As a future financial planner and someone who just got a master’s degree in financial planning, I am a little different take on things. I believe that people can achieve the same results as many financial planners by using low-cost exchange-traded funds that follow an index of sorts, such as the S&P 500. But here is where things can get a little different, and the result is good news for you the investor. Exchange traded funds now use smart-beta indexes to purchase groups of equities and bonds. These funds use these smart-beta criteria to set up the criteria for the fund to follow. Meaning there is no management involved with the running of the fund thereby reducing the costs. This results in a much lower expense fee, on average these funds run about 0.6% compared to over 1.2% for funds managed by actual people.
The smart-beta funds follow a strict set of criteria that the programs do not allow for deviation as a fund run by a manager could possibly do. These funds look for advantages in certain equities, and then they try to take advantage of these irregularities. Say you want to have a fund that follows underpriced equities. The people who set up the exchange traded fund will write a set of parameters that it will follow and then search for the equity that falls into its criteria. Then no matter what happens to the managers of the fund the exchange traded fund will continue to follow its parameters that were set up initially. Removing the need to have an actual paid manager to run the fund, again reducing the overall costs of the fund.
These funds are set up with academic research as their basis depending on what the owners are using as a basis. As I touched on earlier the funds are meant to be passively managed and not actively managed by a person reducing the costs. Provided the parameters are correct when setting up the fund can operate for years without any human involvement what so ever. This is what allows the fund to keep its expense ratios so low. Once the parameters have been established in the smart-beta funds, they simply search for equities that fit their criteria and act on those parameters that were established.
Now there is a significant drawback to these funds that actively managed funds generally do not experience. In an actively managed fund the manager is held responsible for the fund’s performance and it the fund does not perform well they are relieved from their position. Also, managers retire which can have a dramatic effect on a fund with people leaving the fund to look elsewhere for similar results. With smart-beta funds, you can expect to outgain the market, but it could take years or decades for the results to be seen by the ones who purchased the fund. These in many instances are long-term investments and not fast turnaround investments.
With proper guidance and some research, I think anyone can invest with or without the assistance of a professional with the use of indexed and smart-beta exchange traded funds. Now there are thousands of these funds so it is difficult to pick the one that may or may not be right for you, but that is where a financial advisor can come in handy. If you use a fee-only advisor, they can assist you in developing a financial plan and assist in selecting the right mixture of exchange traded funds for your portfolio.
I really think that exchange traded funds are much better for someone’s portfolio than actively managed funds. Over the long haul, they should perform as well as the market in general. If you consider that the market on average returns about 8%, most of these funds will meet or possibly exceed that over a long period, meaning that they could be solid investments. After all, these funds are designed to find undervalued equities that will exceed the market over a long period. While no investment is guaranteed, these are at least a good alternative to an actively managed fund.
If you need more information or have any questions, please feel free to contact me or leave a message on the post.
