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By Shehryar Khan, CFA | 02-09-2018

How did your fund handle this week's volatility?

Wild market swings provide an opportunity to evaluate your fund's downside protection.

Shehryar Khan: On Monday Feb. 5, global markets declined and volatility was at higher levels than has been seen in quite some time. Market declines, while never fun to live through, do offer you a chance to evaluate whether your fund is delivering what you are paying fees for.

One of the biggest arguments active managers make against passive index investing is that when markets correct sharply, investing in an index fund does not allow you to get out of the way of the market decline, and that active managers will protect you on the downside. While you should never judge a fund by one day's performance, over time a fund that says it will protect investors' capital during times of turmoil should actually do so.

There are no free lunches in life, however, and investors should remember that a fund that actually does provides a good level of downside protection will likely struggle to keep up when markets are stronger and valuations get out of whack. And that is okay! Academic research shows that funds that do better in market declines can afford to lag when markets recover, and will outperform over the long term. Their lower volatility will also make for a smoother ride for their fundholders.

The past few years may have been more painful for investors holding more conservative funds, especially seeing high returns dominate the headlines. But in times like this week, that conservatism will pay off. How your portfolio fares during market declines is also a good time to evaluate whether it is positioned appropriately. But remember, before making any changes to their portfolio, investors should always keep their long-term goals and risk tolerance in mind, and if needed seek the help of an advisor who can guide them through times like these.

For Morningstar Investment Management, I'm Shehryar Khan.

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