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Subject:  Re: index funds in a 401K Date:  4/3/2000  11:51 AM
Author:  Michaelzehr Number:  7242 of 26295

If you're going to invest in both index funds and non-index funds, and you're going to invest in taxable and non-deferred accounts, then you typically get better total yield putting making the non-index fund tax-deferred and putting taxed dollars in the index fund.

But those aren't your only two choices. You could invest in an index fund in your 401(k) and in a basket of drip stocks with your taxed dollars for example.

Over the past decade index funds have been slightly better than managed funds in a tax-deferred account because of the lower management fees. Over that same time period index funds have been much better than actively managed funds in a taxable account because of the tax efficiencies.

Here's one way of thinking through this investment allocation situation:

Your 401k is limited to a few choices, most of which are likely to be large cap funds and you can expect them to perform similarly over the long run. So pick the one with the lowest yearly fees, which is probably an index fund.

Your taxable accounts have all sorts of choices but history has shown that buying good stocks and holding them long term is one of the best approaches. This is especially true when the tax rate of long term capital gains is less than the tax rate on interest, dividends, and short term capital gains. (This hasn't always been true and might not always be true in the future.) So pick good stocks and hold them long term. You don't pay a management fee and most of your return will be taxed at long term capital rates.

But above all invest and invest regularly! The difference between two investment strategies is far less than the difference between investing and not investing.


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