By Dolores Kong
The Boston Globe

When Nobel Prize-winning economists Paul A. Samuelson
and William F. Sharpe are asked for their latest hot
investment tip, they have a humdrum answer: stock
market index mutual funds.

"You shouldn't make investing too exciting," said
Samuelson, professor emeritus of economics at the
Massachusetts Institute of Technology. "It ought to be
a dull, dull business. If you want excitement, take
$500 and go to Las Vegas."

And don't think you'll strike it rich by picking the
next hot actively managed mutual fund, either, said
Sharpe, professor emeritus at Stanford University and
chairman of Financial Engines, an online investment
advisory firm. Although he acknowledges wanting to hit
the jackpot is part of human nature, he says, "That
really can be dangerous."

Samuelson's and Sharpe's academic research, which led
to Nobel prizes in 1970 and 1990, respectively, helped
make the arguments for indexing, and now the two are
being joined by a growing number of fans.

Simply put, indexing is buying and holding a group of
stocks, bonds, or other assets that passively tracks
an index, such as the Standard & Poor's 500. The
performance of the investment mirrors that of the

One result of all the new interest: Vanguard 500
Index, which tracks the S&P 500, has been rapidly
gaining on the actively managed Fidelity Magellan as
the world's largest mutual fund. Although both have
been hit in the recent market downturn, with the
Vanguard fund dipping more, and Magellan being closed
to most new investors for a while, each continues to
hover around $100 billion.

The argument for passively indexing vs. actively
managing your money is heating up. At stake in this
pitched battle are the hearts and minds of investors,
not to mention their wallets.

Each month billions of dollars are pumped into both
index and actively managed mutual funds through
retirement programs, college savings plans, and other
investment accounts.

So passionate are indexers that they call themselves
"Vanguard Diehards" and "Bogleheads" (after John C.
Bogle, who started Vanguard 500 Index, the first index
fund, nearly 25 years ago) on a bulletin board at the
Web site Morningstar tracks mutual
funds and other investments.

Fueling the interest in indexing are books by Bogle
and others, a growing number of Internet sites, new
methods of index investing, and money management firms
making it a specialty.

Indexers point to the numbers as proof: In 1999, only
354 out of 915, or 39 percent, of actively managed
large-cap blend funds beat their benchmark S&P 500
index, and over the last five years only 33 percent
did so, according to the latest Morningstar
statistics. Combined with its lower costs and tax
consequences, index proponents say, the passive
investment strategy has the active one beaten hands

Equally passionate are the active money managers. So
convinced are they of their prowess and ability to
beat the market that some of their comments sound
straight out of the fictional Lake Wobegon, where
everyone is above average.

They point to their high-powered research, analytical
tools, asset allocation models, and other advantages
to having your funds actively managed by them. And
there are plenty of books on the market about the
stock-picking secrets of the pros, notably "One Up on
Wall Street" and "Beating the Street" by Peter Lynch,
who made Fidelity Magellan famous.
And they point to the years that they beat the index.

While Vanguard 500 Index is gaining on Magellan, index
fund investments are still just a drop in the bucket
of all mutual fund dollars. Overall, across all
open-end funds available to US investors, active money
managers still have most of the money, with $4.2
trillion, compared with only $367 billion in index
funds, according to Morningstar statistics as of Jan.

Last year, the net cash flow into actively managed
domestic equity funds continued to outpace that for
domestic index funds, with $91.3 billion into active
funds and $50.1 billion into index funds, according to
statistics kept by Financial Research Corp. of Boston.

Among those on the side of active management are
Ronald H. Muhlenkamp, portfolio manager of the $180
million Muhlenkamp fund, who has been a guest
commentator on CNBC and "Wall Street Week," along with
Louis Rukeyser and Vincent Loporchio, a spokesman for
Fidelity Investments.

"We believe that over time, active management provides
shareholders the best long-term performance," said
Loporchio. "We believe that actively managed funds can
add value through fundamental bottom-up stock-picking.
We have superior research and stock selection, which
helps us deliver strong performance."

He pointed to Magellan's no-load total return beating
the S&P 500 index the last two years. In 1999,
Magellan returned 24.05 percent, while the index
returned 21.04 percent. In 1998, Magellan returned
33.63 percent, while the index returned 28.58 percent.
"That's a significant difference," he said.

Muhlenkamp said of indexing fans: "The first question
always becomes, what index?

