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THE WORST FORM OF INVESTING EXCEPT FOR ALL THE OTHERS

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       Investor's Insight - January 16, 2007           
          "A Digest of Investment Opinion From the 
             World's Leading Financial Advisers"

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THE WORST FORM OF INVESTING EXCEPT FOR ALL THE OTHERS
by Scott Burns

Q: Like you, I believe investing in index funds is a 
better way for individuals to invest. I was just about 
to start investing in index funds in my retirement 
accounts when I came across an old article by Gregg 
Wolper (Morningstar, 2/21/06) titled "The Hidden 
Drawback of Indexing." Wolper said that, "Believe 
it or not, index funds are, in effect, momentum 
players."

Although he did not discourage readers from investing 
in index funds, his concerns seem valid. I would like 
to know your opinion on the concerns raised in the 
article. I would also like to know whether it is the 
right time to jump into index funds at the peak of 
the market when most index funds are loaded with over-
valued stocks. -- J.L., by e-mail

A: Winston Churchill once said: "No one pretends that 
democracy is perfect or all-wise. Indeed, it has been 
said that democracy is the worst form of government 
except all those other forms that have been tried from 
time to time."  The same statement could be made of 
index funds as a form of money management. They aren't 
perfect, but they are better than all the other forms 
that have been tried.

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While Gregg Wolper is correct -- there is a built-in 
momentum element in market capitalization-based index 
funds -- it has never been so great a problem that 
broad index funds haven't outperformed the majority 
of their managed competitors. 

We live in an imperfect world. What we try to do as 
investors is work with the tools that give us the 
best results at the greatest efficiency. To me what 
is truly amazing about index funds is that a tool 
with such visible limitations has so easily and con-
sistently beaten the majority of managed funds over 
not years but decades.

You buy an index fund to avoid stock selection risk. 

You also buy an index fund to avoid market timing 
risk. You buy the asset class as a whole and use 
the best tool yet created to capture its returns -- 
and its risks. When you ask whether it is "the right 
time to jump into index funds at the peak of the 
market when most index funds are loaded with over-
valued stocks," you are expressing an opinion 
about stocks, the market and the future. Opinions are 
something index investors try not to have -- because
they are usually wrong. Overvalued stocks and over-
priced markets often continue to rise. Undervalued 
stocks and underpriced markets often continue to sink.

We can be entertained by all those who have opinions 
about the value of stocks and the level of the market. 
But we should never forget that it is entertainment, 
not a visit to the Oracle of Delphi. Skeptics need 
only endure a few minutes of James Cramer's "Mad Money" 
to get a visceral understanding of opinions as enter-
tainment.

When you become an index investor, you rest in the 
benign assurance that you will capture the market 
return of many asset classes. You also accept a his-
torically verifiable idea: Flawed, vain, violent and 
covetous human beings, on balance, collectively manage 
to create more value than they destroy. 

Q: I am 60 years old and retired, with 80 percent of 
my savings in the stock market. Of that amount, about 
40 percent is in alternative investments sanctioned by 
one of the largest financial firms in the world.

Should I be looking to move that money into safe in-
vestments such as CDs? If so, how does one do that when 
the FDIC insures only $100,000 per bank per customer? 
With my net worth, I'd be running all over town looking 
for banks. Yes, I know that's a good problem have! 
-- E.K., by e-mail

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A: Unless you do a great deal of hunting, you will find 
that U.S. Treasury obligations generally yield more than 
bank CDs of the same maturity. If you visit 
www.banxquote.com, for instance, you will find that the 
national average yield on a five-year CD is currently 
3.91 percent. Visit www.bloomberg.com and you'll find 
that a five-year Treasury obligation yields 4.70 percent. 

People with large portfolios -- those who have to worry 
about the limits of FDIC insurance -- get the best credit
quality in the world with U.S. Treasury obligations. You 
can buy them through investment firms like Fidelity or 
Vanguard. You can also buy Treasury obligations directly 
at www.easysaver.gov. 

You can discuss this issue or any other topic in the new 
Investor's Insight forum. Check it out here...

 
Investor's Insight Forum

(Investor's Insight reflects the opinions of experts. It does 
not recommend any specific investments, and no endorsement is 
implied or should be inferred. For more information, contact 
the individual firms cited).

COPYRIGHT 2006 UNIVERSAL PRESS SYNDICATE

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