I recommend a combination of both index and managed funds to try and maximize returns while reducing the average portfolio expense and its relative volatility. Index funds are inexpensive and can serve as great anchors for a portfolio (e.g. Vanguard S&P 500 Index). This is especially valid if you are just starting out and looking to enter the large cap equity or broad international markets with a small amount of money. Managed funds for mid- and small-cap equities, emerging markets or specialty areas can be used to supplement your portfolio (build around your core portfolio anchors), providing different return (and risk) possibilities. They, in turn, do cost more.

Finding the “best” investment strategy is a little like looking for the Holy Grail. We all know that there is no one strategy that is inherently better than another. However, a mix of strategies that are specific for your circumstances can make a difference in the performance of your portfolio. Index investing, or passive investing, is inexpensive, can provide an easy way to diversify a portfolio and is generally a tax efficient strategy. Mutual fund managers who actively manage a fund argue that by exploiting the inefficiencies of individual stocks they can obtain potentially higher returns than an index but with lower levels of risk, or volatility, for the investor. In the vernacular of the financial industry, we call that “generating alpha,” or in plain English, creating value. Most financial analysts believe that the investment marketplace is reasonably efficient, meaning that most stocks are fairly priced. Jeremy Siegel, one of the true financial gurus of our time, suggests using index mutual or exchange traded funds as the core strategy of building your portfolio, and adding actively managed mutual or exchanged traded funds to provide enhanced returns. Investment strategies should be very personalized and require monitoring and adjusting regularly. Working with a Certified Financial Planner professional you can build a strategy to meet your goals.

Investors face a tough choice when deciding between using index funds and using actively managed funds. Both can help you achieve your goals, deciding which is best for you depends on your desires and understanding the differences. Index funds are popular because the holdings in these funds are closely tied to their respective indices, there is little in the way of buying and selling (called “turnover”) or management involved, resulting in minimal cost to investors. Thus, the expense ratios are low. Index funds also are well-diversified and easy for even a novice investor to purchase. On the down side, because index funds by nature do not correct for market conditions, they passively go in the direction of the market, both up and down. You also will not have the opportunity of out-performing the market. Actively managed funds sell themselves on their ability to “beat the street” with a number of tools: more focused and upto-date research, in-depth knowledge of particular market sectors, constant monitoring of market conditions and the ability to respond quickly to market changes. The manager has a lot more flexibility to take advantage of market opportunities. On the downside, active management comes at a price. Typically, actively managed funds cost in the 1 percent to 3 percent range. As a result, they must not only equal the performance of their fund benchmark, but exceed it by more than their fee in order to actually “beat the street.” Even if you use index funds, you still have a major decision in choosing which indexes you use and how you allocate between them. With this in mind, it is always advisable to sit down with an investment professional to help you make these decisions.

You may be getting lost in the fog of “performance” and “fees.” First, know why you are investing. What are your goals, how long do you have to achieve those goals, what effect will your investment decisions have on your tax situation, etc. Once all of the important issues are outlined, you should then look at all of the tools and strategies available to you and/or your adviser and formulate a portfolio that best suits your goals and objectives. This is not easy, but when done correctly, not only will you be in the best position to increase your wealth, but you will also experience a high level of comfort due to your input and participation in the process.