The Truth About Mutual Funds

I'm no mind reader, but I'll bet you clicked here because you'd rather be a stable boy at the Spastic Colon Elephant Ranch than pick stocks. And you're hoping against hope that mutual funds, some of which you and more than 90 million of your friends already own, will be sufficient in your quest to retire rich. Am I right?

Woo hoo! What's that? Oh, you want an answer? OK, then: No, and yes. Though more than 75% of mutual funds don't beat the market, some are truly great investments. To find the best, Motley Fool Champion Funds advisor Shannon Zimmerman advises following two simple principles:

  1. Stay with tenured, invested managers. Top-flight managers such as Bill Nygren of Oakmark, who's been at the helm for six years, won't deviate from their proven approach to join the flavor-of-the-month club. And they'll invest right alongside you with huge amounts of their own wealth tied up in the fund.
  2. Never, ever overpay. The best managers earn their moola from performance rather than high fees. That's how Will Danoff of the Fidelity Contrafund (FCNTX) does it -- his fund sports no loads and charges just 0.91% annually. Contrafund has gained 10.9% annually over the past 10-year period -- more than three percentage points better than the S&P over the same time frame -- on the back of top holdings such as America Movil (NYSE: AMX  ) , Genentech (NYSE: DNA  ) , and EnCana (NYSE: ECA  ) .

Want to kick my dog, too?
Still, these are the exceptions. Most fund managers will charge you for the right to kick your dog and raid your fridge. (Well, no, they won't do that.) My point is that funds that appear to be perfectly good ideas on the surface still frequently underperform.

Let's take a classic example. Last year at around this time, Shannon named Wells Fargo Advantage International A (SILAX) a "dud of the month" for its 5.75% front-end sales charge and 1.50% annual expense ratio.

What's more, he wrote, the fund almost identically mirrors the MSCI EAFE, which is the equivalent of the S&P 500 benchmark for international stocks. It's as if there's zero value being added. You'd have done better buying and holding some of the fund's international superstars yourself, including China Mobile (NYSE: CHL  ) , UBS (NYSE: UBS  ) , Total SA (NYSE: TOT  ) , and Allianz AG (NYSE: AZ  ) .

Not surprisingly, Wells Fargo Advantage International lost again to the category and the index over the past year. The lesson? If funds are your cup o' joe when it comes to investing, you're better off going light on the Splenda and evaporated milk. Or, in plain English, fewer costly frills tend to equal more market-beating thrills.

Get more for your moola
Of the more than 8,000 unique mutual funds that exist for you to buy today, roughly 75% fail to beat the S&P 500. And most will charge you more (often a lot more) than 1% of your total assets each year for that indignity.

But good funds are out there. Focus your research on low fees (i.e., no loads and an expense ratio that falls well below the category average) and tenured managers who have beaten the market over long periods, you may be able to find a fund that will double your money. And you won't need an elephant-sized shovel to do the necessary digging.

Need ideas for where to begin? Consider Champion Funds. We're offering 30 days of free access to the service. Click here to get started. There's never any obligation to buy.

Fool contributorTim Beyers didn't own shares in any of the companies mentioned in this article at the time of publication. Total SA is an Income Investor pick. The Motley Fool'sdisclosure policyis always championship caliber.


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