Is there ever a circumstance for a plain old mutual fund?
Yes, advisors agree. Although index and exchange-traded funds are wildly popular, given their low fees, recent market vacillations have revealed some weaknesses of these fund forms.
Index funds are driven by algorithms that keep their values in lockstep with market rates, for better or worse. Whatever is happening in the market is mirrored in an index fund.
The entire point of ETFs is that they are traded like stocks, and thus their value fluctuates with the market. But in the recent market turmoil, some ETFs became untethered from their underlying value, losing 25 percent or more in the bobbling market. Trading was halted for those ETFs to let their momentary valuation catch up with their underlying value — a smart move by regulators, but also one that undermined the whole point of having a fund that’s continually traded.
If this is what’s going to happen to index funds and ETFs in tumultuous markets, what’s the point?
“For a long-term investor, daily or hourly liquidity is not what you’re focused on,” says Derek D. Klock, an associate professor in the business college at Virginia Tech in Blacksburg. “For long-term investors, there’s a gigantic role for plain old mutual funds.”
Much of the argument for index funds and ETFs pivots on low fees. But competition has forced down fees even for most actively managed mutual funds, Klock says, while the endlessly complicating structures of index funds and ETFs have pushed up fees for many of them.
The bottom line: Don’t assume that index funds and ETFs are cheaper, and don’t assume that a mutual fund is more expensive.
Advisors agree that one of the biggest purported advantages of ETFs is the ability to time capital gains, thus minimizing taxes. But if your funds are held in a tax-advantaged retirement savings account, this advantage is moot.
The automatic-pilot nature of index funds can tacitly encourage investors to be too passive about managing their portfolios, says Dan Parks, a self-employed financial advisor and adjunct financial instructor at San Diego State University.
Target-date funds and funds that are designed for various risk profiles — in other words, funds that let you choose your preferred combination of risk and expected return — are convenient, he says, but it might be smart to take on those decisions yourself.
Instead of riding the escalator of a target-date fund, consider analyzing key life milestones and having a bit more of a hands-on approach with a mixture of mutual funds, he says. That gives you more flexibility if your milestones are likely to change — say, for example, if you remarry and have additional children coming.
Take a close look at exactly what kinds of funds are offered through your employer’s retirement plan, recommends Lawrence Verzani, assistant professor at William Paterson University in Wayne, New Jersey.
“A regular mutual fund makes the most sense if there are not many index funds offered,” he says. “Maybe your 401(k) has a U.S. equity index fund but you want to add international to your portfolio. Then it makes sense to have an international mutual fund.”
If you simply chose a fund or two based on familiar brand names, know that it’s easy to redistribute your savings among other funds included in the plan, Verzani says. The cost to make the change usually isn’t much, and if you’re switching from a volatile index fund to an actively managed fund with a strong track record, you are likely to make up the difference quickly.
He also advises that it’s worth the time to understand exactly how each fund’s fees compare to each fund’s net performance. And be sure to look at the total picture. “Any number that’s advertised by a mutual fund company is going to showcase the return, but you should focus on your employer match, the expenses of the funds and the asset classes,” Verzani says. The fastest way to accelerate your retirement savings, he says, is to put in the most you can to capture the biggest match from your employer, and to put your money in funds that have proved that they deliver consistent growth for reasonable fees.
You’ll also benefit by understanding how managers of actively managed funds think and aligning your goals accordingly, Parks says. While an index fund simply goes along for the ride with the market, an actively managed fund should be putting the brakes on where it’s needed, minimizing losses. “They have a level of risk management built in that an index fund won’t have,” Parks says.
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Protect Your Investment Portfolio From Volatility With Mutual Funds originally appeared on usnews.com
