Although every investor wants to beat the market, few are able to do it consistently. But what if, over time, you could beat the broad market with something as simple as an index fund?
Some exchange-traded funds—members of a new class of ETFs—have done just that. They are called fundamental-index funds because they focus on companies’ financial results, such as sales or earnings, not just their size. PowerShares FTSE RAFI US 1000 ETF (symbol PRF), for example, leans toward large U.S. firms with strong balance sheets. Over the past five years, it has returned 18.8% annualized, beating SPDR S&P 500 ETF (SPY), a traditional index ETF that tracks Standard & Poor’s 500-stock index, by an average of 3.6 percentage points per year (all returns are through November 1).
QueenieAustralia green formal dresses
Eager to jump in? Not so fast. These newfangled designer index funds offer fresh, sometimes compelling strategies, but they are not magic. For starters, their strategies can take ten years or more to play out. Plus, each index is unique, so it’s important to understand how they are built and any extraordinary risks they pose before you incorporate one into your portfolio.
What are fundamental-index funds?
Instead of weighting stocks by market capitalization, the way traditional indexes do, fundamental indexes use measures that are tied to a company’s financial picture, such as earnings or dividends, to name a few. A few of these funds are a decade old—among them, iShares Select Dividend (DVY), which sifts stocks for those with high dividend yields and ranks them by their yield. But many are much newer. Of the nearly 220 fundamentally oriented ETFs, nearly half have been around for five years or more. Nevertheless, investors are buying. The funds now hold more than $1 trillion in total assets.
QueenieAustralia yellow formal dresses