by Archie M. Richards, Jr., CFP^®
February 23, 2004

Roy writes, "Vanguard's S&P 500 Index Fund is priced at $104 a share. The Dreyfus S&P 500 Index Fund, which has the same portfolio, is priced at only $32 a share. Why are the prices different? Is the lower one better? Does this have anything to do with Neiman Marcus selling a lamp for a higher price than Sears?"

Good questions, Roy. To illustrate, assume that your house is worth $100,000. Two different investment bankers sell shares of your house to the public.

One creates a corporation with 1000 shares, which are sold for $100 each. (Total $100,000.)

The other creates a corporation with 10,000 shares, which are sold to the public for $10 each. (Total $100,000.)

The share prices ($100 and $10) differ only because the companies have different numbers of shares. Which one is the better deal?

The one with the lower operating and selling costs.

The operating costs of the Vanguard S&P 500 Index Fund are only 0.18 percent a year (plus $10 a year for accounts of less than $10,000,) The fund has no selling costs and no redemption fees.

The operating costs of the Dreyfus S&P 500 Index Fund are 0.50 percent a year. It charges a redemption fee of 1 percent.

The costs of both funds are reasonable, but Vanguard's is lower. Even though the price of the Vanguard fund is higher, it's the better deal.

Dreyfus is both an investment manager and a selling organization. It reaches out to persuade potential investors to buy Dreyfus funds. Salesmen like to get paid. I don't begrudge Dreyfus for this. The salesmen talk with people who are not as informed and as curious as you are, Roy. They're not self-starters and probably don't read columns like this one. They worry about bad investment news, and there's always a lot of bad news around. They need persuading. Dreyfus salesmen bring great benefit to their customers by inducing them to make long-term investments in stocks.

Vanguard is an investment manager but not a selling organization. It advertises, but no Vanguard salesmen reach out to potential customers. The company waits for self-starters to contact them. Its costs are therefore lower.

Now, about the hypothetical lamp. We assume that both Sears and Neiman Marcus sell the same lamp, but Neiman Marcus's price is higher.

Sears buyers like low prices. Neiman Marcus buyers are different. That chain of stores has special appeal for the newly rich. People who've made a lot of money feel justly proud of what they've accomplished and don't mind showing it. They like to buy things at prices that everyday people like you and me couldn't afford. High prices make them feel special. The Neiman Marcus approach has no bearing on the choice between the two S&P 500 index funds.

Index funds of stocks, like the S&P 500 index funds of Vanguard and Dreyfus, are terrific long-term investments. The Vanguard price is higher, but it's better nevertheless, because the operating costs are lower.

Harris writes, "In your recommendations of index funds of U.S. stocks, you've suggested 10 percent in large growth stocks, 10 percent in large value stocks, 5 percent in small growth stocks, and 5 percent in small value stocks.

Why divide between growth and value? An S&P 500 index fund contains large stocks, both growth and value. Why not put 20 percent there, with 10 percent in an index fund of small stocks?"

The more variation among sectors, Harris, the better. For example, small growth stocks rose big until March 2000 and then fell about 40 percent. But small value stocks went down to March 2000 and then rose about 40 percent. Quite a difference!

Rebalancing is key. Every year (make it at least a year and a day to avoid short-term gains), sell some of the index funds that have performed especially well and buy those that have performed badly. This levels out the volatility of the whole portfolio.

Spread your money among as many contrasting sectors as possible. With rebalancing, you're better able to endure bear markets without selling. You'll also improve your long-term performance.