Index Fund
An index fund is a mutual fund whose portfolio seeks to replicate the performance of some financial benchmark either by owning a representative sample of the stocks contained in that benchmark or by owning all of them. An index is passively managed which means, unlike actively managed funds, there is no manager taking an active roll in making buy and sell decisions for the portfolio.
Instead, stocks are generally bought and sold only when new money comes into the fund, when the underlying index needs to be rebalanced or when stocks are deleted from the index.
Index funds have a number of significant advantages over their actively managed counterparts:
- LOW MANAGEMENT FEES: Since few portfolio adjustments need to be made, management fees are minimal.
- LOW TRADING COSTS: Since index funds practice a buy and hold strategy, shareholders are not burdened with excessive trading costs.
- LOW CAPITAL GAIN DISTRIBUTIONS: Lack of active trading translates into significantly fewer capital gain distributions.
- FULLY INVESTED POSTURE: Since index funds are fully invested at all times, they are able to capture the full measure of the index’s return.
Asset Allocation
Asset allocation is the process of developing a diversified investment portfolio by combining different asset classes in varying proportions. Asset classes are groupings of assets with similar characteristics and properties. Examples are: U.S. large company stocks, Corporate bonds, International small company stocks and Treasury Bills.
Every asset class has characteristics distinct from one another, and consequently, may perform differently in response to market changes. Therefore, careful consideration should be given to determine which asset classes you should hold and the amount you should allocate to each asset. Factors that greatly influence the asset allocation decision are: your financial needs and goals, the length of your investment horizon and your attitude toward risk.
Modern Portfolio Theory
Modern Portfolio Theory is founded on the idea that for every level of risk there is an optimum portfolio strategy that results in the maximum return for that level of risk. To achieve this optimum risk/return portfolio, one must diversify across asset classes and within sub-asset classes. By following this exercise in diversification, Modern Portfolio Theory holds that you can not only reduce the risk in a portfolio, but also increase the return of the portfolio.
At Plancorp, our mission is to help investors determine their tolerance for risk, then attempt to construct for them a portfolio that lies along our best estimate of the Efficient Frontier, the theoretical curve connecting those portfolios that optimize their return at the level of risk they have determined to be most suitable for them.
Standard Deviation
Standard deviation is a measurement of the fluctuation of returns around the arithmetic average return of the investment. The higher the standard deviation, the greater the variability (and thus the risk) of the investment returns.
