Uncommon Cents

While the vast majority of my money that’s invested are in a few different mutual funds, I do have a smaller portion of my portfolio in individual stocks where I try to beat the market. Note that I really don’t believe that it’s possible to beat the market in the long term, but that doesn’t keep me from trying with a small portion of my portfolio, and when I small, I do mean small–all of these stocks combined total less than 10% of my total portfolio and a lot less of my net worth.

So here’s how the stocks I owned did in 2007, sorted by performance:

                 Adjusted
Ticker	   Price (1/1/07)    Price (12/31/07)	Gain/Loss
IAR                $27.33	       $17.56	  -35.75%
ACAS               $42.31              $32.96	  -22.10%
TM                $134.31             $106.17	  -20.95%
WFC	           $34.37              $30.19	  -12.16%
PFE	           $24.74              $22.73	   -8.12%
T	           $34.46              $41.56	   20.60%
MO                 $61.84              $75.51	   22.11%
VZ	           $35.75              $43.69	   22.21%
MRK	           $42.31              $58.11	   37.34%
AAPL	           $84.84             $198.08	  133.47%

About half of my holdings not just lagged the index, but lost money in 2007. IAR, also known as Idearc, Inc., was a one time dividend from my Verizon holdings. I don’t think I would have bought it outright. ACAS, American Capital Strategies, is a private equity firm that pays a substantial dividend. TM, which is Toyota, has baffled me. It’s a dividend paying company that is either the number one or two auto maker in the world and has been nicely profitable for a long time. It has, however, really underperformed this year. I am not planning on selling my shares, however. WFC, Wells Fargo, is a bank that we don’t have in HI (aside from its mortgage services); my friends who have banked with them have been less than thrilled with their customer service, but it pays a healthy dividend. Like many financial stocks, it has suffered this year, but not as badly as many others. Pharmaceutical giant Pfiezer (PFE) has not really done well in the two years I’ve owned them.

For the ones that have done well this year, the two telecom companies (T, aka AT&T, and VZ, aka Verizon) have done quite nicely for some time; I’m not sure I’m sold on these companies long term, and I really have a philosophical dislike of telephone and cable companies, so I’m not sure how long I’ll hold onto them. Altria (MO), the former Philip Morris, is a long term holding of mine that spun off Kraft this year (which I sold); its opening price is adjusted for the spinoff. Merck (MRK) is the other pharmaceutical company I own, and it did considerably better than Pfiezer did–I’ve owned this about the same amount of time as I’ve owned Pfiezer and I think it has become a long term holding. And finally, Apple (AAPL), which gets its own paragraph.

I originally thought about buying into AAPL (well, recently; I thought about it back in the 1980s when I was in college and had less than no money) in the summer of 2006, when I was on my way home from KansasFest. I took a look at a share price in the high 50s and believed that it was very undervalued.

Of course, I didn’t buy any, although I did talk to several of my friends who also have an interest in investing and tell them I thought it was a buy.

In early 2006, when I had a few bucks to put into my Roth IRA, I decided not to make the same mistake again, and AAPL rewarded me with the biggest gain in my portfolio, more than doubling. I have to think about whether or not I believe they’ll be a good long term holding–I think they will be a holding for at least a few more years–but they were, by far, the best performer in my portfolio.

I have yet to calculate how this portfolio did overall; it will take me awhile to do so. However, it does show some of the issues with buying individual stocks; some don’t do all that well and some do fantastic and it’s difficult to tell which will do what. There’s no reliable magic formula to say, “This stock will double this year, and this one will fall.” So while you can minimize your risks by researching the stocks and the markets they’re in, there’s no guarantees.

I like to pick individual stocks and I like to try to beat the index, but I know that I am very unlikely to do so. I do so mostly for fun, although there is obviously the possibility of profit–and loss–involved. I keep my investments in individual small relative to my total portfolio to minimize exposing a lot of my total net worth to the volatility inherent with an individual stock–this is asset concentration, the opposite of diversification, which increases risk. When people ask me about investing, I do tell them that if I put the vast majority of my money into highly diversified passively managed index funds but I will put a very small amount of my money into individual stocks at my own risk.

How’d your stocks do this year?

