Thursday, May 22, 2008

Retirement Planning - F is for Free-Float

F is for Free-Float

One of the best reasons to use an index fund in your retirement plan that is modeled on the benchmark S&P 500, besides the low cost is the methodology employed by the index to get the best possible measure of how your investment is doing. While all of the stocks in the S&P 500 are considered large-caps, the way they are capitalized is not necessarily uniform.

The simplest way to determine market capitalization is to multiply the price of the shares times the number of shares. This unfortunately makes the mistake of including shares of stock that are held inside the company and are not available for trade part of the company’s total worth.

A company is only as good as the price of its shares. The more shares that are available to the marketplace, the better this yardstick becomes as a measure. Closely held shares that are literally “off-the-market” blur the overall picture.

By using a method called free-float, the indexes can accurately determine what the true market value of a company is. The S&P 500 uses this method in its index.

Free-float drops those restricted shares, ownership holdings and other blocks of stock not available for the public and considers only the shares that could be traded.

These broad indexes have had a reputation for long-term out-performance. Out-performance is a nice way of saying they did better than funds that are similar and for some very obvious reasons. The high cost of running an actively managed fund means that the actively managed fund must overcome those costs in performance percentages before they can begin to post competitive returns.

A is for Asset Allocation

B is for Balance

C is for Continuity

D is for Diversity

E is for (Tracking) Errors

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