Did you know there are close to 15,000 mutual funds? I guess it’s not too surprising because mutual funds usually make up at least a portion of most portfolios. They offer inexpensive diversification for small and large investors alike. But something is wrong with this once trusty investment vehicle. You see, last year only 25% of all those mutual funds had returns above that of the S&P 500! That’s a pretty disappointing reality for all of those investors who occasionally look at their fund statements. That’s why I think more investors need to consider an index funds to make up the conservative heart of their investment portfolios. Here’s why.
Most fund performance is compared to a benchmark index like the S&P 500. In other words, if a fund beat the index, it was a successful performance; below the index, inferior performance. If the index is considered the benchmark, why not own the benchmark? Yes, you might not capture some of those sizzling hot stocks but you would be sure of meeting the benchmark expectation. Over the past 50 years or so, the average annual market return has been around 12%. This return, while not eye-popping, can do magic things over the long run. And that’s what investors want.
For example, investing $ 30,000 at age 22 would return $1,262,746 at the age of 65 if the original investment of $30,000 earned an average 12% per year. All that is needed is fund management to bring in that benchmark return. But as recent numbers have shown, the vast majority of fund managers aren’t doing that despite the fact that they are paid a substantial amount of salary and bonuses.
But there is an easy way to get the benchmark and that is to purchase an index fund. The only management that is required is to periodically readjust the portfolio of stocks in the fund that represent a full correlation to the market.
There are other benefits to owning an index fund. For example, if you want to buy and index fund- or a surrogate for the S&P average called a Spyder-SPY- you can buy it or sell it almost instantaneously. These ETFs (exchange traded funds) trade just like stocks. The traditional open ended mutual fund is not as agile and can take several days to settle. Better yet, an ETF can have options which allow an investor the ability to not only buy the index for about 10% of what it costs to own the underlying share but also use the many strategies that a knowledgeable options trader can use. Not only that, ETFs allow the direct ability to protect unrealized gains by using a put strategy, something no open ended mutual fund can do.
The traditional open ended mutual fund has had an amazing run and still offers the average retail investor a lower risk way to participate in the equities markets. But if you’ve read this far, you aren’t the average retail investor and should take a good look at ETF index funds.