Okay, play before work: when theOtherGuy and I were designing the new site last Friday, it was a total nightmare. I wanted to get the Blog Post of the Week! up before midnight (so that Andrea from SoOverDebt.com could get both of our reader’s attention). Running out of time, I just grabbed a pic of my blog-writing friend Cooper. My cat.
Yesterday, my friend Doug—who has a lifetime of tech work behind him–was commenting on the new site layout:
(finally) Doug: …and one more thing, get rid of the cat picture.
me: Ha!
Doug: I know you think I’m joking. I’m not. It’s a deal breaker. Take down the cat.
me: (suddenly miffed for no reason whatsoever): Ha!
So now, completely out of spite, Cooper’s pic is going to stay on the site for the next seven days. Our Alexa site rank will probably plummet. No advertisers will touch us (nothing new there). But because Doug said “deal breaker”, Cooper gets his seven days of near-fame.
Now, on with the show……
SmartMoney.com yesterday published a list of the top 100 funds of the past 5 years. We’re inundated with these types of lists in January. I had a rare opportunity to read USA Today on my way home from Disney last week, and long-time finance writer John Waggoner penned a piece titled Fund Investors Ran in Place in ‘11. The story discussed what we already know: 2011 was a roller coaster year, with the average stock fund, according to Lipper, losing 2.9 percent. Investors are scrambling to find better results.
That wasn’t shocking.
What I found annoying was the story’s partner: “More on Funds, Quarterly, Yearly Results Tables….”. It was pretty much the same story I saw yesterday at SmartMoney. The obvious (unstated) connection I believe readers will make is that they’ll find better fund by reviewing the best ones from last quarter or last year.
USA Today and SmartMoney wouldn’t run stories featuring the top ten mutual funds (or 100….or whatever) if people didn’t search for this information. I don’t fault them at all. It sells. Turning to the USA Today piece, here’s a listing of the 4th quarter’s best and worst, as well as the 12 months’ best and worst funds. One page over I find the list of the top funds over 5 and 10 years.
Yuck.
Stop reading about the Top Ten Mutual Funds.
In his seminal investing book The Truth About Money 4th Edition’ target=_blank>The Truth About Money, financial advisor Ric Edelman discusses this thirst people have to throw money at last year’s winners. We want to own winning funds. Many of us have heard grandpa tell stories about the legendary returns of Fidelity Magellan back in the day, or of that high-flying Janus Twenty fund in the months leading up to the tech wreck. We want those days back. We’d love nothing more than to be invested with some manager who always makes us money. But as Edelman describes, history works against you if you’re trying to find great results this year by reviewing last year’s winners.
Looking at the top ten mutual funds rarely produces winning result.
WHY SHOULDN’T I INVEST IN LAST YEAR’S WINNERS?
- When everyone clamors to enter a fund, investing millions of new dollars, the fund is doomed to failure. According to this study: Star Power: The Effect of Morningstar Ratings on Mutual Fund Flow, funds with high returns one year and Morningstar rating upgrades nearly immediately experience an unnaturally high gain in assets. These assets must be invested by the manager, who finds it more difficult to spread the investment among quality names. You’ll rarely find a manager can keep up with these huge asset spikes.
- Often, the top ten mutual funds and ETFs are in specific categories which spiked during that calendar year. In 2010, commodity names like silver and cotton performed handsomely. In other years, real estate, large company stocks, or internet stocks have been big winners. If you invested in silver or cotton in January, 2011 based on 2010 results, you stepped in it. To mis-quote Sarah Palin, “how’s that workin’ for ya’ now?”
- You may pay handsomely for a top fund. Funds with high expenses which spike may be especially dangerous. One top fund of 2010, Morgan Stanley Focus Growth B (AMOBX) carries an expense ratio of 1.77 percent. This fund competes against the S&P 500. If you’d purchased iShares S&P 500 index exchange traded fund, your expense would have been 0.09 percent, plus any trading costs. Big difference.
Here are some top funds, ETFs and ETNs listed in “best of” 2010 publications and their 2011 results:
| Fund Name | 2010 Result | 2010 S&P | 2011 Result | 2011 S&P | Who Listed |
| M.S. Focus Growth B AMOBX | 25.87 | 15.06 | -6.43 | 2.11 | The Street |
| Fidelity Growth Co. FDGRX | 20.55 | 0.67 | The Street |
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| Fidelity Contrafund FCNTX | 16.93 | -0.12 | The Street |
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| Proshares Ultra Silver AGQ | 182.44 | -47.47 | USA Today | ||
| iPath DJ-UBS Cotton Index | 96.22 | -22.71 | USA Today |
In November of 2010, TheStreet.com listed the top performing funds competing with the S&P 500 here.
