Best Buys Now

Perhaps you've heard that roughly three-quarters of all mutual funds lose to the market over the long run. The question is why -- why do presumably smart and talented managers serve you worse than simply buying an index fund? Believe me, I've met plenty of fund managers, and the vast majority of these folks are talented and responsible and hard-working -- they're not bad stock pickers.

The best explanation I've found comes from a recent study by professors Cohen, Polk, and Silli. Their study, "Best Ideas," provides pretty convincing evidence that the rules are stacked against smart fund managers. Their few very best ideas do perform well -- beating the market and their other picks by approximately 1% to 4% per quarter (which is significant). However, the very nature of a mutual fund requires managers to pick dozens -- perhaps hundreds -- of stocks.

Who can pick 100 good stocks? No one, really ... and having to load up a fund's portfolio with a bunch of second-tier ideas seriously harms returns.

But what if ..
The knowledge that fund managers' best ideas tend to outperform might be profitable for us individual investors if we knew with certainty which stocks they most loved. One proxy for determining a fund's favorite ideas might be to look at its largest holdings. Take, for example, the famous Fidelity Magellan fund, headed up by Harry Lange:

Fidelity Magellan Top 10 Holdings

% Net Assets

Corning (NYSE: GLW  )




Applied Materials (Nasdaq: AMAT  )




Newmont Mining (NYSE: NEM  )


Goldman Sachs (NYSE: GS  )


General Electric (NYSE: GE  )


MedcoHealth Solutions


Apple (Nasdaq: AAPL  )


Bank of America (NYSE: BAC  )


Data from Morningstar; holdings as of May 31, 2009.

But is Corning really Lange's very best stock idea right now? We can't really know unless we bug his meeting rooms. Maybe it is, or maybe Corning just grew to be Magellan's largest holding. Perhaps Lange has another great idea now, and he's just starting to accumulate shares -- and selling off Corning to do so. There's lag time in reporting fund holdings, and who knows which company is on top now? You undoubtedly see the problem here: We don't want to commit our hard-earned money to a guessing game.

So now you know the big reason for mutual fund mediocrity, and there's just no getting around it.

Unless ...
There's something of a silver lining in this study, however. If you're an experienced and competent investor, you can take comfort in knowing that you're not bound by the mutual fund rules. You don't have to buy dozens and dozens of companies; you can limit your investments to your very best ideas.

Our internal research at Motley Fool Stock Advisor backs up the conclusion of the "Best Ideas" study. Even better, however, you don't have to guess what its best ideas really are. Fool co-founders David and Tom Gardner have been offering up their five "Best Buys Now" every month since June 2006. Our internal tracking shows that these ideas, like the fund managers' best ideas, significantly outperformed the other stocks on our scorecard -- by a margin of 7 percentage points per pick. (The service as a whole is beating the S&P 500 by an average of 42 percentage points each.)

Interested in the five best ideas from Tom and David right now? For the next 30 days you can see them, along with all their recommendations, with a no-obligation free trial. Here's more information.

Rex Moore drives on a parkway and parks on a driveway. He owns no companies mentioned in this article. Apple, MedcoHealth Solutions, and Staples are Motley Fool Stock Advisor recommendations. Nokia is a Motley Fool Inside Value pick. The Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (101)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 17, 2009, at 8:43 PM, Philip6378 wrote:

    The China encourage people in the small & Mid towns to buy LCD TV and Large Home appliance. And government will send rebate for those things. Recent news that South Korea announced new LCD factory for gen 8.5. Hope that GLW will benefit from those demand from it.

  • Report this Comment On July 19, 2009, at 3:04 AM, automaticaev wrote:

    I dont care if they made a magic wand i will not pay 150 for gold sac.

  • Report this Comment On July 19, 2009, at 1:37 PM, plange01 wrote:

    15 months of recession and now close to 7 more in a depression.REAL unemployment is near 20%.1,500,000 forclosures so far this year.rising energy prices,inflation and bankruptcys,these are the facts and there is one more its going to get a lot worse over the next few years.....

  • Report this Comment On July 25, 2009, at 10:25 AM, utahgolf wrote:

    As a new subscriber to MF Pro (also have Income and Adviser), I feel like I am on a fast train to improving my investing knowlege. I am enjoying watching the stratigies and hedging devises the 'pro' uses and implementing them for myself.

    Since selling my broadcast company some years back, I have had mostly bad advise and made bad decisions with the 'stock' portion of my portfolio. I feel that the 'pro' is helping me to assume a more organized and methodical strategy. Thankyou and I look forward to full participation.

  • Report this Comment On August 30, 2009, at 9:41 AM, Riot5000 wrote:

    GLW has been a Darling for Motley Fool for years.

    Check out the performance over time.

    They still would not let it rest.


  • Report this Comment On September 05, 2009, at 4:59 PM, dividendgrowth wrote:

    Fidelity Magellan has been a perma loser for over a decade.

    You should sell what it buys.

    If you want winners, buy what Fidelity Contrafund, Growth Fund of America, and Janus Twenty are buying.

  • Report this Comment On October 04, 2009, at 8:13 AM, Chinastocks55 wrote:

    ACLO.OB: ACL Semiconductor Inc.

    Main distributer for flash memory in South China and Hong Kong.

    I put up a few links here.

    Basically, it comes down to this.

    ACL Semiconductor has 2500+ employees and is the main supplier of flash memory chips and other related chips to Samsung, one of the biggest electronics makers in the world.

    ACLO.OB is distributing memory chips for Apple IPhone and other devices to operate on the new 3G ( full mobile internet) networks.

    Right now the demand for memory chips is huge. Prices are up 33% in July and August and margins, which were very thin, look to be expanding nicely.

    How can it get better for ACLO.OB?........ A main memory chip rival did not survive the recent down turn and went out of business.

    So, putting this all together its not hard to see why ACLO.OB is being scooped up right now.

    Here are some good DD links.

    ACLO.OB has been inching up for weeks as investors move in.

    Imho, It makes perfect sense for this one to head much higher.

    NOTE: I follow China closely and had never heard of this company until a few weeks ago. Based on the stock price its clear I wasnt

    China Unicom 3G launch. They have approx. more customers then every phone company in the USA has put together

    From the recent earnings report concerning their rival, Qimonda AG, going out of business:

    "After the insolvency of Qimonda AG, the Company has recorded increasing demand for Graphic RAM products due to limited supplies. The Company also recorded increasing demand for consumer electronics products in the PRC market such products require the usage of FLASH products. In addition to strong demand in Southern China, demand by Apple for FLASH products for its newly launched iPhone 3G S was also strong."

    Link to Samsung and Apple article:

    Apple to launch in China Oct. 1, 2009:

  • Report this Comment On January 15, 2010, at 3:07 PM, Fool wrote:

    all predictions should be made "ceteris paribus" or everything else remaining the same. Of course, they never do which makes it impossible to do really accurate economic forecasting. But why not? So here is my forecast. Ceteris paribus, we are in for a long stagnation similar to the Great Depression for many of the same reasons. This prediction is guaranteed in the sense that if it's wrong you can return it and get another prediction.

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