Index Funds Aren't Always the Best Choice

NEW YORK (TheStreet) - Investors have been pouring into index funds since actively managed portfolios lagged benchmarks in 2008.

Of the $7.4 trillion in long-term funds, 20% is in passive portfolios. That's up from 11% in 2000, according to Morningstar(MORN).

Should you index all your assets? Probably not. While index funds can be sound choices, they are not always the best options. In some instances, active funds can provide lower risk and bigger returns.

Consider the Vanguard 500 Index Fund(VFINX), the oldest S&P 500 fund, which has declined 0.6% annually during the past 10 years and lagged 56% of large blend funds. Investors would have been better off owning the Franklin Rising Dividend Fund(FRDPX), an active large blend fund that returned 6.5% annually during the decade.

Franklin follows a cautious approach, buying blue chips that have increased their dividends in at least eight of the past 10 years. Holdings include steady performers such as Wal-Mart Stores(WMT) and spice maker McCormick(MKC).

Proponents of index funds may argue that there is no way to know whether the Franklin portfolio will continue outdoing the benchmark. That's fair enough. But the Franklin fund does offer lower risk based on its standard deviation, the amount an investment bounces.

Franklin Rising Dividend consistently reports low standard deviation and outdoes the S&P 500 during downturns. Is Franklin likely to be less risky in the next decade? Yes. Many studies have shown that funds with low standard deviations in the past tend to maintain it in the future.