One of the costs that we face in America that is rising far faster than inflation is health care. In this country, the vast majority (though by no means all, sadly) of Americans have some form of health insurance which helps to relieve medical expenses. Health insurance is typically earned through a benefit of employment (either your own, your significant other’s, or a parent’s in the case of a minor child or young adult student), paid for outright, or provided by the government (in the case of Medicare or Medicaid).

Health insurance, like health care, can be expensive. One of the underrated benefits of my current job is the health insurance provided; to cover myself and my mother I basically pay tax (approximately $75 a month) to get a plan with no inpatient hospital stay copay, $10 office visits, and $7/30 day prescription drug coverage (or $14/90 days if I use their mail order service). In other words, my coverage is excellent.

What’s weird about that is that the benefit is actually worse now than what I had a few years ago, which had free office visits and $3/30 day prescription drug coverage. So even when coverage is by all estimations excellent, it used to be even better, at least in my case. Copays are increasing as the purchasers of insurance–typically employers–find ways to keep the effects of the rising cost of that insurance from impinging on their bottom line.

It unfortunately gets worse. Health insurance seems to be one of the areas where the term “social justice” doesn’t mean a lot. At the hospital where I work, the people who get paid the best–the physicians–have the coverage with no copays (or very minimal ones). The people who get paid the least–the housekeepers, receptionists, and transporters–have coverage that’s about the same as mine, if not a bit worse. If you go outside of the setting of the hospital, the situation continues to escalate. Fast food employees who make minimum wage typically have health insurance that’s absolutely horrid by my standard–$200/day inpatient hospital copay, 50% lab and diagnostic imaging copay, and no drug coverage whatsoever.

All this means that those who actually can afford the most out of pocket pay the least and those who can afford the least pay the most–unless and until they end up on Medicaid (or your state’s equivalent of it), where they end up paying the least out of pocket–but every taxpayer in America ends up paying the rest.

This is not to say that those who work hard and have great jobs don’t deserve great coverage–they do. Traditionally in this country, benefits of employment, including health insurance, have been a big part of what makes people decide to work where they do. One of the things I think about a lot when I consider my current job situation is what health insurance benefits might look like where I end up working next, and it makes me think long and hard about staying where I am. But it’s a really different situation for someone who has a master’s degree and many options for work than it is for someone who is barely literate and can’t find much in the way of work that’s not minimum wage.

There are no easy answers, unfortunately. The government talks a lot about reforming Social Security, a system with some significant but relatively easily fixable–at least for quite a few years–problems, but they almost never talk about a program with problems four times as large–Medicare.

If nothing else, the issues of health insurance hit home for me personally as an employee of a health care organization. Yes, I like it when my salary increases, but no, I don’t like it when the cost of my health care goes up. Yes, I like it when the organization does well financially, but no, I don’t like it when more and more of my tax dollars goes to paying for health care for those who are injured while under the influence of substances or blatantly negligent. I wish I could just wave a magic wand and say, “Here! It’s fixed!” Unfortunately, that’s not going to happen. I’m not really sure how to fix this mess, but it’s clear this will be an issue from now until I die.

One of the ways that the costs of health care affects me is in some of the choices I make. It’s not a secret to some of the folks who read my blog that back in early 2002, before I was diagnosed with diabetes, I weighed 265 pounds (by my doctor’s scale, 272). I now weigh 185 and have done a couple of 100 mile bike rides and plan on doing another this year and running a marathon as well. What I’m hoping is that not only will making better choices about my health help me live longer and healthier, it will save me money and keep medical expenses for everyone–not just me but my employer–down.

Does health insurance affect your bottom line and/or your choices in life? If so, how?

If you found this blog through my guest post over at Blogging Away Debt, welcome! Also, if you’ve come via the pfblogs.org network, welcome too! However you got here, I hope you stay awhile and take this journey down the road of personal finance with me. Mahalo nui loa!

A few posts back I discussed what my portfolio in my 403(b) plan looks like; it’s not quite what my model portfolio is because my 403(b) plan doesn’t offer two of the three funds I like enough to have in my model portfolio. But pretending I could have exactly the funds I wanted, let’s see how they did in 2007 (yes, I realize there’s one more trading day in 2007 but I doubt that one day will make a huge difference–and if it does, well, that’s what editing’s for).

