Inveterate fund geek that I am, I have a strong bias toward the investment option of choice for more than 90 million of us, one that no less an authority than Jack Bogle has called the "finest vehicle for long-term investing ever designed." Among other things, if you're after smart diversification and access to asset classes that might otherwise elude you, mutual funds should be your very first stop.
If, for example, you want to anchor your portfolio with a fund that invests in big boys such as IBM (NYSE: IBM), Cisco, (Nasdaq: CSCO), Coca-Cola (NYSE: KO), and Monsanto (NYSE: MON), and then add a helping of smaller picks such as Avon (NYSE: AVP), Southwestern Energy (NYSE: SWN), and Starbucks (Nasdaq: SBUX), funds make doing so a cinch. Then, once that foundation is laid, you can tread into waters -- such as emerging-market equities and high-yield debt -- that (just making a wild guess here) you're probably a bit less familiar with than stocks.
Put it all together, and what do you have? A well-rounded portfolio that can help you beat the market over time, while keeping a lid on pesky volatility -- provided, of course, that you know how to separate the fund industry's wheat from its plentiful chaff.
Aye, there's the rub
Alas, the vast majority of funds are overpriced laggards, duds that lack proven management teams, long-haul track records of success, and strategies that allow their stock-pickers-in-chief to take advantage of up markets and down. What's more, with more than 8,000 funds to chose from, the odds of throwing a dart and hitting a winner come in two flavors: slim and none.
Good thing we don't believe in dart-throwing. As I started up Ready-Made Millionaire -- the Fool service designed to help you beat the market with funds and stocks, with a set-it-and-forget-it real-money portfolio -- our thesis has been that if you ask and answer a consistent set of questions, you can home in on the industry's best and brightest. In the process, you'll leave your friendly neighborhood stock jock in the dust, crying over his wild stock market ride and outsized brokerage bill.
Free for all
Fund investing is commission-free, if you go directly through the shop that offers the fund. And if you prefer the convenience of keeping all your money under one roof -- and consolidated quarterly statements, too -- not to worry: Most of the major brokerages maintain lists of no-transaction-fee (NTF) funds, which you can snag without paying a commission.
That said, a commission-free dud remains, well, a dud. As you go fund-shopping, then, put these two traits near the top of your list.
1. A manager with a successful track record of at least five years
Lots of otherwise savvy folks get hung up on a fund's past performance, but if a seemingly impressive track record doesn't belong to the manager who's currently calling the shots, that showing -- in the immortal words of Elvis Costello -- means less than zero.
You should focus on the manager's performance, not that of the fund itself. And while there are a handful of exceptions, five years is just about the minimum amount of time a manager needs to weather at least one market cycle -- and to show that he or she has the right stuff.
2. A reasonable expense ratio
Even if you do bypass a brokerage commission, you'll still have to pony up for a fund's expense ratio. All things being equal, the lower it is, the better. But before you assume that you should invest in a low-cost index tracker such as Vanguard 500 Index, remember that with index funds, the most you can realistically expect is to underperform the market each year by about the amount of your annual expenses.
The upshot? While index funds certainly have their place (just ask Jack Bogle!), we think savvy types should shoot higher without paying for the privilege.
The Foolish bottom line
Smart fund investors should consider lots of factors before taking the plunge, but for my money, the manager's track record and the fund's price tag are two critical pieces of the puzzle. With these pieces in mind, we selected the cream of the fund industry's crop as the foundation for our Ready-Made Millionaire line-up. This real-money portfolio is backed by a million dollars from the Fool, and it consists of funds, carefully vetted stocks, and a high-octane ETF.
The service will reopen to new members next week. If you think a set-and-forget portfolio designed to both grow and protect your nest egg sounds like a good idea, click here to snag our special free report -- The 11-Minute Millionaire -- and to be notified when Ready-Made enrollment reopens. Your nest egg will thank you for it.
This article was originally published on Sept. 14, 2006. It has been updated.
Shannon Zimmerman
runs point for Ready-Made Millionaire, and at the time of publication, he didn't own any of the securities mentioned above. Coca-Cola and Starbucks are Motley Fool Inside Value recommendations. Starbucks is also a Stock Advisor choice. The Motley Fool owns shares of Starbucks. You can check out the Fool's strict disclosure policy by clicking right here.
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