In Part 1, I made the case that mutual funds might be the best vehicles for a marketplace victory.
You're probably saying, "Hey, Fool boy. Why shouldn't I just reinvest my money in another common equity?" Fair point. After all, you're a good stock picker. You know what you're doing. But I have to ask again: Will you always be right? Don't you want exposure to another set of ideas?
The argument against
Do you always want to pick stocks? I don't know about you, but even though I love the capital markets and invest in them regularly, I don't kowtow to them on a daily basis and offer up a green sacrifice of disposable cash. I sometimes go a few days in a row without even so much as glancing at a chart. It might be wise to have someone watching over your money -- someone, that is, who is far more obsessed with performance than you. I'm not suggesting that you send your money off to a day trader. What I am suggesting is that a skilled professional who is constantly on the search for money-generating investment opportunities is a prime asset to your financial plan.
In the end, inviting a mutual fund manager to your portfolio can work wonders for its long-term appreciation potential.
But how do I choose a mutual fund?
Many people will disagree with this statement, but I firmly believe that, in many ways, it is more difficult to select a mutual fund than it is to select an individual stock. The reason is simple: When you are analyzing a single company and a single stock, you are weighing a lot of complex metrics and variables, and you take a decent amount of time in deciding whether the risk is worth the estimated reward. A mutual fund is more difficult to study because you are essentially analyzing an entire portfolio of stocks and correlating it with a money manager's track record and style. Let's face it, a mutual fund is just a bigger, more complex body. It's like the difference between a single-cell organism and one that is multicellular in nature: One cell is challenging enough, but figuring out how they all work together can boggle the mind at times. Furthermore, you have to decide if the expense ratio is worth the observed competency of the fund managers, which is never an easy task.
The first thing everyone does -- even though it does not guarantee future performance -- is to look at a chart of the fund's price over a period of time. But a chart of a fund's net asset value isn't a very useful metric. After all, what if the fund is up in an up year and down in a down year, essentially following the market at large? What you want is a selection that consistently beats the market, the performance of which is linked to a single money manager or team.
Again, when you decide to invest in a fund, you are entrusting your money with a person you've never met and most likely will never meet. The only way to conduct an interview is via indirect means, so it is important to check the track record of the manager to see whether her tenure has indeed added value for shareholders. You also want fund managers who have a lot of experience with their own funds so that the track record sample is significant; if the fund you are dying to own is run by a manager with a very short tenure, then do the next best thing -- dig a little and see what the portfolio runner's performance at a previous birch yielded for shareholders.
In addition, keep in mind that it would be nice if the managers practiced what they preached and owned shares of their product -- after all, if they don't believe in themselves, why should you? And you want admirals who aren't necessarily scared of rough waters and bail whenever a giant wave approaches. In other words, you don't want people who go only with the market sentiment, buying momentum and selling panic. You don't want high turnover of the portfolio. One of the best articles summarizing these attributes was written by Tim Beyers -- check out the nifty and illustrative chart he assembled.
The bigger concern is the expense scenario. There are different kinds of costs and fees associated with funds, such as the "loads," which are percentages taken either at the time of deposit or at the time of redemption. Then there are ongoing management fees and, most utterly dreaded of all, the 12b-1 fee (loathed because it basically takes your money to capitalize a fund's marketing plan). You add up enough of these fees and they will subtract enough of your return to put your goal of beating the market at serious risk. Look at the expenses and the quality of the stock picking to see if the combination is worth it. In general, you want no-load funds with no 12b-1 fees.
So ... give me a fund already!
OK, let me mention a fund that sports all of the above criteria. I offer you the Dodge & Cox International Fund (DODFX), a selection from Shannon Zimmerman's Motley Fool Champion Funds newsletter. As this chart suggests, the managers are highly proficient in the art of slaying the market on a long-term basis. There are no loads or 12b-1 fees, and the total expense ratio of 0.77% is quite acceptable considering the stellar stewardship at hand. What's more, turnover is low at 6%, so you don't have a lot of market jumping going on. In addition, the great thing about this particular choice is that it serves a dual purpose: besides being a wonderful vehicle for long-term appreciation, it also saves the individual from having to be an expert in international companies. Imagine if you'd doubled your money on a few stocks and handed those proceeds over to the smart folks at Dodge & Cox? Would have been a simple way to not only conserve the profits, but to grow them. And if you think the fund is composed of only esoteric names from foreign soils, not to worry. Ever hear of News Corp.
The big conclusion
Every portfolio would benefit from having a mutual fund; in my opinion, individuals shouldn't exclusively speculate on what will be the next Apple or Google. And using a fund not just as an investment vehicle but as a strategy for reinvesting gains made from individual stocks makes building up fund positions a breeze. It also takes the tedious guesswork out of which stock will be the next hot thing and provides a simple way of exposing a long-term account to the ideas of others. Let's face it: we won't always be right all the time. If you've made a gain, I urge you to consider socking some of it away in a quality open-ended investment steered by a competent investing admiral. And when you've made the next gain, make another deposit. Mutual funds and individual stock investing: They're symbiotic entities.
For more on the wonderful world of mutual funds, check out:
To sample Shannon's Champion Funds service for free, just click here. A free trial gives you full privileges to the service, including all past picks and write-ups, special reports, discussion boards, and mid-issue updates.
Fool contributor Steven Mallas owns none of the companies mentioned. GlaxoSmithKline is a Motley Fool Income Investor recommendation. The Fool has adisclosure policy.
