Most of my retirement savings are tied up in my 401(k) plan, which from the beginning I've invested in a S&P 500 Index fund and Raytheon stock. I don't (currently) have much choice is the Raytheon investment, but my plan offers many options besides the index fund. I didn't spend much time looking at other options, mostly because I didn't know how to evaluate them. Who cares if a fund beat the market last year -- I want to know if it will beat the market for the next 30 years.
Last spring, the Motley Fool hired Shannon Zimmerman from Morningstar to cover Mutual funds. I've read the Fool as far back as when my family used AOL in the early 90s, and this was the first time I'd considered the idea that actively-managed mutual funds could consistently out-perform the market as a whole. Based on his first few months of articles, I came up with a screen to find the best candidates my 401(k) plan offered.
Stock Investments
At some point I should diversify to bonds for a percentage of my portfolio, but I'm young, interest rates are still going up, and stocks should continue to outperform bonds over the long-haul. I may need to re-evaluate this criteria in time.
Expense Ratio <= 1.00%
I wish I could get a fund that charged less than 0.5%, but actively managed funds don't usually come that cheap. Expenses for investors are like friction to bicyclists -- a drag. You can bet that Lance Armstrong has the smoothest ride possible because a poorly lubricated part could shave seconds off his time. We could trade bikes and he would still beat me, but he'd probably be dead last if he used my bike in the Tour de France. So the lower fee, the better, when it comes to mutual funds.
Equity Turnover Ratio <= 50%
Besides being another form of drag (trading expenses are reflected in the NAV, not the expense ratio), excessive trading is a sign of a manager who is chasing performance rather than evaluating companies from the bottom up. I'm looking for a manager who knows how to pick stocks that will beat the market over the long-term, not managers who get lucky trading over the short-term. 50% churn translates to an average holding period of 2 years.
Manager Tenure >= 10 years
I'm going to compare 10 year annualized returns, so it makes sense that I compare funds that have been under the same management for that period. The actual experience of a particular manager might be a lot more than his tenure on a particular fund, so if I were interested in a particular manager I wouldn't care too much if he were with a fund for only a short time. But so far I don't know any managers who fit that description.Here is the result of that screen (as of today):
Non-Load Adjusted Returns Investment Name 1 Yr 3 Yr 5 Yr 10 Yr LOF --------------- ------ ------ ------ ------ ------ Fidelity Equity-Income Fund 11.98% 6.52% 2.69% 10.72% 13.03% T. Rowe Price Small Cap Stock SHS 15.17% 11.76% 11.80% 13.13% 13.57% Vanguard PRIMECAP Fund Admiral Class 14.53% -- -- -- 7.39% S&P 500 INDEX FUND 13.77% 4.16% -1.15% 11.12% 13.07% Vanguard PRIMECAP Fund 17.86% 7.07% 3.38% 15.48% --
Historical returns
I had to add the S&P 500 Index fund, since the screen didn't know the expense ratio (something less than 0.1%), turnover (about 2%) or management tenure (effectively forever). I also added the Vanguard PRIMECAP fund information from Morningstar, since the "Admiral Class" doesn't have a very long history. (I think the difference is in fee structure or something.) The Life Of Fund (LOF) number is fairly meaningless since a fund started in 1982 will look better than one started in 1999.The T. Rowe Price fund seemed the best investment last spring because it beat the market in good times and bad, and I didn't have any exposure to small companies. In general, carefully picked small companies should do better than larger companies because there is more room to grow. People didn't become millionaires by investing in Microsoft in 1999, but in 1989 when it was relatively small and unknown.
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