Fifty Shades of Funds: An Investment Strategy for Every Taste
Considerations when choosing between index and actively-managed funds
By Paul Jarvis, CFP®
Area voices Financial Planning Blog
Once upon a time, investors chose between two starkly different investment fund options: traditionally “plain vanilla” index funds and broad spectrum actively-managed funds. But over the last decade, funds incorporating aspects of both – such as Smart Beta funds and ETFs – have emerged, leaving investors with more options than ever.
The proliferation of ETFs, automated trading platforms, and the plethora of investment options can often overwhelm investors making it difficult to choose the right investment for your personal investment profile.
As a starting point, the following typical investor profiles might consider these types of funds:
Young Investors: Mutual funds offer children and teens ample diversification at minimal levels of investment. Managed funds often have a “story” behind their holdings that can be much more exciting and entertaining for younger investors than an S&P 500 index.
First-Time 401(k) Participants: A broad index fund provides relatively low volatility and instant diversification without much active thought or monitoring – just the right amount of work for a new participant managing all of the financial decisions that come with a new job.
High Tax Bracket Investors: This investor is likely to have a number of different investment accounts. To minimize annual taxable income, he or she might utilize index funds for taxable accounts and put favorite high-performing managed accounts into tax-deferred or tax-free accounts, to help minimize annual taxable income from investments.
Socially Responsible Investors: Investors that are passionate about a cause, such as women’s rights or environmental preservation, can take advantage of managed funds aligned with their interests.
Plug and Play Investors: Managed funds can make more sense for investors who want a fund that adjusts as he or she gets closer to a life milestone such as retirement. Other managed funds take care of asset allocation, rebalancing and risk management, as opposed to the investor choosing a variety of funds and adjusting his or her holdings in each.
Hedgers: To mitigate particular types of risk, such as rising medical care costs in retirement, an index may be a prudent investment. However, be cautious, as narrowly targeted indexes can be inherently high-risk and volatile.