My model portfolio is:

Vanguard Total Stock Market Index (VTSMX): 50%
Vanguard GNMA Fund (VFIIX): 25%
Vanguard Total International Stock Index (VGTSX): 25%

Of course, numbers don’t always round off perfectly (they actually almost always round off imperfectly). If we’re talking about a portfolio starting the year with a total of $100,000 in it, we can’t quite get $50,000 to VTSMX, $25,000 to VFIIX, and $25,000 to VGTSX; instead, we end up with:

VTSMX: $49,977.10
VFIIX: $24,995.36
VGTSX: $25,003.05

VTSMX started the year at $33.70. It ended Friday with an adjusted close of $35.58. With an expense ratio of .19%–about $.07 per share–it gained $1.81 per share, or 5.37%.

VFIIX started the year at $9.76 a share and ended at an adjusted close (meaning including dividends) of $10.34 a share as of Friday. With an expense ratio of .21%–approximately $.02–the gain is about $.56 per share, or 5.73%.

VGTSX began the year at $17.67 a share and ended Friday at an adjusted close of $19.99. With its expense ratio of .27%–about $.05 a share, the gain is $2.27 per share, or 12.85%.

Our totals currently look like this:

VTSMX: $52,660.87
VFIIX: $26,427.59
VGTSX: $28,215.94

At the end of the year (well, with one trading day left), all three funds were up; the total portfolio was up 7.33% for the year. The VGTSX fund did the best, which reflects recent history (the international index outperforming the domestic index and bonds); the VTSMX fund did the poorest, although it was at least positive. Interestingly, the VFIIX fund did very, very well, which shows that it pays to own quality when there’s a flight to quality; it also illustrates the importance of owning bonds in your portfolio, because there are years they outperform stocks–like this year. In fact, this portfolio beat the S&P 500 index, which is interesting considering it’s made up entirely of passively managed stock index funds and a bond fund which is managed with very low turnover. While this is not the norm–the S&P 500 has only returned a bit over 4% year to date with perhaps 1% more in dividends–it does happen.

This does throw our proportions off a small bit;the international fund is now over 26% of the total, the domestic fund about 49%, and the bond fund a bit under 25%. Not enough for me to consider rebalancing at this point.

In the end, I think that my model portfolio did pretty well; no, it did not have incredible, mind-blowing gains, but it did better than the S&P 500, and its expenses were minimal. In a year when performance was mixed at best, the return on my model was better than the index, which is the best outcome I can hope for.

A few posts ago I questioned if waiting on my holiday shopping cost me more or less than it otherwise would have. Today, I have the final totals.

The vast majority of my purchases this year were gift cards. Nearly all of those were bought at the local Foodland or Safeway, not (just) because of convenience, but also because Discover Card has been running a 5% Cashback Bonus special on purchases at supermarkets. $250 of my holiday purchases fall into this 5% reward category, totaling those at $237.50.

I also bought a few more gift cards totaling $220 that did not fall into this 5% category; they instead are in the 1% reward category, meaning the total there is $217.80. There were a few other gifts that were not gift cards–one at $38.69 with a 1% reward and $52.98, $25 of which was paid with a gift certificate and the remaining $27.98 with a 3% reward, making a total of $65.44 out of pocket.

In the end, I spent $302.94 on my holiday shopping–except the actual bills (nor the rewards) have shown up yet. Most of that will be paid for in mid-February, some in early February. Over a year’s time, that’s $25.25 per month to put away, less than a dollar a day.

To let my friends and family know I appreciate them with gifts, I think less than a dollar a day is well worth it.

As mentioned in a previous post, no amount of discounting actually saves you money; it just lets you spend less money than might be expected on things you may or may not want or need. While I am loathe to buy a membership to have the pleasure of shopping there, I have spent quite a bit of time at Costco and have been a member for a few years. The question as far as this blog goes is–does being a Costco member–or a member of another warehouse outlet store, like Sam’s Club–actually help you spend less?

The outlay for a Costco membership is not substantial but also not trivial; $50 for a year for basic (Goldstar) membership or $100 for the Executive membership which gives 2% back on purchases as well as some additional benefits (none of which are important to me). So for it to be worthwhile, I would have to spend $50 less a year at Costco on things I would otherwise be buying elsewhere.

An obvious money saver at Costco would be gasoline. A dollar a week would be sufficient to “break even” given this example. Given my gas consumption (approximately 12 gallons per week), if the gas at Costco were nine cents cheaper per gallon than their closest competition–which it typically is–I would spend over $50 less per year right there. Unfortunately, for whatever reason, my truck doesn’t do well with the gas from Costco–my milage tends to be about 10% lower than with another brand of gas–so that’s out for me.

