Are actively managed funds a good investment choice? Picking the right investments for FIRE (financial independence retire early)
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| Wildwood Park, Harrisburg, PA |
Robert G. Allen: “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.”
Recently, as I was helping my brother-in-law choose investment types for his retirement account, it got me thinking. It got me thinking, more specifically, which investment types would work for FIRE (financial independence retire early) crowd as well as anyone else who are interested in taking advantage of the power of the stock market.
In this post, I’d like to discuss this valuable tool (actively managed funds) for FIRE (financial independence retire early).
As I had previously discussed, many FIRE movement followers have used index fund strategy as the primary method of reaching financial independence. I, for one, am also a big proponent of this strategy. The value of an index fund is in its simplicity and low expenses compared to other type of funds. Another value of index fund is the propensity of index to have few sure winners that usually outperform others in the same index.
It’s well known that few stocks will usually bring up the rest of the index. Why is that? Well, in a basket of different companies’ stocks which is an index fund, only few of them will generally be home runs, while most will languish at the bottom or do ok. By having few of these ‘home runs’ in the index fund, it benefits the entire index fund.
Companies like Apple, Amazon, and Tesla are good examples of this. At one time, they were small companies. Over time, their vision, performance and their market capitalization eventually brought up whichever index they were originally in. Even after they’ve become big players, they have been key companies that still bring up indexes like the S&P 500 or NASDAQ.
***Easiest way to understand this is by looking at it this way: You have 9 players in a baseball team. While average hitter might hit .270 or so, you have two hitters that hit .300. This improves the ‘team average’ to .276 from .270. An index fund is like a ‘team average’ in a baseball team. Because two stocks (two players) do well, the entire index (team) benefits.***
This is why if you owned a S&P 500 index fund (500 largest US companies), it would’ve returned about 10% rate of return annually. Most stocks in the index do ok, while few like the ones mentioned, do really well. *Incidentally, this fund is something I recommend for long term investment strategy.
So, why change the strategy? Why not just stick to index funds?
I always believe in diversifying investments to minimize risk. I like the idea of having bond mutual funds to offset a bad stock market. I like the idea of a professional (a fund manager) managing my money, as long as the fund has been returning a good rate of return and has had stable management.
There’s nothing wrong with doing the S&P 500 index funds. It comes down to who I am as an investor. I like some diversity built into my portfolio. Or, put it another way: I don’t want to put all my eggs in one basket!
You need to figure out what type of investor you are. If you’re ok with putting everything in one basket (S&P 500 index fund), there’s nothing wrong with it! However, if you like some diversity in things you normally do (you like different styles of music and not just one style, for example), then consider adding actively managed funds to your retirement strategy.
What are actively managed funds?
Actively managed funds are funds that are actually managed by someone (or a group) and they decide what to do with the choice of stocks in that fund as well as when to sell or buy different stocks in that fund. Typically, fees are higher compared to index funds.
If fees are higher, why should I buy actively managed funds?
You would buy these because the rate of returns are better than the S&P 500 index fund even when considering the low expense ratio of an index fund.
I currently own few of these actively managed funds.
One of them is the ‘Fidelity Growth Company’, which has beat the S&P 500 index for the past 10 years and the other is ‘MFS International Intrinsic Value Fund’, which has beat the ‘MSCI EAFE (Europe, Australia, Far East) index for the past 10 years.
See example of Fidelity Growth Company fund below:
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| Screenshot of Fidelity Growth Company fund (see 10 year return) |
These rate of returns are why I chose actively managed funds over index funds to supplement my portfolio.
In conclusion:
- Find out what kind of investor you are: If you like some diversity, then consider adding some actively managed funds to supplement your index funds. You decide what percentage will be devoted to which investments ultimately.
- Actively managed funds can provide higher rates of return compared to index funds. Do research on any fund when considering buying. At the least, look into the rate of return, expense, how long a fund has been in existence, and the overall fund rating before buying.
- Having diversification in a portfolio is usually considered a good practice.
- What you buy in the end, is up to you. Do your due diligence before buying, and get professional help from your 401k or IRA provider as needed.
Adding diversified investments is a sound strategy for achieving financial independence. Remember, you can invest many different ways to achieve the same goal. Ultimately, it’s your money. Research as much as you can, seek help as needed, before considering adding actively managed funds.
Thank you all for reading!
Jake
Wandering Money Pig
Please check out our YouTube channel ‘Wandering Money Pig’ showcasing our travels and our Pomeranian dog! https://www.youtube.com/channel/UC3kl9f4W9sfNG5h1l-x6nHw
