How to Compare Index Funds

All index funds are not created equal. An index fund is really just a collection of multiple stocks, and each index may have a specific function in mind when it was created. Some caution is warranted when buying the multiple index funds available on the market today. Often overlooked details--like expense ratios, management fees, sector concentration and company size--are variables you should factor in when making investment choices.

Difficulty: Moderately Easy

Instructions

1. Compare the holdings of the index funds. Different stock market indexes will be composed of different types of companies. For example, the Dow Jones Industrial Average has 30 industrial based companies, but the S&P 500 has 500 different companies covering a broad range of sectors. The NASDAQ companies are generally technology-based companies, but the Russell 2000 is composed of smaller, less commonly known companies.

2. Evaluate the overall performance of each index fund. Because indexes are composed of different companies, each index will track the overall performance of the stocks they track. To check how each index performed for the year, do a quick overlay of each stock index that you wish to examine.

3. Check the return on investment of actively managed funds compared to basic index funds. A large proportion of higher priced, actively managed mutual funds do not outperform the S&P 500 (the index most commonly used by professionals).
   
   Go to Yahoo! Finance. Input your actively managed mutual fund symbol to track its 1-year, 5-year and 10-year performance. Then overlay with the S&P 500 index to see how your mutual fund stacks up against the index.
   
   If your mutual fund is under performing, you should consider investing in a different mutual or investing in index funds.

4. Evaluate the total cost of an index fund's management fees (also called expense ratio). Many different companies offer different investment products. It pays to shop around to find the cheaper price.

Tips & Warnings

• Occasionally, exchange traded funds (ETFs) that track an index have cheaper management fees than a regular index fund. These contain 3 letter symbols instead of 5 (example: VTI vs. VFINX). The Vanguard Group is widely considered the leader in low cost index fund and mutual fund investing. If you're interested in bare bones investing with excellent customer service, give them a call (see link below).
• Some index funds are not exceptionally diversfied. For example, the Dow Jones Industrial Index Fund is only 30 stocks, whereas the S&P 500 is a collection of 500 stocks.

Resources

• The Vanguard Group
• Yahoo! Financial