Retirement Risks Faced by Index Funds' Successful Run

Investors are accustomed to investing large sums of money in index funds and watching their returns rise. Do they, however, remain the greatest options for retirement?

Fund managers typically struggle to outperform market indices over the long term, which is a well-known fact.

The third-worst year ever for active managers, according to S&P Dow Jones Indices' most recent biannual SPIVA (S&P Indices vs. Active) US Scorecard for 2021.

While both active and passive equity funds produced positive absolute returns, only 80% of domestic equity funds and 85% of active large-cap funds outperformed the S&P 500. Small-cap and mid-cap funds performed even worse. Active funds suffered net withdrawals, while passive funds received positive net assets.

Nevertheless, some market segments have historically favoured more active management. At the end of March, active funds in the alternative and nontraditional stocks sectors exhibited net inflows, according to Morningstar Direct. Bank loans and intermediate core bonds also did so.

Therefore, how should retirees or those getting ready for retirement consider active vs. passive index funds?

According to Jerry Wagner, founder and president of Flexible Plan Investments, "active investment gets a bad rap in that the comparisons are typically made by people who are supporters of passive investing and don't actually think about the realities of the investor situation." "And retirement is one where active investing is really essential."

He pointed out "In essence, we're all engaged investors. since everyone makes purchases and sales. Rarely does someone simply purchase something, store it in a safe deposit box or a certificate, and leave it there forever. Therefore, at some point, we all start investing actively. The issue is how active it is and whether it is a systematic, numerical process."

Wagner thinks that since it's so hard to forecast when to switch, active investing should always be a part of someone's portfolio. And for retirees in particular, achieving one's objective depends on risk management and limiting losses.

"The amount of money you then have to live on is substantially diminished if you take a hit early in your retirement," he said. "However, if you include a risk-management element where you're restricting losses in the portfolio, you have the opportunity to be responsive to the market and to respond as the market suggests, and so you may lower your overall losses."

Diversification on its alone is insufficient, according to Wagner. It is beneficial during brief and shallow market corrections, or what Wagner refers to as "baby bears" (corrections of 0% to 20%). "Most retirees have diversified portfolios that can manage that. The issue arises when you experience the "grizzly bear," or the bear that manifests during a 30 to 70 percent decline.

All asset classes are connected during these downturns, which are prone to lasting longer. So, in a grizzly bear market, diversification is no longer a safety net. We develop risk management and active management specifically for the grizzly bear.

We develop risk management and active management specifically for the grizzly bear.

Because, he emphasised, "That's when the grizzly bear punishes you, early on," if it strikes you in retirement. Therefore, it's crucial to make an effort to maintain capital throughout retirement.

Some of the top mutual funds and ETFs are treading water with the S&P 500 down over 10% this year and the tech-heavy Nasdaq composite down 18%. However, despite generally modest inflows, index funds still racked up assets in the first quarter of $15.3 billion, while active funds lost $6 billion.

According to a Morningstar Direct analysis, market weakness probably encouraged some investors to invest heavily in certain index funds. Alternative investments, for example, served as portfolio diversifiers while markets fell. The third quarter saw an increase in assets for alternative funds of 9.3%. According to Morningstar, that is their biggest growth since 2011 and the third-highest of any category group.