My partner and I had lunch with the person who runs one of the preeminent university finance reach centers in the U.S. (really, in the world). He had three (okay, seven) words of wisdom for investing in the stock market: S&P index funds, small cap stock funds and momentum. Let’s take them one at a time.

 

Index funds, as championed by John Bogle and Vanguard, are a way for the investor to track the performance of the market. Indexers argue that most investors can’t beat the market and end up under performing and paying higher fees trying. According to our research guru, all S&P index funds show the same performance, the only difference being expenses, so pick the fund with the lowest expense ratio. 

 

The market for small cap stocks is less efficient due to the more volatile nature of small companies and less analyst coverage. Thus, an insightful mutual fund manager can outperform a small cap average (what would go into that average is not clearly defined, unlike the S&P 500).

 

Momentum is the concept that stocks will continue to move in the same direction over the short term due to technical and/or fundamental factors. It is a difficult and risky investment strategy for a mutual fund investor, but a good small cap stock manager will have this tool in his or her arsenal.

 

One of my rules for success is to listen to those who are richer and/or smarter than I am. I don’t know my friend’s net worth but I do know that he is a heck of a lot smarter than me. You won’t go wrong following his advice in managing your domestic equity portfolio – make an S&P index fund your core holding and supplement it with a couple of good small cap funds. (See MUTUALdecision’s Top Ten lists of small cap stocks.)