The items I purchase at Costco that typically cost less than elsewhere includes primarily non-perishable in bulk items–laundry soap, hand soap, Diet Pepsi, CD-Rs, and mini DV tapes top the list. One of the items I have purchased a couple of times during my Costco membership that has definitely paid for the membership several times over is a new set of tires for the truck. I also purchase quite a bit of food at Costco, but this is an area where caution is needed–the real area where Costco can cost you is in terms of waste. If you end up tossing out half of an extra large box of oatmeal or a quarter of a large bag of bite sized carrots, you may not have “saved” yourself a dime. In those cases it might be best to share with your family or neighbors rather than succumb to the monetary black hole of waste.

Costco is not automatically the best deal anywhere. For instance, I can get Diet Pepsi at basically the same price (sometimes less, with a sale) at a local grocer. Sometimes, yes, the deals are better–if I was shopping for iTunes gift cards, I can get four $15 cards for about $55–but careful shopping is, as usual, needed to find the best price. I can often find a CD-R or DVD-R 100 pack for a better price in the Sunday paper, although I’ve never found a deal on mini DV tapes as cheap as there.

One of the things that Costco does that I don’t like is that they only accept American Express cards or debit cards; they don’t take Visa or MasterCard or Discover (although interestingly, they do accept other credit cards online). I therefore have an American Express Costco Rewards card, which I only use for Costco or for eating out (where it gives me a 3% reward).

The answer to the question on whether or not Costco can help you spend less is depends on what you purchase there and what use you make of it. Best bets, besides gasoline, are non perishable (or items that take a long time to go bad) bulk items like soap. Food can be a bargain as well, but the potential for waste makes this better for larger families of people who can split the expense with many others. Comparison shopping and looking for sales certainly can beat Costco on most if not all items, and Costco’s brick and mortar stores limit your options as far as payment goes. Overall, I’d say Costco can help you spend considerably less–it does for me–but it’s certainly not for everyone.

Today at Uncommon Cents, this blog was The Perfect Storm. The day started for me with realizing that my post had been selected to be the guest post of the day over at Tricia’s great Blogging Away Debt, followed by Mrs. Micah reviewing this blog over at StumbleUpon, the most traffic (by more than triple!) I’ve had in a single day, followed by a second positive review over at StumpleUpon. So I’m blown away by how things have gone today here at the home of (hopefully) simple personal finance.

Over the last few weeks, I’ve been working hard on building up Uncommon Cents, trying to write quality posts and network with other personal finance blogs out there. I’ve learned a lot and had fun, and I’m hoping to do more of both. I also am hoping that eventually Uncommon Cents can make a bit of money (although to date the older but much more niche A2Unplugged has done a bit better), and in my dreams it would become my fourth source of income (behind my full time job, my part time job, and my investments). I’ve watched my traffic and Feedburner subscribers grow slowly and just last week told someone that growing a blog was something like growing a plant: that with enough love and care it would definitely grow, but you couldn’t rush it.

Then over the long weekend All Financial Matters cited the Working Backwards: What’s an Index? post in their blog, which started a big upswing in traffic over the holiday, and today The Perfect Storm hit, which gave more traffic in a single day than I’ve had all week (and this week was already the biggest week in the blog’s history). In the end, hopefully, more traffic means that the Uncommon Cents message gets to more readers, and it also means more dollars (as well as more attention–quote from the Macalope, “the blog’s just a desperate bid for attention”).

I was over at the hospital this evening and ran into a unit secretary I know pretty well who was working the night rather than day shift; turns out she started an adult residential care home for the elderly recently and can’t work days on Wednesdays because she can’t find someone to watch her clients during the day. She said she just started the business and, like any business, it starts slow but it could pick up if things go right. She also said she invested about $70,000 in home improvements and hope that things go well enough that she can pay that off in a few years.

