One of my readers, Matt, recently emailed me for advice about applying the suggestions in my book. He was considering switching his mutual funds to index funds and asked what his financial adviser thought.
Here was her response:
Hi Matt – All mutual funds have expense ratios (fees) to cover transaction costs, statements, research, prospectus, etc. While index funds typically have lower expenses than a managed fund, you are in effect only buying an index. You have no one selecting the holdings for the fund, nor is there anyone who makes the decision to sell a stock that is dropping.
For example, in 2008, as banks stocks were dropping rapidly, if they were a part of an index like the S & P 500, they were still held by the fund, while a manager of a fund could lower the funds exposure to this sector, thus attempting to limit the downside risk to the portfolio. Additionally, a fund manager researches and finds companies that could represent an excellent value or a stock that has strong potential growth prospects and add it to the portfolio. An index fund does not do this. They add a stock when the stock is added to the index itself.
Please let me know if you would like to discuss further.
What do you think? What would you recommend Matt do?
Note: Let’s be constructive. It would be easy to rip this adviser a new one. But what should Matt do?