As 2022 nears a wrap, a trend is emerging that’s expected to gain traction next year — actively managed investment strategies — along with a custom strategy for people who like the idea of investing in a basket of companies, but want more control of what they invest in .
Assets in direct indexing are expected to climb to $825 billion by 2026, from roughly $462 billion now, according to Cerulli Associates, a global research and consulting firm, based in Boston, Mass. That tops growth forecasts for exchange-traded funds, mutual funds and separately managed accounts.
Here’s what’s behind the developing shift: Many analysts foresee loads of volatility for stocks in 2023, particularly early in the year, and an overall flat return scenario for the entire year, given the combo of still-high inflation, Fed rate hikes, and a potential recession. And some folks want more control.
“It’s part of a much broader trend towards personalized portfolios,” Tom O’Shea, director at Cerulli, told Yahoo Money.
Federal Reserve Board of Governors in Washington, D.C. United States (Getty Creative)
Direct-indexing enters the mainstream
Direct indexing lets investors cherry-pick which stocks to buy in a benchmark index instead of owning a fund that tracks a specific gauge like the S&P 500.
A hands-on approach allows for you to adjust for changing market conditions in a turn-on-the-dime manner, something that is not in the cards for investors in passively managed retirement portfolios that mimic the ups and downs of whichever index is being tracked.
“Direct indexing allows investors to buy the individual stocks in an index directly as opposed to owning a predetermined selection of stocks through a fund,” Marguerita Cheng, a Certified Financial Planner and CEO at Blue Ocean Global Wealth, in Gaithersburg, Md., told Yahoo Money. “Investors can customize their holdings to align with their risk tolerance and investment preferences.”
“But there are some cons,” Cheng added. “Direct indexing, for example, can be more expensive than passive investing and may cause clients to lose focus of their long-term financial goals and encourage more frequent trading.”
(Photo credit: Getty Creative)
Plain vanilla index funds vs DIY
Investing in Steady Eddie index funds — balanced across stocks, such as the S&P 500 index, and fixed-income bond funds put on auto-pilot for months on end — has been standard advice for many individuals, particularly those socking away retirement funds.
The overarching idea is that it’s simpler and less expensive to buy an entire index that is computer-generated than it is to try to select individual stocks to buy and sell. And, generally speaking, you have a better chance of shaking off the slumps in the stock market if you simply stay the course. Moreover, trying to find the perfect time to invest is tricky and almost always a huge mistake.
For scores of retirement savers, however, that passive strategy has been hard to stomach this year as markets have been pummelled. With inflation not yet under control and the overall stock market still teetering–the S&P 500 index has fallen around 19% so far this year, it’s hard to fight back the urge to step in and tweak your accounts, especially if you’re nearing retirement.
“Firms that cater to do-it-yourself investors like Schwab, Vanguard, and Fidelity are rolling out these personalized products and what we’re seeing is there’s a lot of investors who like to own individual securities for a variety of reasons,” O’Shea said.
“The tax benefits are one reason these have appeal,” he said. “They’re not necessarily buying into a mutual fund that has embedded capital gains, for example. They’ll be able to customize their portfolio according to their taxes. And then other characteristics that they might find important. It could be risk, maybe a low volatility portfolio. It could also be ESG, which is increasingly becoming important, particularly to young people.”
A custom solution
This year, Fidelity, for example, launched customized index funds for do-it-yourself brokerage customers. To create a custom index, you pick a group of stocks that you want to invest in based on whatever theme you choose — say, clean energy stocks — then determine the percentage weighting of each investment and invest all those stocks in a single basket.
After a free trial, the service costs $4.99 per month. The custom baskets can be used in non-retirement brokerage accounts, including Health Savings Accounts (HSAs) as well as Traditional IRAs, Roth IRAs, and rollover IRAs. You can invest in up to 50 stocks and create as many baskets as you want.
New York Stock Exchange, Wall Street, Manhattan, New York, USA (Photo credit: Getty Creative)
“We knew investors wanted more than just basket trading; they want a simplified way to monitor and trade their customized portfolios with just one click, and trade securities using Fidelity’s real-time fractional shares engine,” Josh Krugman, senior vice president of brokerage at Fidelity, told Yahoo Money. “This new ability to invest in and customize portfolios built from Fidelity’s thematic models puts direct indexing capabilities into the hands of DIY retail investors.”
Yet, recent Cerulli surveys show that only 14% of financial advisors are aware of, and recommend, direct indexing solutions to clients. For now, these hands-on offerings are still a small slice of the overall mutual fund sandbox.
“For tax-deferred or tax-free retirement accounts, more control over taxes may not be as compelling as rebalancing can occur without incurring tax consequences,” Cheng said. “For taxable accounts, flexibility and control with regards to taxes and security selection can be beneficial depending on the client’s personal and financial circumstances.”
The case for a blended strategy
Passive investing, however, isn’t fading away, by any measure.
