Diamonds, Spdrs and Webs-oh, my!

Invest in market indices with these stocklike instruments

For most of this decade, actively managed mutual funds have lagged behind the performance of index funds-portfolios that mimic a specific market index like the Standard & Poor’s 500-an innovation introduced by Vanguard Group founder John Bogle 25 years ago. As a result, such portfolios remain popular with individual investors. But some have steep initial investments of as much as $10,000, a bit rich for some mom-and-pop investors.

An alternative is exchange-traded index shares, also called unit investment trusts (UITs). These products are the brainchild of the American Stock Exchange, a unit of the Nasdaq, and carry such monikers as SPDRs, DIAMONDS, QUBES and WEBS.

These UITs are baskets of stocks that duplicate the major indices but trade like stocks on the AMEX. For example, SPDRs, or Standard & Poor’s Depositary Receipts, are based on the S&P 500. You can buy just a single share of a SPDR (AMEX: SPY), a trust representing the S&P 500 index.

Since the inception of SPDRs in 1993, the AMEX has introduced a variety of other exchange-based UITs based on the Dow Jones industrial average and international markets.

Unlike no-load mutual funds, however, you have to buy the AMEX exchange-traded UITs through a broker. In other words, there is a commission to be paid. You should buy SPDRs from discount brokerage firms, which charge lower commissions than full-service brokers. And these products are enjoying heavy demand from investors.

“We now have over $22 billion in assets in DIAMONDS, SPDRs, WEBS and others, and they contribute about 40% to 50% of the total trading volume of the exchange,” says Jay Baker, vice president of marketing for the AMEX. Brokers and mutual fund firms own about 65% of SPDRs, compared with 35% by individual investors.

Experts caution that individuals should do some comparison shopping before they abandon index funds.

“These are good investments for some, but there are many situations in which they aren’t. It all depends on the individual investor’s circumstances,” says Frank Stanton, an editorial analyst with Morningstar.com, the online division of Chicago mutual fund researcher Morningstar.

Take investing in a SPDR versus the Vanguard 500 Index fund (Nasdaq: VFINX). A small investor with just $1,000 can’t buy into Vanguard’s fund outright because of its high initial investment of $3,000. You could accumulate the minimum through dollar-cost averaging, but Vanguard levies an annual maintenance fee of $10 on accounts smaller than $10,000.

On the downside, every time you buy a SPDR, you’re charged a commission, so it could become a costly proposition if you’re either an active trader or invest through dollar-cost averaging. For example, if you were to invest $10,000 in $100 increments each month and your broker charges $8 a trade, that adds up to about $800 in commissions over 100 months, or 8% of your investment. However, you can beat this scenario if you invest the $10,000 in SPDRs all at once, says Stanton. On $10,000 an $8 commission adds up to just 0.08% of your investment.

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