"They refer to whichever index has been hot the last
three years. Once upon a time, it was the real estate
index, the gold index, the bond index. Now I assume
it's the S&P 500 index" because of its recent
performance, said Muhlenkamp, whose no-load,
tax-efficient fund is based in Pennsylvania and was up
11.40 percent in 1999 and an average of 15.33 percent
a year over the last 10 years, as of Dec. 31, 1999.

"What people are doing is they're running to Vanguard
because it has been hot, just as they ran to Magellan
after it had been hot. We'd rather run the other way,"
he said. With investors chasing after past performance
even though it's no guarantee of future results, "They
buy at the top and sell at the bottom."

But some proponents of indexing said the key is to buy
a broadly diversified index and hold it for the long
term, and not to run after whatever appears to be the
best-performing specialized index, such as the
recently highflying, technology-laden Nasdaq

While the S&P 500 index has done well lately with
large-company stocks in favor - up 21.04 percent in
1999 and an average annual 18.21 percent over the 10
years ending Dec. 31, 1999 - index fans suggest
tracking an even more diversified index, such as the
Wilshire 5000.

"The S&P 500 really is concentrated in large-cap
stocks. Individual investors should have exposure
throughout the entire US marketplace," said George
Sauter, managing director of the Vanguard Core
Management Group, who oversees the stock index funds
for the Pennsylvania mutual fund family.

He suggests the Vanguard Total Stock Market Index
fund, which tracks the Wilshire 5000 and represents
the entire US market, including small-capitalization
and large-cap stocks, and Nasdaq- and New York Stock
Exchange-traded shares. The Wilshire 5000 index was up
23.77 percent in 1999 and an average 17.61 percent
annually over the 10 years ended Dec. 31, 1999.

And as to actively managed funds whose total returns
may happen to beat the S&P 500 index in a particular
year, index supporters say that once costs and taxes
that can accompany active management are accounted
for, the actual returns may lag the index.

But it doesn't have to be an either/or proposition for
investors when it comes to indexing vs. actively
managed funds.

And it no longer has to be just the original Vanguard
500 Index if the S&P 500 index is what you want to
track, now that there are competitors, including
Fidelity,, and State Street Global
Advisors, offering similarly low-cost and even no-cost
versions of the old standby.

There are now even so-called index shares tracking the
S&P 500, called SPDRS (pronounced spiders), for
Standard & Poor's Depositary Receipts, which trade
just like individual stocks on the American Stock
Exchange, with the ticker symbol SPY. The exchange
also offers index shares that track the Dow Jones
industrial average (nicknamed Diamonds, ticker symbol
DIA), while Nasdaq offers the Nasdaq 100 (nicknamed
Cube, ticker symbol QQQ).

There are advantages and disadvantages to each
approach, depending on an individual investor's
situation, investing style, and tolerance for risk,
say financial advisers, money managers, and

Bob Glovsky, a certified financial planner and
president of Mintz Levin Financial Advisors in Boston,
said while he's more in favor of actively managed
funds, "I wouldn't rule out an S&P 500 index," such as
a Fidelity Spartan or Vanguard fund.

John H. Cochrane, a finance professor at the
University of Chicago, said he favors index funds as
do most academics familiar with the research on
passive vs. active investing, but he also owns
individual stocks as "extremely long-term holdings,
where I neither buy nor sell."

Many of today's indexing fans say they've become
converts because of its boring simplicity and its
effectiveness, as Samuelson and Sharpe point out.

"It keeps things simple, indexing. It's just an
incredibly sound strategy," said Jeff Troutner, senior
editor of an Internet site called,
which features everything you might ever want to know
about indexing.

Without indexing, he said, "investing is so emotional.
Everybody's got an opinion about the stock market -
your brother-in-law, your doctor, your cab driver. You
end up really with a lousy portfolio over time with
that kind of input."

Troutner is also president of TAM Asset Management in
California, which specializes in indexing and
allocates clients' portfolios among different indexes
based on their needs, charging .50 to 1 percent of
assets under management annually.

One of Troutner's clients through TAM Asset
Management, Bruce Joseph, 69, a retired ear, nose, and
throat doctor in Hawaii, said he became an indexing
convert recently after about 30 years of investing in
actively managed funds and individual stocks, without
doing any better than the market over the long haul.

"Managed funds can win for one or maybe several years,
but most revert to the mean and can't beat the
appropriate index," said Joseph. And "picking your own
stock is really a lot of work, even when you do it

With the simplicity of indexing, he can now spend his
retirement years focusing on leisure with his wife.
"We travel some, play tennis a couple of hours. I read
a lot of fiction and do what I've always wanted to
do," said Joseph, caught by telephone in Hawaii just
before he left for his morning sets of tennis.