that the bedrock of any portfolio is a safe index of stocks. But can't we do better than the standard index mutual funds? I have a different kind of index investing in mind. It's not index mutual funds, but index shares. Browse through these lists of index shares (links are in the top left of the linked page) which trade exactly like regular stocks on the American Stock Exchange. There are two index shares in particular that I'd like to highlight.
First is Consumer Staples (AMEX: XLP). This sector, one of nine that makes up the S&P, is comprised of 68 companies that account for one-fifth of the weight of the entire S&P 500. It includes Rule Maker holdings Pfizer (NYSE: PFE), Schering-Plough (NYSE: SGP), and Coca-Cola (NYSE: KO), as well as maturing Rule Breaker Amgen (Nasdaq: AMGN) and Drip Port holdings Johnson & Johnson (NYSE: JNJ), PepsiCo (NYSE: PEP), and Campbell (NYSE: CPB). In fact, when measured by market cap, Motley Fool portfolio holdings make up a third of the Consumer Staples index.
The Consumer Staples index is heavily weighted in pharmaceutical companies, which make up over half of its holdings -- eight of the index's top ten holdings are pharmaceutical/biotech companies. Making up a tenth or so of the index at any given time are food companies (Philip Morris (NYSE: MO), Unilever (NYSE: UN), Best Foods (NYSE: BFO), etc.), beverage companies, and consumer product companies (Procter & Gamble (NYSE: PG), Gillette (NYSE: G), Kimberly Clark (NYSE: KMB), Colgate-Palmolive (NYSE: CL), etc.). The last tenth of the index gets split between the major grocers/retailers (Walgreen (NYSE: WAG), Safeway (NYSE: SWY), Kroger (NYSE: KR)) and medical/health companies, from Baxter (NYSE: BAX) to Boston Scientific (NYSE: BSX). It's an extraordinarily resilient group of companies, one which was up 24% during 2000. Best of all, the expense ratio on this index share is a low 0.28%, or $28 per $10,000 invested. For more on the Consumer Staples sector, see the Consumer Staples information page.
The other index worthy of any investor's attention is Technology (AMEX: XLK), which, with 89 companies, is about a third of the entire S&P 500 by market cap. Together with the Consumer Staples sector, these two make up about half of the S&P 500's value at any given time. What's in the Technology index? Well, from just Fool portfolios, there are Rule Makers Cisco (Nasdaq: CSCO), Microsoft (Nasdaq: MSFT), Intel (Nasdaq: INTC), JDS Uniphase (Nasdaq: JDSU) and Yahoo! (Nasdaq: YHOO), not to mention Rule Breaker AOL-Time Warner (NYSE: AOL). Like the Consumer Staples index, about a third of the Technology index's market cap is comprised of companies in Fool portfolios. Many other oft-discussed and admired companies are in the index, including many FOOL 50 components.
Naturally, the Technology sector is more volatile than other sectors of the S&P, and it won't surprise anyone to hear that this past year was a tough one for this sector (-42% for all of 2000). But will it surprise anyone if 10 and 30 years from now this sector outperforms all others? I think there's a chance that Consumer Staples could give it a run, due to its exposure to the revolutionary advances of biotechnology, but my guess is that the Technology sector is where the most growth will occur. Like the Consumer Staples sector, Technology exacts an expense ratio of only 0.28%. For more on the Technology index, see the Technology information page.
When it comes to assessing index shares from a long-term perspective, there's unfortunately not much history to talk about here, as these sectors weren't tracked in this way until recently. And as much as I'd love to do a Rule Maker analysis of these indexes, I'm not sure how to proceed, or if it's even possible. But it seems obvious these indexes represent outstanding long-term buy-and-hold options.
For decades now, Standard and Poor's has been doing a great job of selecting 500 of America's best companies for their marquee index, much to the everlasting embarrassment of the actively-managed mutual fund industry. Some people complain that it isn't fair to compare mutual fund performance to an index, because fees and taxes are so much lower. They're right. It isn't fair -- and that's exactly why we love index investing.
But there's no reason in this world why investors have to take the good with the bad in index investing, no reason you should have to purchase the whole S&P 500 and with it, perennially underperforming sectors like Basic Industries (AMEX: XLB), Energy (AMEX: XLE), Industrial (AMEX: XLI), and Utilities (AMEX: XLU). I would even consider leaving out Consumer Services (AMEX: XLV), Cyclical/Transportation (AMEX: XLY), and Financial (AMEX: XLF). Nothing but the best for us, thanks.
Another reason to stick with S&P sectors, besides trusting that Standard and Poor's knows what they're doing, and that they'll still be doing it a hundred years from now, is that S&P is independent. Unlike, say, the Nasdaq 100 Index (AMEX: QQQ), which simply indexes the largest market cap stocks that trade on that particular exchange, the stocks in Standard and Poor's indexes come from any American exchange, and are included not merely because of their size, but because S&P is convinced they belong.
Index shares trade in every way just like any other share of stock, and even though they offer the safety of indexing, they also offer a kind of focused investing -- enough of both for safety and outsized returns. They're wonderful long-term investments, some of the only true buy-and-forget investments an investor can Foolishly make.
We believe the Rule Maker Portfolio, with thoughtful company selection, can ultimately do better than even these uber-indexes -- and we believe you can, too. But an index of some broad sort probably ought to form the cornerstone of any individual's portfolio (XLK and XLP serve as my own). While there are a great many other indexes, these are the ones that deserve the first look.
Until next time, cheers!