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The Mistake with Index Funds


Why try and beat the market when you can match market returns? Why wouldn't you want to invest with the lowest investment fees?


These are the two main arguments for investing with index funds. An indexed find is designed to mimic a particular stock market index. For example, an S&P 500 index fund should return roughly the same amount of growth and loss as the S&P 500 index. Who wouldn't want stock market returns?


The problem with most actively managed mutual funds is that they try to beat the market and fail. In addition, actively managed mutual funds are more expensive in regard to fees than index funds. High expenses reduce growth and add to losses.


So, you have a choice – actively managed mutual funds with higher fees that do not beat the market versus index mutual funds that match market performance with lower fees. It seems like a no-brainer.


Most people argue that one is better than the other. I would argue that they both have their place in an investor's portfolio. Here is the one mistake that people make when it comes to index funds. Yes, you do get market returns. You also get the stock market risk that goes along with market returns. Unfortunately, investors get too hung up on the above two arguments for index funds and forget about the risk.


I would approach index funds in this manner. If you are fine with stock market risk and have the appropriate risk level, I would take index funds over actively managed funds that are trying to beat the market. It is true that most actively managed mutual funds do not beat the market.


If you have a lower risk level, actively managed mutual funds that manage for risk are more than likely your better choice. Always be true to your risk level.


Are you going to pay higher fees? Yes, because you are paying for a risk strategy. However, let's put it into perspective.


Let's say that you have a conservatively based actively managed mutual fund that is 1% higher in annual fees than an index mutual fund.

Is that higher fee going to matter when an index mutual fund loses 40%, and the actively managed fund loses only 8%? There are always two sides to a story.


ASK BOB about money and investment issues. Bob is always happy to visit with you. Bob Brooks is a Financial Adviser and host of The Prudent Money Radio Show, which airs daily at 3 PM CST on 91.3 FM, 97.5 FM, and 99.9 FM in the Dallas Forth Worth metroplex. Listen online at www,prudentmoney.com/radio-show. You can reach Bob at 972-386-0384 and online at info@prudentmoney.com.