Portfolio managers should help their clients quantify their risk tolerances and return needs within the bounds of the client’s liquidity, income, time horizon, legal, and regulatory constraints.

An index fund is designed to duplicate the composition of a specific index series or market segment. There is a strong argument suggesting that portfolio managers cannot beat the market after fees, therefore an index fund should be used to try to match the market.

LOS c, (Part 3): Explain the rationale for investing in index funds.

Which of the following statements regarding index funds is least accurate?

A) One disadvantage of index funds is that they do not provide access to international securities.

B) One advantage of index funds is that they allow for diversification that is typically not available to the average individual investor due to a lack of resources.

C) One might conclude from the efficient market literature that an investor should mimic the market's performance and minimize costs by buying index funds.

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Inferior stock selection would not be a reason because, in an efficient market, all securities are priced perfectly. Therefore, there are no undervalued or overvalued securities. Since all securities are perfectly priced, the investor should select a strategy that minimizes taxes, transactions costs, and management expenses.

If markets are efficient, prices are correct. Therefore, the best investment strategy is one that chooses a market index and then minimizes investment expenses, such as transaction costs. Markets may still be volatile if important news is arriving to the market, at which time the market will react to the news, perhaps with great volatility until the news is digested.

The minimization of risk is not a rationale for investing in index funds.