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Funds In Focus: USAA 500


The "In Focus” series will take a regular close look at financial products and services of interest to military families. This installment will take a close, hard look at the USAA 500 fund.

USAA 500 is the United Services Association’s flagship large cap index fund. It’s a popular fund choice among USAA clients, with $3.7 billion currently under management. As large cap funds go, however, it’s not particularly big, and there are other funds out there that are much bigger. It comes in two share classes – member shares and reward shares. We’re interested in the member shares at this point.

You can follow along by going to Morningstar.com and typing in “USAA 500” in the quote search engine. Morningstar.com is one of the premier clearinghouses on the Web for mutual funds data. It will list up to date return information (as of close of trading the previous business day, or after 4 pm on the same day). It also will give you the portfolio as of the last time the fund publicly announced its holdings, which they typically do once per quarter.

Strategy

The USAA 500 is a typical large cap index fund. It seeks to replicate the performance of the S&P 500 index of large cap stocks as closely as possible. It makes no attempt to identify winning stocks. It simply holds the stocks in the index, come rain or come shine.

As we discussed in our index funds vs. active funds article, this is generally an effective strategy. Indexing is proven to reduce fund expenses and increase tax efficiency – resulting in a significant cost advantage over most actively-managed mutual funds.

Portfolio

As an index fund, USAA 500’s portfolio is easy to figure out. It just holds the stocks in the Standard & Poor’s 500 index of large cap stocks. It just holds the stocks in the index, in proportion to their market capitalization. These companies are the largest 500 companies publicly traded on the New York Stock Exchange. The fund also usually keeps a percent or so of its portfolio in cash, to meet whatever redemptions may come in on a given day.

The industry weightings are almost exactly even with the industry weightings of the S&P 500 by design. If you own the USAA 500 fund, and nothing else, you have broad exposure to the fortunes of a wide variety of industries.

As of 18 April, 2012, an investment in the USAA 500 fund would give you exposure to the following broad industries:

Sector Percentage of Portfolio
Basic materials 2.81
Consumer cyclical 9.20
Financial services 12.99
Real estate 1.82
Communication services 4.20
Energy 12.14
Industrials 12.15
Technology 18.67
Consumer Defensive 11.41
Health care 11.22
Utilities 3.41
Source: Morningstar

Valuation

USAA 500 is neither growth-orient nor particularly value-focused. The portfolio as a whole currently sports a price-to-earnings ratio of 13.35. That means you are paying $13.35 for every dollar of earnings in the portfolio. That’s not really cheap, but not outrageous either. It’s well within a typical range for U.S. equities over the past 30 years or so. At its peak in the year 2000, the S&P 500 was trading at a P/E ratio of about 40. That meant every dollar of earnings cost investors $40 in cash. They were betting that earnings would continue to grow at a rate that would justify that high price (At the height of the technology/Internet stock bubble, the Nasdaq 100, consisting of mostly technology stocks was trading at 100 times earnings!) Those prices, we know now, were not sustainable, and the market collapsed beginning in March of 2000.

Fees

The fund has an expense ratio of 25 basis points, or 0.25 percent. This is rather high for an S&P 500 Index fund, though still much cheaper than the expense ratio for comparable actively-managed funds. Nevertheless, it’s difficult to justify paying 25 basis points every year for an index fund, when military families can contribute to the Thrift Savings Program and buy the nearly identical C Fund at an annual expense ratio that’s 90 percent cheaper, at just 2.5 basis points.

Folks, this is the best investment deal going. Even notoriously inexpensive exchange-traded funds don’t have this beat.

If you are eligible to contribute to the TSP, it makes more sense to contribute as much as you can to the TSP’s C Fund for your allocation to equities – and use the USAA 500 fund for anything over that. You can buy an S&P 500 fund for slightly less than USAA’s price, though, through Vanguard, Fidelity, or T.Rowe Price. If you’re planning on buying and holding for a long time, you may consider the Vanguard 500 ETF, as well, which is simply shares of the index fund that trade over the exchanges like a stock. Unlike the mutual fund shares, you’ll pay a stockbroker’s commission to buy and sell. But the ETF has extremely low ongoing expenses.

Not as low as the TSP C Fund, though, so I’d start there and build out.

Caveat: If you’re in the TSP, you’re in a tax-deferred account. This means you’ll pay income tax on the withdrawals you make in retirement. If you’re a buy-and-hold investor and you want to pay a lower long-term capital gain rate instead, then you’ll want to hold your fund outside of the TSP and outside your IRA, 401(k) or other tax-deferred account. The Vanguard 500, or the Fidelity Spartan 500 or the T. Rowe Price 500 funds can be excellent choices for this purpose. (The normally excellent TIAA-CREF family doesn’t make the cut here, because the expense ratio on its S&P 500 fund is even higher than USAA’s, at 40 basis points.)

Accessibility

To open an account outside an IRA, you need to be able to make a minimum contribution of $3,000, if you buy directly from the fund, which you can do without paying a sales commission, or sales load. Additional contributions have to be $50 or more.

If you open an IRA, however, you need less money to get started with: Just $2,000. If you start an automatic investment program, or AIP, and let the fund company draft your bank account, every month, though, you can start with just a $50 contribution. USAA has done a great job of making their funds accessible to any military family.

The Bottom Line

Although USAA is a very fine financial services company overall, its long affiliation with the military doesn’t negate the fact that expenses matter, and that there are lower-expense alternatives outside of USAA. If you want the tax-deferred version of the S&P 500 index, there is nothing better than the TSP. Start there.

USAA’s big plus, however, is customer service and convenience for military families. As 1-800 number advisors go, USAA’s are excellent, and they have a lot of experience specific to serving military families that a customer service rep or advisor at Vanguard or Fidelity or T. Rowe Price can’t normally match. And that’s worth something.

I rate the USAA 500 fund a moderate buy.


Contributed by Jason van Steenwyk

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