Best Time to Invest In Actively-Managed Funds

How to Get the Most Out of Actively-Managed Funds

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Active investing is an investing strategy and philosophy that usually has an objective of outperforming a broad market index, such as the S&P 500. As the word "active" implies, an investor will actively seek and trade investment securities that they believe will "beat the market."

Portfolio managers of actively-managed mutual funds will have often have the same objective of outperforming a target benchmark. Investors buying these funds will ideally share the same goal of obtaining above-average returns.

But it is a commonly known fact that most actively-managed funds don't beat their benchmark indices over long periods, such as 10 years or more. This largely due to the fact that active investing requires more time, financial resources, and market risk. As a result, expenses tend to pull down returns over time and the added risk increases the odds of losing to the target benchmark. But is there a best time to invest in actively-managed funds? Can they be smart over shorter time frames or used in combination with index funds?

When Actively-Managed Funds Can Beat Index Funds

Although index funds can beat out actively-managed funds over time, there are certain market environments where actively-managed funds hold a significant advantage over their passively-managed counterparts:

  • Bear Markets: When investors are in panic mode and prices for almost every stock in the universe are falling dramatically, broadly diversified index funds, such as those investing in the S&P 500 index, will typically go over the cliff right along with the market. But a skilled manager with an active investing strategy can anticipate major market declines or make adjustments to minimize the worst effects of the bear market. For example, in 2008, in one of the worst bear markets in history, even the best S&P 500 Index funds fell 37%. However, a well-managed large value fund like Vanguard Equity-Income (VEIPX), fell 31%. That's still a negative but not near as bad as the index.
  • Early Bull Markets: Immediately following a major bear market, when stocks are in full recovery mode, actively-managed funds that invest in growth stocks can recover even faster, which means bigger returns than the major market indices. For example, in 2009, when stocks were beginning to bounce back from bear market lows, a large-cap growth fund, Fidelity Growth Company (FDGRX) jumped 41%, whereas the S&P 500 climbed 26%.

With all that said, it is difficult to know the right timing to buy actively-managed funds. And since poor timing decisions can be damaging to portfolio returns, most investors are wise to take more of a passive approach with their investing.

A smart compromise can be to combine the elements of passive investing with active investing with a core and satellite portfolio structure. As the name implies, the portfolio consists of a "core," such as a large-cap stock index mutual fund, which represents the largest portion of the portfolio, and other types of funds—the "satellite" funds—each consisting of smaller portions of the portfolio to create the whole. The satellites can include actively managed funds from diverse categories.

The bottom line is that investors should be careful timing the market and building a portfolio with a combination of passive and active funds can be a smart idea.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.