I have been pretty successful in picking mutual funds. Most of the funds I have owned over 25 years have outperformed their corresponding indices. I am fortunate to have owned some of the best performing mutual funds during their heyday, including Janus Twenty and T. Rowe Price Capital Appreciation. I have also picked a couple of dogs, but they have been the exceptions.
This is the second in a series of five posts on mutual funds.
Disclaimer: I’m not an investment professional nor am I licensed to sell securities. This information is provided for entertainment purposes. Before investing, you should seek the advice of an investment professional. I’m not affiliated with nor do I receive compensation from mutual fund companies.
Proven Track Record
I only pick mutual funds from well established fund companies, with a solid track record of high performance. I never pick the hot new funds that burst on to the scene. I only invest with funds that have been around for at least ten years, with the same fund manager. I want to make sure the fund manager has experience in up and down markets. I don’t want someone learning on the job, with my money.
In my experience, if a fund company has good fund managers and a sound investment strategy, they are most likely to produce winning funds in the future. Past performance is not a guarantee of future results. However, experience and discipline are valuable commodities on Wall Street.
Who is more likely to win the next World Series, the Cubs or the Yankees?
If I don’t believe a mutual fund will outperform its corresponding market index for the next 10 years, I’m not going to invest in it. Since 80% of funds under-perform their market indexes, we can eliminate those right away and concentrate on the funds with superior performance. For a fund to outperform its index it must have a great fund manager and it usually has low fees. Funds with high fees eventually wind up in the under-perform category.
First, I look for funds that have a 10 year return in the double digits. This has become a lot harder to find since the market crash, so you may have to settle for around 8%. If you find high 10 year performance in a fund, check the 1, 3 and 5 year categories to make sure the gains didn’t happen in a short period. Because of the crash, you will see some ugly 3 year performances, but that’s OK. You are looking for consistent performance, not high volatility.
History has a way of repeating itself, as do good fund managers.
Why You Need a High Return
There are two reasons why you need a high return on your investments.
1) Taxes reduce your return, while inflation erodes your principal.
2) With compounding, a few percentage points make a huge difference.
In the example below, I calculated what would happen to $10,000 placed in a retirement account, for someone aged 18. I used 4% for the true rate of inflation and 0% for taxes, since retirement accounts are deferred. $10,000 would be worth just under $1,300 after 50 years of inflation. If placed into a CD or Money Market yielding 3%, it would be worth just over $6,000. If placed in corporate bonds yielding 6%, it would more than double to just under $27,000. If placed in mutual funds averaging 8% and 10%, it would be worth just over $71,000 and $184,000, respectively.
A 2% higher return can almost triple the size of your retirement nest egg.
Saving vs. Investing
Wednesday, I was talking to my daughter’s boyfriend, who just turned 18. He told me he wanted to start saving some money and he asked me where he should put it. First, I told him about mutual funds, instead of going with a savings account. Then, I explained the Rule of 72s, the rate of inflation and compounding. He was quickly lost. When I told him he could earn a lot more money by investing instead of saving, he started to understand.
Savings accounts have their place. They are great for money you may need quickly, such as an emergency fund. They are great for overdraft protection. And, they are great if you will need the money within a short period of time, such as saving for a car. But, they are horrible as a long-term investment.
If a bank pays you less than inflation, you are guaranteed to lose money.
The Bottom Line
The bottom line is that Return is everything when it comes to investing. If you let someone else borrow or manage your money, they will become wealthy, instead of you. If you spend the time to find good investments, you will reap the reward, instead of your bank or broker.
“The four most dangerous words in investing are This Time It’s Different.”
Sir John Templeton – Mutual Fund Pioneer