Should you invest in ETF?
Wealth management is a complex process of defining the client’s needs and designing a portfolio that is rightly exposed to meet the client’s requirements over a very long time. Most may confuse the definitive of wealth management and wrongly consider wealth management as stock selection. The latter has a scope too narrow and can be dangerous.
There is a huge ecosystem of professionals support the wealth management industry. Wealth managers are a critical person in the process. They determine the investment objectives and finalize the weighting targets for the individual portfolio’s targets. This process of finding the right instrument is carefully led by the pre-determined investor’s IPS — investment policy statement.
Determining the IPS is the first and most important step. A good IPS will mitigate the risk of the portfolio. Imagine the IPS as the parameter of your house. You draw clear parameters to ensure your family members do not cross over the line and be exposed to danger. A fund manager may have multiple interesting investment opportunities, some of them may possess unique risks that cannot be easily diversified in the context of your portfolio. A group of random collections, all promising high returns spell danger and volatility.
Investors have unique characteristics and different IPS. A retirement fund may have a time horizon of 20 years and prefer income to capital gains. A growth portfolio may have a longer time horizon of 50 years to fund the young executive’s savings. The growth portfolio will require a mix of high risk products. The same investment prospect cannot be equally considered for two different portfolios.
Given the complexity, the first goal of the investor is to select a highly skilled and persistent wealth manager. This is not a straight forward task. More than 80% of managers do not beat the market. An investor that prefers the cheapest investment strategy that outperforms most fund managers will be automatically attracted to the index fund investing. Index funds replicate the performance of benchmarks and do not make an attempt to outperform. Given the non-discretionary decision to replicate the market, professionals label this strategy as passive management. The benefits of passive are clear. Firstly, this strategy is simple and does not require complex selection of managers and determining of IPS. Secondly, the simplicity implies cheap fees since managers are not paid exorbitant incentives to outperform he market.
Investors need to make an informed choice between two options.
1. Adopt a more active process to select managers and to determine the investor policy statement and
2. Invest in a non-discretionary equity index fund.