We could be accused of having a beef with the mutual fund industry. And we wouldn’t deny that charge. Mutual funds are everywhere and the industry that creates and distributes them has grown large – so large in fact, that many investors have no idea that there are drawbacks to owning funds, or even that they have a choice.

Without question, there is another option: custom portfolios. In contrast to mutual funds, custom portfolios are designed with the individual investor’s needs as the primary goal. In some ways, it’s like having your own mutual fund, so to speak, built and professionally managed for your objectives. Think about this analogy: mutual funds are to custom portfolios what unaltered, off the rack clothes are to custom tailored suits.

As a way to illustrate the differences and benefits of structured portfolios, Peloton compiled 4 key things you can’t do with a mutual fund (and absolutely can with a custom portfolio):

  1. Speak to the manager. Unless you have an extremely large investment in a fund, its decision makers won’t give you the time of day. One of the layers of brokers and customer service reps may answer your questions sufficiently, but if not, there’s not much you can do. In contrast, many firms managing custom portfolios provide you opportunities to speak with your money manager.
  2. Manage capital gains and losses effectively. Mutual funds are required to distribute net, realized investment gains – at least annually. Because the manager is serving taxable and tax-exempt investors in one fund, everyone in the fund will receive the same gains distributions. If you own a fund in your IRA, gains distributions are not nearly the problem that they would be for someone who’s invested taxable money in a fund. On the other hand, custom portfolios can manage gains very precisely, even to the point of timing gains and losses, to suit your unique tax planning needs.
  3. Structure cash flows. As investors move from saving for retirement and growing their investments to taking distributions from their portfolios, portfolio structure becomes as important as return. Peloton prioritizes sources of withdrawals to ensure that the portfolio cash flow capacity and growth capacity are intact: current cash on hand is taken first, followed by bond interest & dividend income, bond principal, and finally stock principal. Mutual funds may need to sell bonds at inopportune times, simply because other investors are demanding their money. Likewise, selling stocks to meet expenses at the wrong time (say, March of 2009) could have a disastrous impact on your portfolio’s long-term health.
  4. Adhere to a strategic asset allocation. We believe the single factor driving the level of portfolio growth and stability is asset allocation: the mix between stocks and bonds. Peloton manages asset allocations for each investor, adhering to that client’s unique investment strategy. Reviewing your fund’s composition at Morningstar.com may reveal that the portfolio manager has decided his “all equity fund” would be better off with 20% (or more) in cash. Setting aside our bias against market timing, carrying a large amount of cash at the wrong time may not match your needs at all.

Mutual funds are inescapable, as many 401(k) and 529 plans offer only a list of funds from which to choose. Funds were originally created for investors with small amounts of money to band together in order to hire professional management, and that need makes mutual funds a reasonable alternative for some investors today. But in many other cases, a custom portfolio offers a more strategic and tailored solution. Contact Peloton to learn more.