In January 2011, USA Today published a chart of the top performing funds of the year, which included ETFs and ETNs.
HOW SHOULD I PICK FUNDS?
- As writer Steven Covey preaches, begin with your end in mind by laying out achievable goals.
- Determine the return you’ll need to reach your goal.
- Pick a mix of assets which has historically achieved that goal with as little risk as possible, using asset allocation software.
- Choose funds using this primer we unveiled last year (for free!)
- Protect your downside with stop losses (if possible) or a strict loss-management strategy. We’ll address this area in the next few weeks.
(Photo credit: Crosa: Wikimedia Commons)
That’s the thing about bigness. I would think that a large fund would have a hard time investing a few million into high-growth small-caps without causing a pump-and-dump situation.
I wish I could find the study, but it’s been proven. ESPECIALLY in small caps, its easy to beat mutual funds.
I would like to comment about investors being overly concerned about chasing the hottest funds. Why not concentrate your efforts on concenrtated narrow sectors though exchange traded funds. Their are now over fifty single country funds available and maybe over 100 narrow sectors like airlines steel solar so why the concern for the the top ten funds from last year. Each one of these countries and sectors is a index of and by itself. The solar exchange traded fund {TAN} is now down 90% from its high in 2007. If I were an investor or trader. I would simply look for any exchange traded fund or closed end fund that does not use any leverage in their portfolios and start buying after their is a 75% decline from its all time high’ and than buy twice as much if that exchange traded fund or closed end fund declines another five percent an 80% decline from its all time high’ buy twice as much at a 85% decline from its all time high buy twice as much at a 90% decline from its all time high’ and finally buy twice as much at a 95% decline from its all time high. Now I know that some of these funds will not decline 90% from their all time highs maybe not even 80%. Another thing that you might be wondering about I would run out of money If I followed that method right wrong. Example take one hundred thousand dollars. Buy 500 dollars of xyz fund at 25 dollars off 75% from its all time high of 100 dollars. Buy 1000 dollars of xyz at 20 dollars off 80% from its all time high of 100 dollars. Buy 2000 dollars of xyz at 15 dollars off 85% from its all time high of 100 dollars Buy 4000 dollars of xyz at 10 dollars off 90% from its all ltime high and finally Buy 8000 dollars of xyz at 5 dollars off 95% from its all time high for a total of 15500 about 15 percent of total cash assets. I am giving an example here the actual investment amount for an exchange traded fund or closed end fund that you are investing in would be the percentage of cash in the account not the percentage of both equities and cash combined.. The investment percentage for each fund would be based on the cash portion of your total portfolio at any given moment in time simply because the dollar amount of cash in the account would change fairly often, So if you have 40% of your portifolio in cash you would use that as your basis for determining your allocation not the total value of both cash and equities. The idea is to have your biggest positions in the funds that have declined the most and the smallest positions in the funds that have declined the least. Also keep in mind when you buy an exchange traded fund you are buying a basket of stocks so the fund cannot go to zero unlike a stock.Than when any fund has regained three quarters of its value that would be 75 dollars in the case of eyz use a 10% trailing stop loss to protect your gains. Who knows you may sell out of the fund with in 90% of its all time high. And their you have it a simple but brilliant strategy. Also keep in mind that you will have tremendous diversification using this method which would mean you could easily employ some leverage in the form of buying on margin. Even without margin I believe that this could be one of the greastest investment methods of all time you will be almost assured of crushing the performance of the standard and poors five hundred. The.Only thing that could change this outcome would be a great worldwide depression.
To most of this, I would say a simple “amen.”
However, I have one disagreement. Investors often feel like they can tell where the market is headed next. It’s only when you give up this “gimmick” and realize that you have no flippin’ clue that you actually begin to protect your investment appropriately. I never know when an investment will go down more. Just because it’s the lowest ETF of the bunch, doesn’t mean it’s good.
There’s actually a bigger argument here, which is the concept of time vs. goal. However, we’ll leave it at that today.
Thanks for the well-thought comment. Overall, I love the strategy.