Final answer:
Your friend is indicating that the Prudent Mutual Fund has a lower Beta, meaning it offers more protection against market downturns compared to an ETF that mimics the market portfolio. A lower Beta suggests the fund is less volatile, providing more stability during market swings. Diversification within these funds can further help mitigate individual stock risks.
Step-by-step explanation:
When your friend mentions that the Prudent Mutual Fund gives you more downside protection compared to an exchange traded fund (ETF) that mimics the market portfolio, they are implying that the fund has a lower Beta. The Beta of a fund is a measure of its volatility, or systematic risk, in comparison to the market as a whole. A lower Beta means the fund is less volatile and should decline less in value when the market falls, hence providing more downside protection. However, it is also likely to rise less when the market goes up. In contrast, an ETF that traces the market portfolio typically has a Beta close to 1, indicating that its volatility matches that of the market.
Diversification, another valuable aspect of mutual funds, can help offset some of the risks associated with individual stock volatility. Despite this, even a diversified portfolio, like those that mimic broad stock market indices, can undergo significant fluctuations. For instance, in 2008, average U.S. stock funds declined by 38%, substantially impacting investors' wealth, particularly those nearing retirement who relied on these funds for retirement income.