You've heard us say it many times on this program. It's practically a mantra for our economics editor Chris Farrell. Go for index funds. They are the easiest and often the most cost-effective way to keep a portfolio in balance. In theory, your index fund mirrors the performance of say, the S&P 500. But what if you could count out an extra percentage point or two beyond how the index performs? That's the goal of something called enhanced index funds. And here to tell us more is Rob Hennessy of Smartmoney.com. Rob, what is the difference?
Well, you figure, a regular index fund tries to track the performance of an index. Most of them try to track the S&P 500, and they make up, you know, really, a lot of what we invest in say, 401ks and things like that. You always wanna do what the broader indexes do. What enhanced index funds do is they try to do a little better.
And from what I gathered, the whole point of this is to do just as well as the index fund itself, which you really wouldn't do if you factor in the fees, if you just took the regular index fund. So the enhanced funds supposedly make up for that difference.
HENNESSEY: Right. And the argument's always been, you know, you're paying investment managers to essentially come in with a tie with the main index. You're not, you've never paid an investment manager in these index funds to beat it before. And so, in order to make up for the fees that, that kind of get eaten from your account just by doing what the broader index is doing, these guys try to make up that difference by getting you more performance. The problem is a lot of the offerings that are out there now have high fees. Also, there's no guarantee that they're going to beat the index.
In fact, some of the bigger of these funds under perform the index. So when you look at it that way, you're paying more to do worse than an index fund. Now, a lot of the managers say it's still very early. We still have to get a kind of comfort level. And they say ultimately, they'll even out and will do better. But, you know, the performance so far has been sort of middling.
So is this something that investors should may be wait and see if they perform the way they should or not?
Absolutely. And if you want an index fund because you want the safety of just performing the way everything else is doing, then go that route. If you wanna be aggressive, pick a fund that may be doesn't track an index. Pick a fund with, you know, a track record that historically, has beaten the broader averages and then you're getting that enhancement. With the enhanced index funds, there's really no track record to go through. And anytime you buy a mutual fund, you wanna see how past performances and what their philosophy is. There's really not a lot of that past performance yet. So they're definitely a product to be wary of.
All right. Rob Hennessey is an editor at Smartmoney.com. Thanks for coming in.