In the early days of investing, if someone wanted to make an equity investment, they purchased individual shares of stock, and achieved diversification by purchasing shares of a number of different stocks. Similarly, if an investor wanted exposure to debt, they purchased individual bonds, and achieved diversification through purchasing bonds of various companies, with varying maturities.
If an investor had a lot of money, a well-diversified portfolio could be created with individual stocks and bonds, but investors who either had less to invest initially, or who made small contributions to their portfolios over a long period of time, found investment with individual stocks and bonds to be an inefficient way to creating wealth.
1. Mutual Funds
The mutual fund industry emerged as a way for the average investor to purchase stocks and bonds more efficiently and to be able to achieve broad diversification with smaller amounts of money. As the mutual fund industry matured, investors could invest through index funds, which invested in various indexes which were not actively managed, and thus had low expenses, or actively managed funds, which allowed investors to benefit from the expertise of successful money managers. Since these funds are actively managed they generally have higher internal expenses than index funds.
2. Exchange Traded Funds
In recent years, ETFs (Exchange Traded Funds) have become very popular, and allow investment in various indexes throughout the world. ETFs trade like stocks, but offer the diversification of a mutual fund. They are generally inexpensive to trade, and are well suited to more active trading strategies,such as the risk-based strategies we employ.
Most of our clients have both mutual funds and ETFs in their portfolios. This allows for the diversification and active management by some of the best investment managers in our industry, while providing the flexibility and ability to respond quickly to changing market environments.