Author Topic: How to Tell Which Mutual Funds to Own  (Read 4573 times)

britri3650

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How to Tell Which Mutual Funds to Own
« on: November 02, 2013, 12:31:59 PM »
I'm trying to educate myself in asset allocation with respect to retirement investing. I have about 14-16 yrs. til retirement but really haven't figured out what's the most important factors to consider when choosing a mutual fund. I know Bogleheads invest in index funds. But what about funds such as Fidelity Contrafund. It's ten yr. return basically equals the S&P but it's expense ratio is higher than an S&P index fund. But Morningstar rates the Contrafund at five stars. I don't get it. If a fund's performance over a given timeframe exceeds the S&P index, accounting for fees and expenses, isn't that fund a good investment over an index fund?

GreenGuava

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Re: How to Tell Which Mutual Funds to Own
« Reply #1 on: November 02, 2013, 12:49:04 PM »
If a fund's performance over a given timeframe exceeds the S&P index, accounting for fees and expenses, isn't that fund a good investment over an index fund?

First, the S&P 500 is an outdated index.  Look at total market for your domestic stock.

Second, yes, if it beats the relevant index going forward, it'd be worth it.  But past performance isn't a good indicator of future results, and not only do very few active funds beat the index at all, but very few of those repeat such a feat.

Next to past performance, Morningstar ratings aren't a good predictor.  Their own study demonstrated this, and it isn't surprising why:  they're based on past performance.

Honest Abe

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Re: How to Tell Which Mutual Funds to Own
« Reply #2 on: November 02, 2013, 06:27:12 PM »
I don't know how Morningstar rates funds and I don't care. Bottom line is: what is the expense ratio and what index/market am I trying to buy into?

Will

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Re: How to Tell Which Mutual Funds to Own
« Reply #3 on: November 02, 2013, 10:39:16 PM »
I like watching NASCAR.  I have a favorite driver.  He wins some, but obviously loses most of the races he is in.  There are some good teams with good drivers, and there are some not-so-good teams with less-than-average drivers.  Any driver theoretically could win any race, and there are some drivers who manage to win a couple in a row (maybe 3 if they are really lucky).  But one thing I would never ever do is always bet on my favorite driver or always choose the driver who won last  the last race. 

I think the same holds true for investing.  If you choose the "hot" fund, or the fund that has done well for the last few years, what is to say they are going to continue to do so?  They might not ever do well again; you just never know.

To me, using my NASCAR example, index fund investing is like getting a chance to bet on all the drivers at the same time.  Maybe one index fund would be all the Chevys in the field.  Maybe another is all the American manufacturers.  Or all the foreign-born drivers.  Who knows?

With indexing you can get virtually every stock sold in the world, and every bond.  It doesn't get a whole lot simpler than choosing Vanguard because they are so low cost, and then going with Total Stock, Total International Stock (yeah, yeah, I know: they have a Total World now) and Total Bond. 

Frankies Girl

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Re: How to Tell Which Mutual Funds to Own
« Reply #4 on: November 02, 2013, 11:20:19 PM »
I actually own some Contrafund - it's a small amount left over in my 401K that I haven't gotten around to selling off yet.

I am ambivalent about selling it off just now since it has been performing well, and even with the higher than index fund operating costs, is pulling in a better overall return. But I hold onto it with the understanding that it would be better to just dump it and move the funds over to the index funds, as I'll have to keep a closer eye on it than the index funds to see the tipping point of "doing well" and "not so much."

Simpler is better, and I'm probably going to get over the nostalgia of holding that fund from my early days pretty soon.

alanwbaker

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Re: How to Tell Which Mutual Funds to Own
« Reply #5 on: November 18, 2013, 10:42:11 PM »
The single best predictor of a fund's returns to the investor is its expense ratio.  In the long run the funds with the lowest management expenses win.  It may be counterintuitive, but the math supports it.

bUU

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Re: How to Tell Which Mutual Funds to Own
« Reply #6 on: November 28, 2013, 04:10:35 AM »
I'm trying to educate myself in asset allocation with respect to retirement investing. I have about 14-16 yrs. til retirement but really haven't figured out what's the most important factors to consider when choosing a mutual fund. I know Bogleheads invest in index funds. But what about funds such as Fidelity Contrafund. It's ten yr. return basically equals the S&P but it's expense ratio is higher than an S&P index fund. But Morningstar rates the Contrafund at five stars. I don't get it. If a fund's performance over a given timeframe exceeds the S&P index, accounting for fees and expenses, isn't that fund a good investment over an index fund?
Generally not. If you look at all large-cap domestic equity funds (because that's 87% of what you're talking about when you talk about the Contrafund), including those that no longer exist because they did so poorly, and either were terminated or buried inside some other fund, the index funds do better. The fact that we're talking about the Contrafund now means that its advantage is baked into its value already. A few years ago we were talking about Puritan, or BRK, or whatever. The point is that looking back you can always find funds that did better than the index, but over time generally funds falter or simply cannot maintain their advantage. In many cases, it is because a fund's success makes it too big to apply its strategy effectively.

So, in a nutshell, you could get lucky: Contrafund may actually return more than its benchmark index over the fifteen years until you retire plus the fifteen to thirty years it'll take for you to drain its assets (many people forget about the fact that they're going to be heavily invested for at least the first half to two-thirds of their retirement, to fund that last third of retirement). Alternatively, it may have had its day and the index fund will start beating it soon, simply because whatever advantage the Contrafund could have stemming from the work of its professional analysts will be eaten away by its higher fees.

However, I'm not convinced that that logic applies reliably beyond the definitively efficient markets, such as large-cap domestic equities. I think small-cap is pretty efficient as well. I'm not so convinced that international equities is. And I don't think you can ensure you're going to get the best returns from your international allocation by investing in international index funds. I think, at least for now, professionals have something to offer in that regard. And I'm also convinced that the bonds market is so screwed up right now that I don't want to be in a bonds index fund either.

Full disclosure: I have about 50% of my large-cap domestic equities position in index funds, almost 30% in "other Vanguard funds" (such as Wellington). Another 10+% comes from one managed fund that I'm invested in heavily, for its expertise in finding value in Asia and Europe (but the fund still holds a good amount in domestic equities as well). And the remaining 10% are in legacy holdings for which I haven't found a good time (tax-wise) to liquidate and roll into something "better". By comparison only 10% of my international equities position is in index funds.


chasesfish

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Re: How to Tell Which Mutual Funds to Own
« Reply #7 on: November 29, 2013, 04:48:54 AM »
The challenge with any actively managed mutual fund is only a very small percentage of them beat their index or benchmark every year.  There are some pretty obvious reasons for this:

Something requires these mutual funds to own at lest 25 different securities, which makes them just a slightly managed index

The fees the investment managers earn are always a drag on earnings.

The good manages need to be relatively small so they can buy good size positions on companies without driving up the price.


I've been very fortunate, I've had access to a really good investment manager in my 401k who's beat the market by a percent or two.  Unfortunately past performance doesn't guarantee future results and the fund is trending towards the S&P now because of how large the fund is getting.

I also buy Vanguard Wellington, 0.27% expense ratio for an actively managed balanced fund.