Many investors prefer mutual funds that are designed to track a particular index because index funds are diversified, cost-effective (no high-priced stockpickers to pay), and tax-efficient (no in-and-out trading to generate taxable gains). However, a one-index-fund strategy might not be prudent.
The S&P 500 index, like most major stock market indexes, is capitalization-weighted. As technology stocks soared in price from 1995 to 1999, so did their capitalizations. Thus, they made up an ever-increasing portion of the S&P 500. Based on this experience, money going into an S&P 500 index fund might be seen as a bet on the sectors that have been hot recently.
Instead of investing in an S&P 500 fund, you might split your money between the Vanguard Value Index Fund, which owns the value stocks in the S&P 500, and the Vanguard Growth Index Fund, which owns the growth stocks. Does this just re-create the S&P 500, because the two funds together hold the stocks in the larger index?
Not really. You might start out with an even split but you can re-balance, putting money into the side that has underperformed. Thus, you’d be buying low and selling high, a long-term strategy likely to pay off.
