your 401(k) #10: actively managed funds


En Español

Looking at your retirement account investment options…

“Small Cap Value Fund…. Large Cap Growth Fund…. 500 Index Fund…

WTF are those?! Isn't there just a “stock fund” option?”

We already know that mutual funds differ based on which asset class they invest in. But they're also grouped by how your money is managed, and which kinds of stocks they invest in.

When it comes to how your money is managed, there are two types of mutual funds:

  1. Actively managed funds
    • These are run by a “pilot” - professional stock pickers who play an active role in selecting the fund’s investments.
  2. Passively managed funds
    • These are also known as index funds and are kind of on autopilot. The managers don't handpick stocks. Instead, they simply invest in the stocks tracked by an index.

In this post, we’ll focus on actively managed funds because they’re the most common and least understood.

Actively managed funds are run by professional stock pickers. The managers rely on research and analysis to pick certain stocks that they think will do well and make money for their investors. The fund managers’ goal is to outperform, or generate a higher return, than its benchmark. A fund’s benchmark is typically an index that closely matches a fund's investment style.

Which stocks a fund invests in depends on its objective aka strategy. If you look at the fund options in the Summary Plan Description of your retirement account, you’ll see that each fund has its own unique objective. The fund’s objective dictates two important factors (among other things):

  1. The size of companies that the fund will invest in
  2. The valuation range


company size (market cap)

We already covered sizes in video #9 of THE BASICS unit. Here's a quick recap:

  • Small Caps: Valued between $300mm and $2bn
    • The term “small” is a bit misleading. Many small cap companies are actually very large corporations!
    • Examples include WebMD, Shake Shack, and Burlington Coat Factory 
  • Mid Caps: Valued between $2bn and $10bn
    • Examples include Foot Locker, Tupperware Brands, and Buffalo Wild Wings
  • Large Caps: Valued between $10bn and $100bn
    • Examples include UPS, Starbucks, Netflix, and Costco

A company’s size says a lot about where it falls on the risk-reward spectrum; typically, a company’s size is inversely related (opposite) to its risk/reward potential.

  • For example, small cap stocks are considered higher risk because they are often younger, less established companies. But with that risk comes higher potential reward. A small company can grow into a large one with an awesome product and execution.
  • Large cap stocks, on the other hand, are already big so they tend to grow more slowly. They're also considered lower risk because they're typically older, more established companies.That's not to say they're without risk, though.  
As we learned with Enron and some big banks in 2008, the bigger they are, the harder they fall.



As for valuation, companies and their stocks are ranked in a range from value to growth.

  • Growth Stocks
    • Belong to companies that are growing faster than their peers and that are investing a lot of money in growth projects.
    • These companies are thought to have substantial growth potential for the foreseeable future.
    • Growth stocks trade at higher valuations because investors bake the company’s future profit potential into the company’s current stock price.
      • Remember, if you own stock in a company, you own a sliver of its assets and future profits. If you think a company will make a lot more money in the future, you may be willing to pay a higher price to own its stock today to ensure you’ll get to benefit from that growth.
  • Value Stocks
    • Belong to companies that have fallen out of favor for some reason.
    • Some of those reasons could be:
      • Disappointing financial results due
      • A new competitor entering the space or losing market share to a competitor
      • Poor management
      • Bad use of money and talent
      • Dying or irrelevant business model
      • Temporary manufacturing problems
      • Being unheard of or flying under the radar
      • Less glamorous/sexy business (not one of the hot, up and coming businesses people are talking about
      • Bad news (product recalls, faulty equipment, lawsuits, departure of executives)
      • Complexity. Perhaps the company has multiple business lines and analysts don’t know how to value them all together. Or maybe one business line is dragging down the rest of the good businesses.
    • Because of these issues, value stocks trade at lower valuations than growth stocks.
      • Sometimes this means the stock is “on sale” or “discounted”, but in some cases, it may spell trouble.
      • Just because a value stock is trading at a depressed price does not mean that it will ever go back up to its “fair” price.
  • Blend Stocks
    • And in between value and growth stocks are blend stocks, which exhibit a mix of value and growth characteristics.


style box

Luckily, all of these factors are neatly and conveniently organized in a handy-dandy graphic called a style box. This box was popularized by the research company Morningstar, and it makes navigating the confusing mutual fund waters so much simpler.

