When you sign up with Guideline, we recommend a managed investment portfolio based on your age, time horizon, and risk tolerance. (The term portfolio used here refers to any collections of financial assets and/or securities e.g. stocks, bonds, or cash). A typical managed 401(k) portfolio (including what you will see at Guideline) usually consists of diversified mutual funds.
What’s a mutual fund?
Mutual funds are a type of investment that pools money together from a bunch of different people. This money is then used to buy a collection of diversified, professionally managed portfolios that include different types of securities, like equities or bonds, that everyone is invested in together - hence, the word ‘mutual’. These portfolios would normally be inaccessible to most people, as their commissions and fees would be too prohibitive on an individual basis. When grouped together, however, they become much more cost effective.
Who manages a mutual fund?
Typically, mutual funds are managed by investment companies (e.g. The Vanguard Group). They can also be managed by financial professionals, hedge funds, banks, and other financial institutions.
Why mutual funds?
Mutual funds are a popular choice among investors because they generally have the following features:
- Professional Management: When you select a mutual fund, you’re also selecting a professional to manage your money. Rather than researching every investment before you buy or sell, you can leave it to the professionals to handle it for you
- Asset diversification: Usually, mutual funds invest in a wide range of different companies and industries. This helps reduce your risk if a particular company or industry declines or crashes because you’re not keeping all your eggs in one basket
- Affordability: Most mutual funds have a relatively low dollar amount for the initial purchase of shares and subsequent purchases. They also allow you to invest without making individual purchases and trades, so you’ll be spending less
- Liquidity: Mutual fund investors can sell their shares at any time with relative ease (for the current market value plus any redemption fees)
How do mutual fund expenses work?
Mutual funds can be managed either actively or passively.
Actively-managed funds may adjust their portfolio composition often, based on research on both current market conditions and individual company performance. They may also compare their own performance against a specific index as a benchmark to beat.
In comparison, passively-managed funds usually mirror the securities that compose a market index, like the S&P 500. Since these funds require less management, they usually come at a lower cost than their active counterparts, while giving the investor broad exposure to a specific market.
Because actively-managed funds involve a fair amount of work by the fund managers, their expense ratios tend to be higher than those of passively-managed funds.
What kinds of funds does Guideline use?
Because they provide the lowest cost possible to our portfolio and have a better track record compared to the majority of actively-managed funds over time, Guideline uses passively managed funds to emphasize the importance of asset allocation as the most important factor in driving portfolio return. You can learn more about our managed investment portfolios here.