Football coaching legend Vince Lombardi said, "Winning isn't everything, it's the only thing." He was referring to life on the gridiron, but his words ring true for investing. Investors love when they feel they have found a winning stock or mutual fund, and there's no better satisfaction then watching your nest egg grow.
Many moons ago, when I was in college, I used to flip through The Wall Street Journal and watch my fledgling investment in Janus Worldwide hum along, every day another tick up. Thanks to the fund manager, Helen Young Hayes, my investment was soaring. Winning matters in investing, and it sure beats the alternative. Here are my four keys to picking a winning mutual fund.
1. To thine own self be true
Good mutual fund managers know who they are, and stick to what they know. Problems occur when managers veer away from their style, which refers to their investment strategy such as value investing or focusing on large-cap or small-cap stocks. When managers buy stocks outside of their usual wheelhouse, it's called style drift, and it is one of the reasons most portfolios fail at diversification.
Style drift usually happens when a manager chases performance. For example, a domestic large-cap growth fund manager might buy small-cap growth stocks to boost the performance of the fund. The problem occurs if you have a separate small-cap mutual fund elsewhere in your portfolio. Then you might be overexposed to that sector, which increases your portfolio's overall risk. The second obvious problem with style drift is that the manager may be buying stocks they don't know very well. Good money managers don't try to put on a charade by pretending to be something they're not.
You can check a manager's history of style drift using Morningstar, which does a good job of showing the manager's style over time. If you see little consistency and no history of sticking to a mandate, be concerned.
2. Is your fund in the marketing business or the investing business?
Some mutual fund management companies are not clear about which business they are operating in. Certain companies spend a lot of money on marketing and are usually not in the investment management business, rather in the mutual fund marketing business.
The late founder of Vanguard Jack Bogle cautioned against these types of entities in his book Don't Count on It, which showed that fund companies offering a lot of mutual funds typically underperfomed, and companies with just a few funds in their lineup performed the best. On average, investment companies with many funds spend a lot of time and money on the marketing side of the business, which means they have to charge more in fees, which detracts from performance.
Bogle knew a thing or two about mutual funds, and his advice comes back to keeping fees low, which is timeless advice. Sticking with low-fee fund families like Dodge and Cox, T. Rowe Price, and Vanguard will help you avoid high-marketing, high-fee funds. Funds with an expense ratio higher than 1% are considered high-fee. High fees are a hurdle for managers to overcome, and they eat away at your return. Mutual funds come with many different-sounding names for fees; be sure to check the prospectus for the expense ratio.
If you're giving your money over to someone, you'd best make sure this isn't their first rodeo in the markets.
Obviously, don't hire a newbie or a recent graduate, but experience is more than how long someone has been investing other people's money. Consider their experience in the fund's sector or style. If an international large-cap fund manager is the new manager of your emerging markets fund, that should raise an eyebrow. Look for a fund manager who's a seasoned expert in the style of the fund, not a jack of all trades but master of none. If you're going to pay someone to manage your money rather than just mimicking the index, they should have a knowledge base that gives your money an edge in the market.
At the end of the day, it all comes back to performance. If you have a winning mutual fund with a smart manager, all other points become moot.
Most funds go through periods of outperformance and underperformance and that's to be expected with active management, because managers make bets to outperform. Sometimes they pay off big time, and other times they fail spectacularly.
When looking at performance, pass on funds that struggle to beat their benchmark over three, five, or 10 years. That's a long enough time frame to evaluate whether a manager is worth their salt or not. Fund managers don't always outperform their benchmark -- that's OK, as they are making bets that may take time to develop. The key is not to stick with an underperformer forever; you'll be better off owning the index by investing in an low-fee ETF. The good news is that once you pick a fund that meets all four criteria I've listed here, you won't have to reevaluate your holdings for these 4 criteria often, but rather let it ride and check it annually.
They say football is a game of inches, one in which a pass here or a penalty there can make or break a game. The same is true for investing in mutual funds. The margin of error is slim, the stakes are high, and you have to do everything you can to increase your odds of winning.