So the week’s events got me thinking; of all possible business endeavors, blogging is among the cheapest. This despite the fact that many, including myself, don’t really consider it a business; right now it’s a hobby that I hope will grow into a small part time income. Even with this week Uncommon Cents is small potatoes in terms of traffic, especially compared with some of the personal finance greats like The Simple Dollar and Get Rich Slowly. But at the same time, unlike my friend at the hospital, I didn’t have to make a five figure outlay to get started: I already was paying for this server space for my podcast, so all I had to do was get a domain name, install WordPress in a new directory, select a theme and tweak it a bit, and start writing. So if there’s still power in the press, the Internet makes the press available worldwide, instantly, and cheaply, and a blog can be started for free or close to it, might blogging not hold a ton of untapped potential for not just dollars but huge amounts of influence? It’s clearly not for everyone–not everyone can write–but today, for the first time, anyone who can write can not only get their message out cheaply (or even freely), at lightning speed, to a worldwide audience, censor and edit free, they also have the possibility of getting paid for it.

And if that’s not an entrepreneurial opportunity, I don’t know what is.

Here’s hoping to some more Perfect Storms; enough to blow the winds of entrepreneurship this blog’s way!

I love my iBook. I really do. I’ve had it for a long time now: I ordered it in October of 2004. I even got a Visa extended warranty for it, so it’s still covered until 2008. In the last year it’s gotten a motherboard swap, a battery change, and a hard drive upgrade; it’s lost a rubber foot or two, and it’s certainly far from pristine, but it’s been ridiculously useful since the day I owned it.

That said, it’s crying out for replacement. I do like the new MacBooks [the MacBook Pros are not my kind of form factor and out of my price range in general, although I wonder what kind of goodies (MacBook Thin anyone?) MacWorld Expo 2008 will bring], but I keep waiting because of the uncertainty of my job situation.

However, this week I received word that American Express was giving at least some of its cardholders a $100 off $1000 purchase online coupon at The Apple Store for Business. I am one of those cardholders. That certainly is tempting, given that Macs are not discounted very often. So, let’s take a look at how this might work out in terms of dollars and see if it’ll entice me into biting a new Apple.

First, which model of MacBook for me: I would be most interested in the middle of the line model: MB8062LL/B, as far as Apple’s SKUs go; this would be the white 2.2 GHz model with SuperDrive, 1 gigabyte of memory, and a 120 gigabyte hard drive. This retails for $1299 new.

I actually have access to both the Apple Store for Education as well as the Government Apple Store; I also occasionally purchase from Amazon, given their free shipping (same price but not as quick as Apple), and I am not opposed to buying refurbished models from Apple as well. Apple has not yet offered a refurbished version of this particular model [although it has offered the previous model, a white 2.16 GHz model with SuperDrive, 1 gigabyte of memory, and a 120 gigabyte hard drive (it also has an older, lower performance graphics system which isn't very important to me) for $1049]. Apple itself charges tax on purchases shipped to me; that would add 4.712 % to the purchase price. I believe this coupon is applied after tax is applied.

First, let’s take a look at how much the model I want lists for at all these various places:

Apple Store for Business: $1299 (pre $100 coupon)

Apple Store for Education: $1199

Apple Store for Government: $1222

Amazon: $1294 (pre $75 rebate)

Now, none of these vendors charge for shipping; however, Apple does charge tax, which would then make the amounts a bit higher for them:

Apple Store for Business: $1299 + $61.21 - $100 coupon = $1260.21
Apple Store for Education: $1199 + $56.50 = $1255.50
Apple Store for Government: $1222 + $57.58 = $1279.58
Amazon: $1295 + no tax charge - $75 rebate = $1219.00

Also, to take advantage of this offer, I must use my American Express card. This is not horrible, but there are other cards I have which may offer me other types of benefits which may be more enticing. Let’s take a look at those as well:

Amazon.com Visa: 1% Amazon.com reward on purchases at most vendors, but 3% at Amazon.com plus up to one year warranty extension and the possibility of purchasing additional years.

American Express: 1% Costco reward on purchases of most things (including a MacBook from either Amazon or Apple) plus up to one year warranty extension on new products.

Discover: 5% Cashback Bonus from The Apple Store, but no warranty.

Typically, I am not a fan of extended warranties, but the exception is portable electronics. I have an extended warranty from Visa on this iBook and it has helped me avoid hundreds of dollars being spent on repairs and battery replacements, so I consider either AppleCare or some other extended warranty a must. The problem with AppleCare for me is that it’s quite expensive, so much so that I have eschewed it in favor of other alternatives recently (like the Visa warranty). The American Express (up to a) year of additional warranty is free if purchased with an American Express card, although it does specifically exempt refurbished items; there is also no provision for purchasing more years of warranty. The Visa warranty is also free for up to a year; to extend it for another year (a total of three years, the same length as AppleCare) would be $87.99 for an item of the MacBook’s pricing; to get two years on top of that–five years total, probably beyond the useful life of the MacBook, although I have gotten that much use out of an iPod with several swaps due to this warranty–would be $137.99.

