Three Alternatvies of Indexing

(1/28/2006)

In the last few days, I was thinking about adding PRF (Powershares FTSE RAFI US 1000 Index Fund) to my portfolio.

I first discovered similar concept with the Fortune 500 index fund, which include 500 companies with the largest revenues. However, the index still used the market capitalization as the weighting factor.

When PRF was first announced several months ago, I got very interested in the concept. Over the past few days, I have researched online all the related information about the PRF fund and its associated index. I feel this is a great alternative to the currently dominant S&P 500 indexing methodology.

Now I have investments in all three alternatives.One is the market-cap weighted methodology. Several main index families use this method. S&P 500 index, Russell 1000, or Wilshire 5000 all use this method. Most of these index funds are the traditional ones. I can find them almost all in Vanguard funds. One can also have similar investment with SPY.

The second alternative is the S&P 500 equal weight index fund RSP. I have investments in this one for a while already. I really like RSP because it rebalances its components every quarter. This way, the buy low sell high principle is used four times in a year. Another benefit is the equal weight favors the smaller components in the S&P 500 index.

Now there is the third alternative PRF. This index fund completely does away with the market capitalization weight. It uses four economic parameters to weigh its components. The four parameters it use are sales revenues, cash flows, book values, and dividends. Each contributes the same weight. The original thinker in this methodology is Research Affiliates LLC. It calls the RAFI index as the main street index while it calls the S&P 500 index as the Wall street index.

I believe all three alternatives have their own merits. So one should invest in all three funds: SPY, RSP, and PRF. This way one can avoid the disadvantage of each one of them.