Index Hugger

Someone who just loves indexes. Like how tree huggers love the environment.

Also, in the world of finance, an index hugger is a type of actively-managed mutual fund that closely follows the performance of a particular index. See: Lipper.

Because the fund is actively managed, it comes with significant expenses (on a relative basis), making it an expensive way to latch onto the performance of an index. It's like hiring an expensive landscaping service to mow your lawn for hundreds of dollars when the kid down the street would do it for twenty bucks.

You have money you want to invest. You're overwhelmed by picking individual stocks and don't have time to research all the potential funds out there vying for your money. You just want your dough to track the S&P 500, the broad measure of stock market performance. If the market goes up 3%, you want to earn 3%. If the market dips 1%, you are fine losing 1% on that day.

Your best bet is to put money into an Exchange-Traded Fund, or ETF, that tracks the S&P 500. It's a low-cost way to have your investment track the general market.

However, your brother-in-law works for an index hugger tied to the S&P 500. The managers of the fund don't try to pick winners and losers. They just make sure their fund tracks the S&P 500, hoping to find just a few stocks that beat it, thus warranting their higher fees. Any move that index makes, their fund moves the same amount. It's the same action as the ETF, just more expensive. Your brother-in-law and his buddies skim fees off the top, cutting into your potential profits.

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Finance: What's the Difference Between M...121 Views

00:00

And finance allah shmoop what's the difference between mutual funds

00:05

and index funds The answer this guy or well this

00:10

team what do they do They manage the mutual fund

00:15

mutually together You know what nemo They make bets on

00:19

apple and amazon in crotchless tuxedo pants Dot com will

00:23

these bets or into teligent investments In the parlance of

00:26

the industry our elements oven actively managed fund The mutual

00:31

fund is active in that it buys and sells hoping

00:35

to be smarter than the market and find areas you

00:38

know where they're inefficiencies where investors are throwing out the

00:41

baby with the bath water so that they buy the

00:44

shares here a twelve bucks and hope to sell them

00:47

if they hit thirty bucks in two years when the

00:49

new products get released and people are going absolutely bonkers

00:53

for self velcro ing neckties or whatever and index generally

00:57

stands pat on the hand It's dealt throughout the course

01:00

of the year making only small tweaks to invested amount

01:03

so that the fund itself conforms to the structure or

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rules it set out when it was created But there

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are a few vital and insidious differences that should make

01:13

investors today very wary about investing in mutual funds or

01:17

any actively managed fund When mutual funds first became popular

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the investing marketplace was kind of the wild wild west

01:24

that was the nineteen fifties and sixties and a savvy

01:27

fund manager could beat the market by five and even

01:30

twenty percent per year year over year It was kind

01:33

of a golden age of mutual funds and money flowed

01:36

into them But like all good things this market wrinkle

01:39

easy winds and the investing world had to come to

01:42

an end Why competition when there were only a few

01:46

mutual funds out there and a few private investors it

01:49

was relatively easy to identify baby bathwater things you know

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diamonds in the rough Today there are literally thousands of

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mutual funds With such massive competition performance relative to the

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market has lagged dramatic In fact over a typical seven

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to ten year holding period only a very small handful

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of mutual funds beat the typical index fund investing in

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the same or analogous areas of stocks or bonds It's

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like one in twenty ever really beat the market and

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it gets worse Mutual funds charge relatively large fees compared

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With index funds whereas a typical index fund might charge

02:24

twenty basis points to manage your money that is twenty

02:27

cents for every hundred bucks you have with them for

02:30

year The analogous mutual fund My charge One percent or

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more that's five times surprise for demonstrably no better investment

02:38

results and wait It gets even worse Mutual funds trade

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stocks and bonds and other securities index funds rarely trade

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or if they do it's a very small amount of

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trading around the margin keeping index in compliance with its

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legal charter But many mutual funds have turn over the

02:54

apple variety of like fifty eighty or even one hundred

02:57

percent Turn over means that a fund has sold the

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stock to realize a taxable gain You know book a

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profit by taking cash from selling the stock or to

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realize a loss sometimes as well we'll each time of

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fund transact It pays a commission to our friendly excellent

03:14

golf skilled brokers but more painful to most investors is

03:18

that in transacting the fund realizes taxable game So what

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does that mean Well here's the math If your mutual

03:24

fund is up twelve percent given year when the market's

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up ten percent it would be an absolute top of

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the pyramid performance here For the fun of beating the

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market by two hundred basis points would likely mean that

03:34

mutual fund was in the top forty right up there

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with rina's latest it single So what is that awesome

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performance after tax for the mutual fund Well if the

03:44

fund had traded like the typical one it would have

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had turnover of about sixty percent of its assets and

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half of those sales would get ordinary income tax treatment

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think high rates of something like forty percent with federal

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and state taxes combined for most and long term gain

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of twenty percent for the rest Well the wealthy pay

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higher taxes so we're rounding down the numbers here even

04:04

being conservative So if half of the sixty percent or

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thirty percent of the gain of twelve percent which is

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around four percent his tax at forty percent then take

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away one point six percent from the performance to get

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an after tax net result number Then after another thirty

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percent tax at the long term gain rate of twenty

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percent you'd have take away another point six percent so

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in total you'd have to subtract one point six plus

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point six or two point two percent from the twelve

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percent humongous rock star year to net nine point eight

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percent in after tax returns Nope not very exciting relative

04:34

to that index fund And yes there are differences here

04:37

even important ones But the bottom line is that if

04:39

a huge performance top two percent fun has results Not

04:42

much better and or maybe worse than just a basic

04:45

index funds Why does anyone invest in mutual funds anymore 00:04:49.487 --> [endTime] Well this guy

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