- These 'Spiders' Could Lure Big Bucks

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These 'Spiders' Could Lure Big Bucks

April 18, 2000: It's A Kind Of Mutual Fund That Is Virtually Tax-Proof

By Jennifer Openshaw of WFN Women's Financial Network
April 15, 2000, 12:02 a.m. EDT

Got hit with huge capital gains this tax season? Unfortunately, that comes with the territory when the stock market performs well. But what if you could invest in the Standard & Poor's Composite Index of 500 stocks and control your tax liability?

You can. One way is to invest in a passively managed index fund. Another is to invest in Standard & Poor's Depositary Receipts -- a.k.a. "SPDRs" or "Spiders." Designed to closely track the performance of the S&P, a Spider represents ownership in a unit investment trust whose value is priced at one-tenth of the S&P 500 stock index.

Tax Management

With a Spider, you receive similar performance results as the S&P 500, but without the subsequent tax liability. That's because Spiders are incredibly tax-efficient -- they've only paid out one 9-cent capital gains distribution since they were first introduced in 1993.

Spiders also offer advantages that can't be matched by an index fund. For example, SPDRs never suffer from the problem of having too many assets under management. "Spiders are very similar to a closed-end mutual fund," says Joe D'Orazio, a CPA and attorney in Falls Church, Va. "Only a finite universe of shares are issued, so someone else has to sell their position for you to buy."

In contrast to mutual funds, whose sales become effective at the end of the market day at its closing price, Spiders may be traded all day long�like stocks. In addition, investors never experience performance drag due to the manger's decision to carry a large cash position, and you're not subject to a minimum initial investment (index funds may range from $1,000 to $3,000).

Performance And Expenses

If the broader S&P does well, so will your Spider. The difference between index fund and SPDR performance is negligible, as evidenced by the 24.4 percent return of the Vanguard 500 Index Fund vs. 23.9 percent for SPDRs from February 1, 1994 to January 31, 1999 (assuming all dividends were reinvested). Annual SPDR expenses, at just over 0.18 percent, are also in the same range as most low-cost index funds.

On the other hand, Spiders do suffer somewhat from dividend drag. Since the security is set up as a unit trust, dividends accumulate and are posted at the end of each quarter -- instead of daily, like mutual funds. If you reinvest dividends, you may miss out on some of the incremental returns during an appreciating market. In a declining market, however, Spiders may come out ahead.

Spawned Offspring

Now that Spiders have hit mainstream investing, their slow but steady rise in popularity have spawned other, sector-specific security offerings. For example, the American Stock Exchange is trading a plethora of new arachnid-like products designed to segment out nearly every sector represented in the S&P 500 -- currently nine in all.

Presently, you may invest in technology (XLK), which tracks and holds at least 20 technology stocks in the S&P 500, including Microsoft, Dell, AOL, Cisco and Oracle, according to D'Orazio. He observes that for investors betting on a particular segment of the stock market, Spiders make an interesting play due to their tax efficiency. Other sector SPDRs offered on the American Stock Exchange (AMEX) include:

Consumer Staples (XLP)
Energy (XLE)
Financial (XLF)
Industrial (XLI)
Utilities (XLU)

Like a mutual fund, a Spider offers an entire portfolio of stocks in a single transaction. However, like a stock, you have to pay a brokerage commission to trade SPDRs. While large masses of investors haven't exactly flocked to this hybrid investment in recent years, that may change as continued market volatility forces them to take a more prudent look at the growing tax liability of stock portfolios.