There are two types of mutual funds available on your company 401(k) retirement plan menu.
First, there is an active mutual fund. This is the most commonly known type of mutual fund. An active mutual fund manager tries to justify their higher annual management fees by picking individual stocks. The investment objective in this mutual fund is to try to outperform the overage stock market averages.
Second, there is an index mutual fund. An index mutual fund owns the individual stocks that make up the popular stock market averages. These mutual funds have lower annual expenses.
The U.S. major stock market indices have fallen farther and faster than any time in U.S. stock market history. So, what has happened in the last few weeks to the market value of index mutual funds?
During the past decade, U.S. equity active funds have lost approximately $1.4 trillion in assets. Index mutual funds and ETFs took in about $1.6 trillion in assets.
Investment returns were largely the reason for the stampede into index mutual funds. Over the last 10 years, less than a quarter of all active funds managed to beat their passive rivals, data compiled by Morningstar Inc. showed.
The current generation of company 401(k) retirement plan participants can clearly be labeled as “indexers.” What if just “buying-and-holding” the index does not work any longer?
Right now, we may very well likely be at one of those historical, “It works until it doesn’t” moments in company 401(k) retirement plan investment management history.
The worldwide stock markets are in the midst of a violent correction. Active mutual fund managers are able to sell the worst stocks they own in order to meet redemptions from existing shareholders.
The best news is that active mutual fund managers will be able to hang on to the best stocks they own. Many of these stocks are not part of the major U.S. stock market indices. That fact is a key investment management strategy advantage right now, and going forward.
Many active mutual funds are beating the U.S. stock market averages handily during this stock market correct. That is, these mutual funds are falling at a much lower rate.
Historically, when and individual stock or a collection of stocks (a mutual fund) is able to fall at a slower rate than the overall stock market averages, those are the same stocks and mutual funds that regain their principal values sooner.
That investment management concept is called relative strength. But that information is for another blog post.
Active mutual fund managers are cutting risk levels. They are raising cash or trimming big losers would allow a portfolio to avoid deeper losses. Index mutual funds can’t, and don’t, make that critical investment management move in declining stock markets.
After this stock market correction runs its course, many passive mutual funds will own individual stocks with strong fundamentals and quality balance sheets. The prices of these companies will be “on sale” at the lowest levels of the last several years.
Ric Lager
Lager & Company, Inc.