In 2021, passively managed index funds for the first time accounted for a greater share of the U.S. stock market than actively managed funds’ ownership, according to the Investment Company Institute’s 2022 Factbook. Passive funds accounted for 16% of the U.S. stock market at the end of 2021, compared with 14% held by active funds. A decade ago, active funds held 20% and passive ones, 8%.
“I don’t buy this idea of the end of passive investing for a minute,” Daniel Wiener, chairman of Adviser Investments, in Newton, Mass., told Yahoo Money. “I have not heard or read of a single person of any substance saying that the end of passive investing is nigh.”
Importantly, fees are low for pre-set index baskets of stocks and bonds.
In 2021, the average expense ratio of actively managed equity mutual funds was 0.68%, compared with average index equity mutual fund expense ratio of 0.06%, according to a report by the Investment Company Institute. Active management ETFs have an average expense ratio of 0.69%.
The passive approach of set and forget makes perfect sense, particularly if you’re investing for the long haul and aren’t hardwired to be a stock jockey. The batting averages also support passive investing.
Over the past 15 years, more than 70% of actively managed funds failed to outperform their comparison index in 38 of 39 categories, according to the S&P Dow Jones Indices (SPIVA) mid-year 2022 survey on the performance of active mutual fund managers.
Moreover, the S&P 500 has increased on average by 29% in the three years following a 20% plus decline dating back to 1950, according to data analysis by Truist chief market strategist Keith Lerner.
“It doesn’t hold water – if expectations are that returns will be lower in the years ahead then both passive and active funds with low expense ratios should be the preferred investment vehicles,” Wiener said. “So, T. Rowe Price, Vanguard, and Fidelity funds with low operating expenses, as well as low expense ratio ETFs, will remain the preferred investments.”
Kerry is a Senior Reporter and Columnist at Yahoo Money. Follow her on Twitter @kerryhannon
TORONTO – Canada’s main stock index was higher in late-morning trading, helped by strength in energy stocks, while U.S. stock markets also moved up.
The S&P/TSX composite index was up 34.91 points at 23,736.98.
In New York, the Dow Jones industrial average was up 178.05 points at 41,800.13. The S&P 500 index was up 28.38 points at 5,661.47, while the Nasdaq composite was up 133.17 points at 17,725.30.
The Canadian dollar traded for 73.56 cents US compared with 73.57 cents US on Monday.
The November crude oil contract was up 68 cents at US$69.70 per barrel and the October natural gas contract was up three cents at US$2.40 per mmBTU.
The December gold contract was down US$7.80 at US$2,601.10 an ounce and the December copper contract was up a penny at US$4.28 a pound.
This report by The Canadian Press was first published Sept. 17, 2024.
TORONTO – Strength in the base metal and technology sectors helped Canada’s main stock index gain almost 100 points on Friday, while U.S. stock markets climbed to their best week of the year.
“It’s been almost a complete opposite or retracement of what we saw last week,” said Philip Petursson, chief investment strategist at IG Wealth Management.
In New York, the Dow Jones industrial average was up 297.01 points at 41,393.78. The S&P 500 index was up 30.26 points at 5,626.02, while the Nasdaq composite was up 114.30 points at 17,683.98.
The S&P/TSX composite index closed up 93.51 points at 23,568.65.
While last week saw a “healthy” pullback on weaker economic data, this week investors appeared to be buying the dip and hoping the central bank “comes to the rescue,” said Petursson.
Next week, the U.S. Federal Reserve is widely expected to cut its key interest rate for the first time in several years after it significantly hiked it to fight inflation.
But the magnitude of that first cut has been the subject of debate, and the market appears split on whether the cut will be a quarter of a percentage point or a larger half-point reduction.
Petursson thinks it’s clear the smaller cut is coming. Economic data recently hasn’t been great, but it hasn’t been that bad either, he said — and inflation may have come down significantly, but it’s not defeated just yet.
“I think they’re going to be very steady,” he said, with one small cut at each of their three decisions scheduled for the rest of 2024, and more into 2025.
“I don’t think there’s a sense of urgency on the part of the Fed that they have to do something immediately.
A larger cut could also send the wrong message to the markets, added Petursson: that the Fed made a mistake in waiting this long to cut, or that it’s seeing concerning signs in the economy.
It would also be “counter to what they’ve signaled,” he said.
More important than the cut — other than the new tone it sets — will be what Fed chair Jerome Powell has to say, according to Petursson.
“That’s going to be more important than the size of the cut itself,” he said.
In Canada, where the central bank has already cut three times, Petursson expects two more before the year is through.
“Here, the labour situation is worse than what we see in the United States,” he said.
The Canadian dollar traded for 73.61 cents US compared with 73.58 cents US on Thursday.
The October crude oil contract was down 32 cents at US$68.65 per barrel and the October natural gas contract was down five cents at US$2.31 per mmBTU.
The December gold contract was up US$30.10 at US$2,610.70 an ounce and the December copper contract was up four cents US$4.24 a pound.
— With files from The Associated Press
This report by The Canadian Press was first published Sept. 13, 2024.
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
