With the US equity market testing bear market levels and global markets experiencing their worst first half in decades, it’s a good time even for index-based investors to take a closer look at their portfolios.
Five time-tested tips to consider can apply just as well to so-called “passive” portfolios that run on indexes as they would to more active investment strategies:
- Keep it Simple. Some index-based portfolios resemble the kitchen junk drawer, with overlapping stocks and unintended doubling of certain market exposures. Review your index investments to confirm no gaps or overlaps. Morningstar’s US equity indexes, for example, correspond to individual segments of the Morningstar Style Box, so investors combining large-, mid- and small-caps can get non-overlapping market exposure.
- Stay Consistent. Take a closer look at your index methodology – it’s like a roadmap to your portfolio and should be publicly available. An index methodology is set in stone and only changes for extenuating circumstances. And even when those changes do occur, they need to follow the rules as outlined in the methodology.
- Watch Your Costs. Index-based investing is traditionally less expensive than active management, but it isn’t free. Review your index-based investment fees to understand how much you are paying and compare them to other similar products. Costs can make a big difference over the long-run and are one of the few things we can control.
- Know What’s in Your Index. There is no excuse for index-based investors not to know exactly what they own. Index methodologies are public and index holdings are updated and shared on a regular basis. And, importantly, even if two indexes claim to provide exposure to the same asset class, their holdings may differ due to different methodologies.
- Stay Diversified. Of course, you might not want to hear this when nearly every asset class is down in 2022, but diversification is still considered a tried-and-true long-term investment approach. For indexers, this can be achieved through index building blocks.
Alex Bryan, US Equity Product Manager, Morningstar Indexes
“Indexes are an incredible tool for investors, but like any investment strategy a thoughtful approach to index-based investing is prudent in the long term. And challenging market conditions such as we’ve experienced so far in 2022 provide a good reason for index-based investors to take a closer look at what’s underneath the hood of their portfolios.”
Matt Camuso, ETF Strategist, BNY Mellon Investment Management:
“Index based ETFs can be efficient tools for investors to gain diversified exposure on a certain asset class in a timely manner.”
These tips are expanded on in the recent paper - Improving investor outcomes with index-based investing. If you would like a copy of the paper or to speak with Alex Bryan, please reach out to Tim Benedict at firstname.lastname@example.org or (203) 339-1912.