IndexFunds.com Staff

Consumer Reports Endorses Indexing, Confusedly

Consumer Reports, the non-profit consumer advocate magazine, recommends an investment philosophy that is remarkably similar to indexing in its lead article "Mutual Funds: Which way is Up?" of its March issue.

So why does the group hesitate to endorse indexing itself as a broad strategy? Does Consumer Reports really understand this investment theory?

After a long dissection of active funds, the article lists the following features that investors should seek in funds:

• Simplicity: "Keep it simple".
• Clear delineation of asset classes: "Know what you own".
• Low cost: "Watch out for expenses".
• Low capital gains: "Beware of hidden tax traps".
• Long-term horizon: "Stay focused on the long term".

These are virtually all the features where index funds are strong and active funds are weak.

But after opening the door, Consumer Reports doesn't walk through. Instead of fully endorsing indexing generally, it parrots existing investor patterns by recommending large cap index funds and smaller-cap active funds. It the crucial recommendations section, the 8-page article proclaims:

"Build your portfolio around a few core holdings of two or three domestic funds and one international fund. For most investors, the most promising place to begin is with an index fund that tracks the S&P 500."

"The advantages of index investing are many. Large-cap index funds own shares in hundreds of bellwether companies. After allowing for the low fees most of these funds charge, index investing ensures that you will earn no less (and no more) than the stock market itself - a bet worth making, since the indexes have had average annual returns of better than 11 percent."

There is almost no discussion, much less recommendation, of indexing other asset classes.Why would these arguments work in favor of large-cap stocks but not small-cap and mid-cap ones? A case can be made for only indexing with large-caps, but it isn't made here. The article goes on to say that with a large-cap index fund as the core holding, active funds can be chosen to keep invested in mid-cap, small- cap, growth and value equities.

"You may want to round out your portfolio with a good, actively managed fund whose long-term investment style and record appeal to you," the article says.

Note the tentative expression "may ... appeal to you". Is this a beauty contest or a consumer watchdog report? The article is full of similar hesitancy.

Maybe Consumer Reports doesn't understand investing as a science as it does materials, mechanical engineering and toxicology. It either doesn't have the expertise or isn't applying it consistently. That would explain its confusion.