Portfolio Management December 8, 2016

    Do you know what types of investments are in your IRA or 401(k)? You might have set up your retirement account some time ago, and don’t exactly remember what your choices were. Or maybe you're just getting started, and you’re anxious to pick the best options.

    Either way, there are some compelling reasons to learn more about index funds and how to access them within your portfolio.

    What is an index mutual fund?

    Mutual funds generally fall into two categories.

    • Actively managed mutual funds employ a portfolio manager (or a team of managers) who select and monitor the investments in the fund based on analytical research, market forecasts and personal judgement.
    • By contrast, index mutual funds track or mirror the performance of the broad market—or various market segments, e.g. large U.S. companies, tech companies, small international companies and so on.

    Index mutual funds, typically called index funds, are often referred to as "passive" or "passively managed" because the manager's security selections are guided by the holdings of the relevant index. When you buy an S&P 500® index fund, for example, it seeks to mirror the holdings of that broad market index, which is made up of big U.S. companies.

    Why would you want to invest in index funds?

    You've heard a lot about index mutual funds, but why would you want a fund that isn't actively managed by a financial professional? First, index funds are generally less expensive to own compared to active funds. Mutual funds come with an underlying cost, called an expense ratio. In 2015, the average annual expense ratio of actively managed equity funds was about 0.84%, according to the Investment Company Institute, compared to an average cost of 0.11% for index funds. Keeping investment costs low over time can keep more of your money invested.

    Second, research shows that few active managers are able to consistently outperform their benchmarks. So when you purchase an index fund, you're paying less—typically for better long-term results. For example, according to S&P Dow Jones Indices, approximately 85% of U.S. large-cap managers underperformed the S&P 500 Index over both the one-year and 10-year periods ending in June 30, 2016.

    Percentage of active funds underperforming benchmark

    What are ETFs?

    An exchange-traded fund (ETF) is like a variation on the traditional index mutual fund. While it's true that some ETFs are actively managed, the majority are structured as passive funds. They differ from traditional index funds in a few ways, most notably that you can trade ETFs, like stocks, throughout the day. Traditional index funds only trade once a day, after the market closes.

    ETFs are also known for being inexpensive, and in many cases their underlying costs are even lower than traditional index funds.

    For most investors, index funds and ETFs are two affordable and convenient ways to build a diversified portfolio. But with thousands to choose from, it can be hard to know which ones will best suit your goals.

    How Schwab Intelligent Portfolios™ Can Help

    With a minimum investment of just $5,000, Schwab Intelligent Portfolios will recommend an ETF-based portfolio, hand-picked by a team of professionals to include up to 20 different asset classes, based on your personal objectives, timeline and risk tolerance. Contact a Schwab investment professional at 855-694-5208 or reach out through live chat to learn more.

    Investing involves risk including loss of principal.

    (1116-PHBY )


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