Smart Beta

A fish who knows their life is a pointless circling of a small tank.

Fund investing traditionally breaks into two camps: index investing and active investing.

Index investing involves putting money into a fund tied to a particular index, like the S&P 500. You are never going to outperform the market (or the particular sector you've invested in). However, you aren't going to get killed by management fees, and you're not in danger of underperforming either.

With active investing, an actual person picks stocks for the fund. Their goal is to outperform the general market. They pick stocks that will be winners and stay away from ones that will be losers. Theoretically, that sounds amazing...except that fund managers pick wrong all the time. Plus, even when they're right, some of the added gains get eaten up by fees.

Smart beta investing splits the difference between these two large categories of funds. It isn't a "dumb" index investment, which just tracks an index. The smart beta strategy seeks to outperform the market by weighting some stocks more heavily than others and staying away from clear losers.

However, these funds aren't actively managed either. The smart beta funds start with a particular index, but reweight it based on pre-set factors. Basically, a ranking system is set up, a set of criteria created, to judge stocks automatically. The funds aren't actively managed in the sense that a team of people are poring over spreadsheets and making decisions. Instead, decisions are made at the outset, and a computer does the rest. As a day-to-day endeavor, people aren't involved.

The structure of the smart beta funds keeps expenses low, closer to the rate of index funds. However, you get some potential for outperformance compared to the overall market.