Active v index investments: Why both are important for clients and the market

Appearing on The ifa Show, Stellar Wealth founder and financial adviser Nicole Gardner explained that many investors and advisers can be drawn to index fund over active investments due to the idea that it is low cost and delivers guaranteed results, including herself in the past; however she now believes that doing so is harmful for both investors and the market.

Explaining this, Gardner said index funds create a “self-fulfilling loop” because generally, they prioritise more successful stocks, such as Microsoft or Apple, and thus if people are only investing in these same stocks via an indexed fund then they will, of course, continue to get bigger.

Although this may be good for those top companies, it does make it challenging for others to compete, as well as creating a top-heavy market, much like we have seen with the Magnificent 7.

“I just question if just investing in the index is the right thing to do, and I don’t necessarily think it is,” Gardner said.

While the point of investing at its most basic is to make money, Gardner argued that only investing in index funds encourages investors to buy stocks in companies without really considering whether they are actually a solid investment.

“You need active investors doing the research and setting rational prices on companies and their value, not letting these bubbles form because ‘Oh, it’s in the index so it must be good’ and just blindly investing without actually considering the value of that company,” she said.

After what has been a somewhat rocky time for markets, Gardner noted that active investing also means that advisers can more easily respond if and when something happens within markets while index funds can be valuable for long-term goals, both of which are crucial to the overall investment strategy.

“I think there is some value to the efficiency of the index, but I think it’s important to not be locked into one or the other. I think there’s pros and cons for each style – index and active,” she said.

“It does give us the ability to rebalance in a way that is intelligent, that makes sense, that is still within the plan.”

The ability to be flexible has proved particularly valuable in recent months after US President Donald Trump’s so-called “Liberation Day” in April saw global markets rocked and left a number of clients feeling uneasy about the US market.

“I have had a lot of clients question how much we want to be invested in the US over the coming years, and so when you have an active or a hybrid approach, you have the ability to make little tweaks and make adjustments if it’s appropriate to the overall strategy,” Gardner said.

“That hybrid strategy does give us the ability to pull some levers if we think it’s appropriate.”

Even so, Gardner was adamant that even with the power to make changes, it is important that advisers and clients alike aren’t overreacting when market swings do occur, with advisers playing a crucial role in keeping the long-term front of mind.

“We plan for these kinds of things. All my clients, whether they’re young or retired, we’ve got more than enough cash, emergency funds, reserves, all those sorts of things in place,” she said.

“We’re always investing from a long-term view. We don’t need to change our strategy really. Just minor, minor tweaks is not a change to the overall strategy.”

To hear more from Nicole Gardner, tune in here.