Screen Shot 2016-08-12 at 1.01.33 AM.png

As you can see, the size of companies increases from bottom to top, and valuation increases from left to right. That gives us a total of nine styles of domestic (US-based) equity mutual funds:

  1. Small Cap Value
  2. Small Cap Blend
  3. Small Cap Growth
  4. Mid Cap Value
  5. Mid Cap Blend
  6. Mid Cap Growth
  7. Large Cap Value
  8. Large Cap Blend
  9. Large Cap Growth

An actively managed mutual fund’s goal is to outperform its area of the market. Their success is measured by comparing the fund’s return to its benchmark, which is typically a specific stock market index.

  • For example, large cap funds typically compare their performance to the S&P 500, while small cap funds compare their returns to the Russell 2000.

When deciding which fund(s) to invest in, it’s important to compare a fund to its benchmark.

  • If a fund consistently outperforms (generates a higher return than) its benchmark, you may be able to make more money investing in that fund rather than in the index itself.
  • If a fund consistently underperforms (generates a lower return than) its benchmark, you may want to consider another fund or the index itself.


pros & cons

There are some pros and cons to investing in actively managed funds. We’ll start with the cons because a) there are more of them and b) they’re talked about a lot in the money-sphere these days.


  • More expensive
    • Active funds charge you higher fees because you're paying for experts to actively manage your money.
    • That higher fee eats into your investment earnings every year.
  • Underperformance
    • Studies show that those higher fees aren't always worth it. Most actively managed funds do not outperform their benchmarks over time.
  • Less tax efficient
    • Because actively managed funds have a "pilot" behind the wheel, the stocks in the fund's portfolio can change as fast as the manager can trade them.
    • If a stock is held for less than a year, any profit made on it is considered a short term gain and taxed at the fund's regular income tax rate. Active managers tend to buy and sell stocks more frequently, which means a higher tax bill.
    • Profits made on stocks held for longer than a year are considered long term gains and taxed at the lower capital gains rate. 


  • Control and Flexibility
    • Actively managed funds can be a better bet when the market is stale or going down.
    • Because they've got professional stock pickers at the helm, they have more flexibility and can choose which companies to invest in at certain times.
    • For example, if the stock market is falling, the managers can rotate the fund’s portfolio from riskier stocks to safer assets.

funds you may see in your account

***Note: I have no relationship with the following companies. The names below are meant to be for educational purposes only, and they should not be considered advice nor a recommendation to buy/sell investments.

If you look at your retirement account’s investment options, you’ll probably see funds with names like these:

  • Small Cap Value Funds
    • Fidelity Small Cap Value Fund
    • Northern Small Cap Value Fund
  • Small Cap Growth Funds
    • T. Rowe Price New Horizons
    • Vanguard Explorer
    • Small Cap Gr Eq Fund
  • Mid Cap Value Funds
    • T. Rowe Price Mid Cap Value
    • Fidelity Low-Priced Stock Fund
    • Vanguard Selected Value
    • Fidelity Value
    • Vanguard Mid-Cap Value
  • Mid Cap Growth 
    • T. Rowe Price Mid Cap Growth
    • Prudential Mid Cap Growth
  • Large Cap Value Funds 
    • MFS® Value Fund
    • American Funds American Mutual Fund
    • T. Rowe Price Value Fund
    • TIAA-CREF Large Cap Value
    • Vanguard Windsor II
  • Large Cap Blend Funds
    • American Funds Fundamental Invs,
    • JPMorgan US Equity
  • Large Growth Funds 
    • Vanguard Large-Cap Equity
    • Fidelity Large Cap Growth
    • Vanguard US Growth
    • TIAA-CREF Lg Cp Gr
    • T. Rowe Price Blue Chip Growth
    • Fidelity Contrafund

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