How should you weigh the virtues of indexing against those of an actively managed fund? Both approaches have their own unique attributes and drawbacks.

When you invest in an index fund, you know exactly what you will be getting. Funds pegged to the S&P 500 are the most popular of this genre and include exactly 500 stocks -- those included by S&P in this index.

Advantages to indexing include exposure to a wide swath of the stock market, a strongly diversified equity portfolio, and no need to worry about how a portfolio manager is moving your and other peoples' money among stocks. It is nearly impossible for any individual investor to replicate an index on his or her own, due to the millions of dollars it would take.

Studies have consistently shown that very few actively managed funds are able to outperform their benchmarks over the long term. Of course, indexes exist on paper only. Funds, both index and actively managed, have expenses that bring down the fund's total return and make it difficult for a fund to match the index's performance.

As for actively managed funds, a portfolio manager has the advantage of being selective about which stocks to invest in. For instance, a portfolio manager who was troubled by the situations that have caused some major companies to declare bankruptcy might have divested his fund of those stocks at the first sign of trouble. An index fund, on the other hand, would have to wait until the index declared that these companies no longer warranted inclusion in the respective index.

A portfolio manager may use his own theories and formulas to decide at what price a stock is fully valued and when it is a bargain, and either buy or sell accordingly. Scrutinizing the portfolio manager's credentials should be of paramount importance in considering an investment in an actively managed fund. This information is included in the fund's prospectus.

A well-diversified portfolio has room for both types of funds -- the trick is to incorporate them in the right proportion.

Most of the indexes used as benchmarks by actively managed funds are devised by two companies: Standard & Poor's, a division of The McGraw-Hill Companies, of New York City and Frank Russell Company of Tacoma, WA.

The Standard & Poor's 500 (S&P 500) enjoys wide popularity as a benchmark due to the degree to which it encompasses the large cap segment of the U.S. stock market. The companies included therein are, generally, the 500 largest domestic publicly traded companies. Their size is decided by market capitalization, which is easily arrived at by multiplying the company's outstanding shares by those shares' market price.

The composition of the S&P 500 may change due to the ascending and declining fortunes of publicly traded companies. At other times, two index components may merge, thus opening a new slot. S&P recently announced its intention to remove seven non-U.S. companies from the S&P 500, so as to make the index a better reflection of the U.S. large cap market. In 2000, a total of 58 companies were either added to or dropped from the S&P 500. Last year, that figure dropped to 30. This year's number (through June 30) is 10, which doesn't include the seven aforementioned foreign companies.

Standard & Poor's also manages an array of indexes that concentrate on the small- and medium-cap segments of the market, as well as indexes that have a geographical focus.

Russell maintains 21 U.S. stock indexes, as well as indexes that focus on Canadian and Japanese companies. Russell's U.S. indexes are arranged according to market capitalization and/or investment styles (growth or value) and are adjusted during the second quarter of each year to reflect current stock market capitalizations as of May 31. The newly adjusted indexes then take effect a month later on July 1 and remain in place until the next readjustment a year later.