Index fund selection should be deliberate process

NEW YORK -- Index funds have long been a favorite of financial planners, who tout these investments as a relatively inexpensive way to diversify a portfolio.

That endorsement is generally well-deserved. Funds that mimic indexes such as the Standard & Poor's 500 or the Russell 2000 tend to have lower costs than those run by managers, and in some cases, they earn higher returns. But shareholders should be selective -- the number of index funds has grown in recent years and, in a bear market, their returns can vary.

"There are a lot of options out there, and investors need to choose carefully," said Ray Mignone, a financial planner in New York. "In this market, there are certain indexes that I think will do better than others."

As of May, there were 234 index funds, compared with 117 just five years ago, according to Morningstar, a fund and stock data service. Although the funds initially focused on broad market indexes such as the S&P, the menu has expanded to include to track more specific indexes, such as the Dow Jones Real Estate Index, for example.

In recent years, value stocks have outpaced growth stocks in the broader market, and smaller company stocks outperformed larger ones. So it's not surprising to see the same trends in index funds.

As of June 21, index funds that track a blend of large-cap stocks, such as those in the S&P, had a negative return of 13.0 percent for the year, according to Morningstar. By contrast, index funds of small-cap stocks had a negative return of 4.2 percent during the same time.