The Whole Pie - or Slices
Index funds and ETFs carve up the market in new ways
The first index fund was created as a way for investors to gain exposure to the broad stock market through a single fund. The Vanguard 500 tracked (and still does) the Standard & Poor's 500 index of blue-chip stocks, a benchmark that today represents about 80 percent of the market value of all U.S. stocks.
So much for simplicity in investing. In recent years, the financial services industry has taken indexing in many different directions. Now, nearly 500 broad-based stock index funds have joined the Vanguard 500 on the market. Plus, hundreds of specialized index products have cropped up to offer investors thin slivers of the equity market.
Want an index fund that tracks shares of only small- or medium- or large-capitalization stocks? No problem. Or a fund that specializes in either growth- or value-oriented stocks? Got that, too. There's the Vanguard Growth Index fund, for instance, which invests only in fast-growing, blue-chip companies. And you could try the Vanguard Small-Cap Value Index fund. It invests only in what fund management deems the undervalued shares of small firms.
New entrant. The flood of niche index products has swelled with the explosion of a newer vehicle, the exchange-traded fund. An ETF is a specialized investment that trades like a single stock. But like a mutual fund, an ETF represents a cross section of holdings in dozens, if not hundreds, of different securities.
You can find index ETFs that track single sectors of the economy. An example is the Industrial Select Sector SPDR fund, an ETF run by State Street that tracks only industrial stocks in the S&P500. If that's still too broad for you, you can drill down further and invest in a single industry within that sector-say, aerospace stocks, with the Barclays iShares Dow Jones U.S. Aerospace & Defense Index ETF.
If a single industry is too confining, you can use index funds to invest in specific themes. Concerned about global water shortages and think there's money to be made in alleviating them? The PowerShares Water Resources Portfolio, an index ETF, can give you exposure to companies working in water-related industries.
And with investor appetite for international stocks at record levels, index funds and ETFs now give investors an array of foreign options. You can invest broadly overseas, through a global index fund. You can target a specific region, like Europe or Latin America. Or you can put your money to work in individual foreign countries-and not just big markets like Japan or the United Kingdom. Through Barclays iShares ETFs, you can invest in the stock markets of countries ranging from Belgium to Brazil to Singapore.
This story appears in the May 7, 2007 print edition of U.S. News & World Report.