So, I could add on a warranty the equivalent of the $183 AppleCare charge if I bought with Visa for $87.99; shopping around for AppleCare brought it about $20 lower, but it’s still considerably more than the Visa option.

That makes my totals look like this:

Apple Store for Business: $1260.21 + 183 AppleCare = $1443.21
Apple Store for Education: $1255.50 + $87.99 Visa warranty = $1343.49
Apple Store for Government: $1279.58 + $87.99 Visa warranty = $1367.57
Amazon: $1219.00 + $87.99 Visawarranty = $1306.99

Interestingly, due largely to the warranty, even with the $100 coupon, the Apple Store for Business remains the most expensive of these options. The price at the Apple Store for Education actually comes out to be less because the discount I get ($100 in this case, seemingly identical to the $100 coupon) is pre-tax, meaning that I save the $4.50 or so that the state would otherwise collect from me, and the Visa warranty is less than 1/2 the price of AppleCare. Amazon is the best deal of the new machines after rebate, due to their not charging me tax (truthfully, I am supposed to pay this to the state of Hawai’i at the end of the year). The one area where the Apple Store for Business coupon comes out looking great is if I priced out the refurbished MacBook, but that’s not an Apples to Apples comparison as it’s an older model. Now, if the Apple Store starts selling refurbished current models, I may be back in business with this coupon.

Note that while I discussed them briefly above, none of these take into account the rewards I get by using the various cards; the $39.21 I could get in Amazon.com gift certificates (you get it in $25 increments) from the Amazon Visa or the $14.43 at Costco I could get with my AmEx or the even higher reward I could get from Discover (even though it would be more than offset by the AppleCare cost). It also ignores the Amazon Affiliate status I have which might get me a bit of cash back as well. But in the fairest comparison I can do quickly, it looks like the $100 off $1000 coupon at Apple Store from AmEx is good, but not good enough for me to bite right now. So I’ll wait for a bit, and hope in the next few days there are refurbished current MacBooks in the Apple Store for Business…

Since I got so much nice feedback on yesterday’s post on what an index is, I thought we’d once again take a trip backwards, this time on Christmas Eve (insert “It’s a Wonderful Life” jokes here), let’s discuss what a mutual fund is.

A mutual fund is a form of investment that takes money from many investors and invests it in some type (or types) of securities (such as bonds and stocks). It is managed by a professional fund manager. Think of your mutual fund shares like your plate at a Christmas pot luck–by yourself, you may have only been able to get a single dish, but with the help of all of the others at the party, you can have a little of dozens of dishes.

Beyond that, there’s lots of variation in mutual funds. A mutual fund may be actively managed (meaning that the securities in them are traded frequently) or passively managed (meaning that the securities in them are virtually never traded); it can also follow an index or a certain sector of securities; it can have a load (a sales charge) or not; and it can have high expenses or not. There are so many mutual funds that it’s impossible to discuss them all, so let’s just look at some generalities.

One of the big advantages of mutual funds is that they bring more purchasing power to the small investor. If I want to own every stock in the Standard & Poors 500 index, it would be unfeasible (if not impossible) for me to do so as individual stocks; however, if I purchase a mutual fund that follows the S&P 500 (like the Vanguard 500 Index Fund), I can, with the convenience and economy of one single fund purchase, have performance that is essentially equal to the S&P 500 without having to purchase 500 or so individual stocks on my own. This means I get the risk reduction of diversification with only one transaction, saving me time, money, and the headache of investing in each company individually. All I have to do is go to my discount broker or directly to the fund family, lay down my money, and tell them I’d like to purchase as many shares of their no load S&P 500 index fund as I can.

It’s also possible to choose funds for almost every possible market sector or interest. If I want a fund that tracks the performance of the total stock market, I can do that. If I want a fund that does the same but with bonds, I can do that. International stocks? No problem. If I want a fund that seeks dividend payouts or follows energy stocks or is socially aware, I can do all of those too. Or if I want a fund that seeks out growth stocks or value stocks or large cap or small cap or even a “fund of funds” (a single fund that is made up of several, say a domestic stock fund, a domestic bond fund, and an international stock fund)… there’s a fund for just about everyone and every niche.

