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Actively managed mutual funds have certainly taken their lumps over the years, often getting knocked for excessive fees and middling results. Everyone from academics to investment professionals to the average person on the street has weighed in on active funds' shortcomings. And now, apparently, even famous cartoonists are getting in on the action.
Made for comedy
In a recent article in The Wall Street Journal, Dilbert comic strip author Scott Adams shared his distaste for actively managed mutual funds, and revealed that he prefers low-cost exchange-traded funds for his own portfolio. Adams has skewered the investment industry before in the pages of his comic strip, with his Dogbert character claiming that mutual funds are for investors who aren't bright enough to know about alternatives like index funds. Ouch!
As a longtime fan of the Dilbert comics, I can certainly chuckle at the "Dilbertian" approach to investing. I think Adams' wariness about active funds is certainly warranted. But while index funds and exchange-traded funds can have a place in any investor's portfolio, do actively managed funds deserve the silent treatment? How would Dilbert the investor fare in real life?
Keeping it simple
According to Adams, roughly 25% of his portfolio is housed in two broad-market exchange-traded funds: the SPDR S&P 500 (NYSE: SPY ) and iShares Emerging Markets ETF (NYSE: EEM ) , which account for the bulk of his stock exposure. I think those are great fund choices. It's hard to go wrong with low-cost, well-diversified ETFs. However, there are actually two similar funds that I think could serve Adams and other investors better, although by just a small margin.
For broad domestic market coverage, Vanguard Total Stock Market ETF (NYSE: VTI ) is a tad bit cheaper than the SPDR and offers wider exposure, including mid-cap and large-cap stocks outside of the S&P 500 Index. Likewise, Vanguard Emerging Markets Stock ETF (NYSE: VWO ) comes with a 0.27% price tag, compared to 0.72% for the iShares ETF. Over time, those cost differentials can really add up.
While these ETFs form a good backbone for a portfolio, investors need a few more pieces of the puzzle. It's not clear what other ETFs or stocks Adams may own, but if you're thinking of employing the "Dilbert" approach in your own portfolio, I'd recommend at the very least filling in a few more holes with other cheap ETFs. First, I'd throw in some exposure to developed foreign economies with a solid, low-cost fund like iShares MSCI EAFE Index (NYSE: EFA ) .
Likewise, investors should have an allocation to small-cap stocks that are left out of indices like the S&P 500 SPDR and don't get a lot of stage time in market capitalization-weighted funds like the Vanguard Total Stock Market ETF. To get access to the red-hot growth power of small-cap stocks, I'd recommend picking up the iShares Russell 2000 Index (NYSE: IWM ) or the Vanguard Small-Cap ETF (NYSE: VB ) . With these additions, the stock portion of any investor's portfolio should have the basic bases covered. Just don't forget about the bond side of your portfolio. Every investor, even the youngest and most risk-tolerant, should have at least a minimal allocation to bonds to dampen volatility.
Didn't you get the memo?
Lastly, while I agree that the vast majority of actively managed mutual funds simply aren't worth investors' time, the truth is that there are a small number of funds that consistently beat the market and actually earn their management fees. The trick lies in finding these funds. One active fund that I think more than earns its stripes is Fairholme (FAIRX), managed by guru Bruce Berkowitz.
Thanks to Berkowitz's stock-picking prowess, the fund currently ranks ahead of 99% of its large-blend peers over the most recent 10-year, five-year, three-year, and year-to-date time periods. That's not to say it will always look this good in the rankings, but it's hard to argue that Berkowitz hasn't added value above and beyond what a simple index fund or exchange-traded fund could offer.
Berkowitz avoided the worst of the fallout from the financial crisis in the fall of 2008, thanks to his skepticism on stocks like AIG (NYSE: AIG ) and Lehman Brothers. His stock calls and his timing over the years have been right on more often than not. There are other talented managers like Berkowitz out there, although at times it can be hard to distinguish them from the flash-in-the-pan types that so many people have gotten burned with.
So while I don't think that I would follow a pure "Dilbertian" investment strategy in my own portfolio, I think Scott Adams and his comic creations have some important points to make about real-world investing practices. Low-cost ETFs are a winning strategy for most investors, as long as you get adequate market exposure. While most active funds aren't worth the paper their prospectuses are printed on, don't discount the rare few that do consistently make money for their fundholders. I'm no pointy-haired boss, but that sounds like an initiative most investors could get behind.