Index Funds or Managed Mutual Funds?

Question:

I have a question regarding index funds and managed mutual funds. I have always invested in index funds. I have a Roth IRA in Vanguard 500 index. I was wondering what opinion do any of you have of index vs. mamaged mutual funds. I heard to always invest in index funds because of the low expenses, but I know that some managed mutual funds beat the index funds. What would be some good no load manged funds to invest in that would beat the indexes. I looked at Dodge and Cox, but there funds are closed to new investors. Does anyone know of any good ones out there with low expenses and that charge no loads. Thanks

One advisor's response:

I think that as long as you follow your investments and review on at least an annual basis (preferably more), then you'll do better in managed funds. Index funds are great for the investor who doesn't have time to research funds and evaluate the best managed funds.

My Response:

I'll put what the previous poster said in a different way:

Most people cause problems with their investment accounts by trying to time the market and/or squeeze that extra point of yield by changing allocation. The real winners in investing have 1) discipline to continue adding to their accounts over time; 2) a diversified allocation plan geared to their risk tolerance; 3) a strategy to adjust and rebalance that allocation plan over the arc of their life cycle; and 4) the understanding that Rome wasn't built in a day, and that patience is one of their primary tools that they must apply.

Regarding the development of a diversified allocation plan, the simpler the better, in my opinion. Notice that I said "development of a diversified allocation plan", not "choosing which funds to invest in". Boring old index funds and ETFs are just fine, but some folks prefer managed funds. Go for it, if you wish, but remember that the items I listed above are every bit as important as fund choices, if not more so.

Why NOT max out 401(k)?

Question:

I don't understand why I wouldn't max my pre-tax contribution to my employers 401(k) and put any other funds into Roth IRA (if I can afford anymore). Right now I am contributing 6%, employer matches first 3% (cheap @#$). My wife's is about the same. I have around $42k and she has $39k. (32 and 31 years old).I put about $300 a month into our Roths ($150 each). Wouldn't I be better off just bumping up the % and then any bonus money into a Roth? The only complaint I have about my 401k is that the choices are limited (I work for a bank so I'm stuck with our funds). My wife (who works for a different bank) as some great choices. Maybe I just don't understand the tax consequences. Roth taxed on contributions now but gains are not taxed later. 401k, not taxed now but EVERYTHING is taxed later. Is this accurate? Please advise.Thank you.

My Response:

The non-taxation of the growth in the Roth account is probably the greatest benefit. A secondary benefit of the Roth account is that these accounts do not have Required Minimum Distributions at age 70 1/2 as do trad IRA and qualified plans (such as a 401(k)). The third benefit is flexibility, where a Roth account would allow you to access your contributions at any time, for any reason, with no penalty or tax. Not so with the other accounts.Lastly (for this post), as you stated above, many times your choices in a 401(k) plan are limited. A Roth IRA account doesn't have these limitations.

Something different

Taking a little bit different tack, I'm going to post some responses to questions that I've given on the few bulletin boards that I regularly visit. We'll get back to the overall Financial Planning process eventually....

Question:
I read a snapshot in another financial magazine about a single woman who makes good money (around $100k). Who was maxing out her 401(k) ($14k this year). She did have some cc debt around $16k, IIRC, some student loans, etc. Nothing overly major that caused strain on her budget. The magazine or planner that they had review her situation suggested that she cut back on her 401(K) contributions to pay more towards her debt. My question is why cut back on the 401(K) if you can comfortably fund it and pay for your debts? You can't go back in time to place money in the 401(k) for tax deferral and compounded savings. I believe it would be better to maintain the maxed out 401(k), cut back on spending and apply that towards the cc debt. It might take a bit longer to pay it off but the 401(k) would continue to grow.

My Response:
The planner was probably working from the assumption that expenses are fixed. You're right, cutting expenses would be the first place to look for funds to pay down debt. Reduction of the debt needs to take a high priority, and it's a matter of opinion as to whether or not that priority outweighs current contributions to 401(k).



That's it for now... more to come.

jb