Sorting through the thousands of mutual funds available can be an overwhelming task. Would you ever like to just throw up your hands and forget it? Well, you can - and without sacrificing much, if anything, in the way of performance.
The simple solution is to use index funds. An index is a measure. Standard & Poor's, for example, measures stock-market performance with its well-known S&P 500-stock index.Mutual funds that emulate the index buy and hold all the S&P 500 stocks on the theory that few investors can consistently beat the market.
"In aggregate, all investors are the market," says George Sauter, who's in charge of Vanguard's array of index funds. "For one investor to outperform, another has to underperform. It's a closed game."
Some fund managers do outperform the S&P 500 index, but it's not easy. Over the past 10 years, fewer than one-quarter of stock funds beat the index. After taxes, index funds do even better than their actively managed counterparts.
Because turnover is low, index funds generate fewer taxable gains. If you use good index funds in a taxable account, you're practically guaranteed to beat most stock funds over the long haul. Moreover, you won't have to keep such close tabs on your portfolio.
If an actively managed fund loses its star manager, that may be reason to sell. But an index fund doesn't take great skill to manage. The key number to watch is annual expenses.
For the most part, Vanguard (800-635-1511) has the lowest-priced index funds. For the broadest U.S. stock index fund, consider Vanguard Index Total Stock Market. The fund owns all of the 700 biggest stocks, with the largest stocks getting the greatest weighting.
In addition, it has smaller positions in 1,100 smaller stocks. That makes this fund more representative of the entire U.S. stock market than Vanguard Index 500, which mirrors the S&P index.
Morgan Stanley's Europe, Australia and Far East (EAFE) index of 1,000 foreign stocks serves the same function the S&P 500 does here. Vanguard splits EAFE into two funds: Vanguard International Index European and Vanguard International Index Pacific.