For those who’d like to outperform Wall Street, low-expense index funds usually do the trick. They simply mirror the stock averages, minus a tiny expense charge — and are thus like betting on an average horse ridden by a 20-pound jockey. Your friends are betting on actively managed funds that hope to beat the market by knowing which stocks will do best, yet are ridden by 150-pound jockeys (i.e., higher expenses), making it hard for all but the most spirited to outperform your average nag.
But now comes for your consideration a “stock,” for all practical purposes, traded on the American Stock Exchange (symbol: SPY) that does much the same thing. Ridden by a 19-pound jockey, each share represents one-tenth of a unit of the Standard & Poor’s 500 average. Called Standard & Poor’s Depository Receipts — SPDRs, or spiders for short — they represent tiny shares in all 500 stocks in the average, weighted proportionately. So if the S&P is 750, each SPY share will be selling for almost exactly $75.
The disadvantage of trading SPY is that although the annual expense ratio is very low — just nineteen hundredths of one percent — there is a brokerage commission to pay when you buy or sell, as with any stock — which there is not with, say, the Vanguard Index Trust. (So if you trade SPY, it makes sense to do so with a deep discount broker, where the commission is trivial.)
The advantage over an index fund is that you can buy or sell with a quick phone call, as you would any stock; and if you think the market is headed down, you can short SPY — you can’t short most mutual funds — and do so without worrying about “the uptick rule” that normally governs short sales. (Normally, you can’t short an exchange-listed stock on the way down — “no fair piling on, guys” is the rough reasoning behind the rule — you have to wait for an “uptick;” that is, until the stock price has bounced up a notch. But the uptick rule is waived with SPY because it’s not a real stock.)
Also, Vanguard restricts the number of times you can move money in and out of its fund each year. You can buy and sell SPY all day long.
And with index funds, your order is executed at that day’s closing price. With SPY, you can set limit orders and know exactly the price you will pay. Or, if you sense the market is going to tank, you can get that morning’s price rather than the price at the end of the day.
So if you were thinking about shifting some money into “passive management” but prefer electronic trading, say, to filling out mutual fund forms, here’s a way to do it.
Please note, I am not saying the Standard & Poor’s 500 Index is a bargain here. I don’t pretend to know which way it’s headed (but it’s no bargain). I’m just saying this is a handy and efficient way to “buy the market” when you do think it’s headed up, or to short it — if you’re very brave, very rich, and very careful — if you think it’s headed down. (One problem with shorting: the market’s long-term upward trend — if only for inflation — is against you. Another: you can hold a short for a year or ten, and it’s still taxed as a short-term capital gain if you make money.)
- If your tastes run to smaller stocks, check out the American Stock Exchange’s “MidCap 400 SPDRs” — the same deal, only based on one-fifth the current price of the Standard & Poor’s MidCap 400 Index. MidCap stands for “companies with medium-sized capitalizations” and “capitalization” means the overall value of the company — the total number of shares the pie is divided into, times the price of each slice. A company with 500 million shares outstanding at $70 each is capitalized at $35 billion. Big. But a company with 40 million shares at $20 each — $800 million — might find itself in the MidCap Index. The symbol for this one: MDY.
- If it’s non-U.S. exposure you seek, then the acronym is not SPDRs, it’s WEBS — World Equity Benchmark Shares. Ask your broker.
Quote of the Day
In 1800, 75% of [an American's] working man's expenditures went for food alone. By 1850, that had dropped to 50%. Today it is a little more than 11%.~The Wall Street Journal, September 20, 1996
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