To be honest, I never considered this approach before.
I typically do not like paying fees to fund managers. I am especially skeptical of standard mutual funds when their track record can be worse than the market almost as frequently as above the market. According to that great champion of individual investors, Motley Fool:
The average actively managed stock mutual fund returns approximately 2% less per year to its shareholders than the stock market returns in general.
Most of my advice is to pick great companies and invest in them with caution, taking profits when the market moves against the company’s stock. I do suggest that a certain portion of your portfolio reside in index funds – I typically tell people to pick their favorite broker and buy a DOW index fund, a S&P index fund, and at least one international index fund. I rarely care about the brand since we are just trying to match whatever the market is doing.
Crossing Wall Street just did a great post describing a fairly mathematically correct method of creating your own S&P Index fund. This would allow you to avoid any fees leveraged by the index fund management company. Not a bad idea. Note though that not all of these companies are Good Companies (in fact at least one of them is a Poor Company) but that is okay since you are only investing in these companies because they are your own home-grown index fund.
Looking to build a quick-and-easy index fund? Of all the stocks in the Dow, United Technologies [stckqut]UTX[/stckqut] has had the strongest daily correlation with the S&P 500 going back to the beginning of 2005. Each day’s UTX gain or loss has a 69.7% correlation with the S&P 500.
If add in Dupont [stckqut]DD[/stckqut], the correlation jumps to 80.5%. (Note this is average daily change, so it assumes you invest equal amounts each day.)
If you add is Disney [stckqut]DIS[/stckqut], the correlation rises to 85.4%.
Now the extra correlation really is hard to come by. If you add ExxonMobil [stckqut]XOM[/stckqut], the correlation rises to 88.9%.
If we add American Express [stckqut]AXP[/stckqut] the daily correlations rises to 90.6%.
Verizon [stckqut]VZ[/stckqut] brings it up to 92.6%.
If you want to go for seven stocks, IBM [stckqut]IBM[/stckqut] will bring you up to 94%.
Now we’re almost out of room. Wal-Mart [stckqut]WMT[/stckqut] will bring our eight stock index fund up to a 95% daily correlation with the S&P 500. This is, of course, an equally weighted fund.
Obviously, you will spend $15-$20 per stock as you buy and eventually sell each stock (I assume you know where to buy or sell a stock for $7-$10). this may make this strategy not work for you depending on the amount that you invest in your “fund” so do the math before you get online with your favorite broker.