Movers and SHAKERS
Actively Managed Funds are No Guarantee for Beating the Market
According to Dimensional Fund Advisors, while the types of businesses most prominent in the market vary through time, the fact that a small subset of companies’ stocks account for an outsized portion of the stock market is not new. Given the difficulty of predicting which companies will outperform or underperform supports the importance of having a broadly diversified portfolio. Are individual stocks or index funds the best path for gaining exposure to the market?
The Case for Index Funds:
Index funds offer a low cost means for diversified exposure to the market or segments of the market. Index funds help minimize company-specific risk that can dent returns. During the March 2020 market sell-off, many individual stocks performed substantially worse than the S&P 500 index, including those vulnerable to travel restrictions and social distancing, including cruise lines, airlines, and hotel chains and experienced a slower recovery as the market rebounded. The main argument against owning an index fund is the inability to outperform the market. However, the broader market has provided respectable returns over time. For example, during the period January 1970 through June 2020, the S&P 500 annualized return with dividends reinvested was 10.4%. Excluding dividend reinvestment, the annualized return was 7.3%.
The Case for Individual Stocks:
Owning individual stocks can be a good choice for investors with ample funds and the ability to own enough equities across industries to be appropriately diversified. Due to low trading costs, a portfolio of individual stocks can be bought at relatively low cost, and the investor can easily track what he/she owns, dividends received, and can vote their shares on company matters. However, there is still the issue of monitoring holdings, rebalancing when appropriate, and staying up to date on market trends and/or company developments. Importantly, for investors that have time to make informed choices, there is the potential to outperform the market or spot that next Apple, Amazon, or Facebook that will accelerate the path to wealth.
Investors should choose investments that are appropriate based on return objectives and risk tolerance. This likely encompasses a mix of active and/or passive funds, individual company equities and/or other asset classes. While actively managed funds can be a great option for certain strategies, S&P Global Indices found that many actively funds underperform their respective benchmarks. Because actively managed funds are by nature constrained from owning broader benchmarks, they risk missing out on the stocks that drive broader market returns. As a result, many investors may elect to own individual stocks at relatively low cost for the actively managed portion of their portfolios. Selecting a subset of individual micro or small-cap stocks for a portfolio that may include large cap index funds for broad market exposure and diversification, may offer more opportunity to capture alpha due to smaller cap companies being underfollowed by the analyst community and the potential for higher growth. For micro and small cap investors, www.ChannelChek.com may be an excellent resource for generating investment ideas.
Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.
Large and In Charge? Giant Firms atop Market Is Nothing New, Dimensional Perspectives, Dimensional Fund Advisors, 2020.
Index Funds vs. Individual Stocks: What Does the Coronavirus Market Collapse Teach Us About Both Investing Strategies?, USA Today, Adam Shell, March 23, 2020.SPIVA U.S. Year-End 2019 Scorecard: Active Funds Continued to Lag, S&P Global, S&P Dow Jones Indices, Berlinda Liu, April 8, 2020.