In my opinion, the best of the mutual funds are the no load index funds, which feature index matching performance, extremely low expenses, and unmatched diversification. The vast majority of the money I have invested is invested in two index funds–the Vanguard Total Stock Market Index Fund and the Vanguard Total Bond Market Index Fund–and the majority of the remainder would be in a third–the Vanguard Total International Stock Market Index Fund–were it an option in my 403(b) plan. And before I sound like a Vanguard shill–I’m just a satisfied customer–there are alternatives, such as Fidelity and T. Rowe Price.

So go ahead and indulge your investing appetite with a steady diet of mutual funds, particularly low cost, no load index funds–although you will certainly have a huge variety to choose from. While they may seem boring to some, just remember that owning a mutual fund of the no load, indexing variety is a lot like being at a pot luck–a little of everything tends to be a lot more fun than a lot of a single thing. And in this case, a little of everything will help to make your life a wonderful one too.

It was pointed out to me the other day that I discussed index funds before I really discussed an index. Considering that this blog is supposed to be about simple personal finance, perhaps we need to go back in time to discuss what an index actually is.

An index is a theoretical portfolio of stocks or bonds representing a particular market or a portion of it. One of the best known of all indices is the Standard & Poors 500, which represents the stocks of 500 very large corporations, the majority of which are American. Another well known index is the Dow Jones Industrial Average (typically referred to as “The Dow”), an index of 30 of the largest publicly held companies in the United States.

An index serves several functions; one of them is that they can be considered an indicator of the health of an economy. Many economists follow the S&P 500 to try to gauge in what direction the economy is headed. In addition, an index is often used as a baseline for determining how well investments are doing; many (including me) will often say something like, “I’m outperforming the market,” meaning that I’m comparing how my personal investments are doing versus the S&P 500 index (or perhaps another index, such as the Wilshire 5000).

Studying the performance of an index over time–for this post we will use the S&P 500 as the example–tells us that while the numbers vary depending on the calculation, the historic return of the S&P 500 is approximately 10% per year. While the performance varies yearly–sometimes great, sometimes negative, always unpredictable–over the years, the index has produced fine, if somewhat unexciting, performance. Think of it as the tortoise.

What if you wish to be the hare? How do you beat the index? Well, first, assuming you can–which we’ll address in a minute–you will have to take an approach unlike an index fund, which tracks the index. All the index fund does is approximate the performance of the index, usually by holding the same securities in the same weighting as the index (in, of course, a smaller scale). Because it owns a large number of different stocks, it has the risk reduction strategy of diversification built-in, insuring that if one of its stocks goes horribly south, it won’t ruin the entire portfolio. Since it doesn’t often sell securities, it doesn’t experience the capital gains–and tax consequences–that happen with frequent selling, and it doesn’t require much effort on the part of the fund manager, resulting in very little in the way of expenses and taxes, so owning the index fund means that you’ll come very, very close to matching the performance of the index.

An attempt to beat the index must either concentrate its assets–meaning less diversification, meaning more risk–in stocks it hopes will outperform the index, actively trade from one asset to another in search of performance (meaning tax consequences and lots of effort on the part of the investor, as well as the costs of trading), or both. While it certainly is possible to beat the index from time to time, sometimes for long periods of time, eventually risk catches up to the vast majority of folks out there who try to beat it, or their costs catch up to them (I estimate that in an actively traded portfolio, beating the index by 2% is necessary to actually be “even”, given the tax and expenses of trading), or both.

The performance of the index is relentless, and the performance of those who try to beat the index is variable. The vast majority of investors, professional or otherwise, who attempt to beat the index fail, at least over the long term. Yes, some–such as Peter Lynch and Bill Miller–are able to do so for years, but they are a very rare breed. Even if it is possible to beat the index, is the performance of “just” the index unacceptable? The stock market has proven itself over the years to be the best performing investment over time, and owning an index fund is the lowest cost, lowest risk way to invest in it. Yes, it’s fun to try to beat the index–I try it all the time, in very small increments–but in the long run, like the tortoise, the index catches up to the hare and passes it by.