Pop quiz! How many stocks are there in the United States? When I looked this up recently, I was surprised by the answer. I'd thought it would be around 8,000 -- give or take a thousand -- but according to the folks at Fidelity Investments, "Although the exact number of stocks in the U.S. is not recorded, it is estimated to be about 15,000." Wow!
The broadest stock market index fund is the Wilshire 5000, which includes around 5,100 companies. Investors can rest assured that this does cover most of the value of the entire market. Even the S&P 500, with its 500 top American firms, encompasses roughly 80% of the market's value.
Next question: How many mutual funds are there? Go ahead and guess. I'll offer the answer below the following interlude, which features the lovely poem "Wish for a Young Wife" by Theodore Roethke:
My lizard, my lively writher,
May your limbs never wither,
May the eyes in your face
Survive the green ice
Of envy's mean gaze;
May you live out your life
Without hate, without grief,
And your hair ever blaze,
In the sun, in the sun,
When I am undone,
When I am no one.
Now that you've made your guess (and have made a mental note to read some more poetry), permit me to offer the answer, according to the Investment Company Institute: There are about 8,000 mutual funds in existence -- more than one for every two public companies out there. They've been growing in number, too -- especially during the go-go years of the past decade. In 1996, there were only about 6,248 funds. (Did we really need nearly 2,000 more funds in the past 10 years? It's hard to believe that's the case.)
These outsize numbers beg the question: How can an investor sift through all these funds and pick the good ones? After all, with 8,000 funds, a whopping 4,000 will be below-average performers.
Red flags
First off, there are some simple red flags to be aware of that can help you dismiss thousands of funds. In our Motley Fool Champion Funds newsletter, analyst Shannon Zimmerman routinely reviews these factors, as he presents his "Dud of the Month."
Here are some red flags:
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Steep fees. Shannon reviewed an S&P 500 index fund from Morgan Stanley, which charges an annual fee of 0.7%, when you can get the same underlying performance from Fidelity and Vanguard S&P 500 funds for less than 0.2%. Worse, the A class of the Morgan Stanley fund charges a whopping 5.25% load, and the B class sports an expense ratio of 1.5% plus a 1% marketing fee that serves the fund company, not shareholders. If you're looking at a managed stock fund, an expense ratio under 1% is attractive. You might pay a little more for exceptional expected results based on a great track record.
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Questionable strategies. Shannon highlighted a fund that aims to deliver 125% of the return of the Nasdaq 100 by investing with borrowed money. (The fund also charges a 1.75% expense fee, which is stripping nearly two percentage points off each shareholder's return each year.) He pointed out that investors can earn the Nasdaq 100's return inexpensively by buying Nasdaq100 Trust Shares (NASDAQ:QQQQ), which are called "Cubes" by those in the know.
- Faking investors out. Shannon zeroed in on a not-so-uncommon quality in many duds: piggybacking on the returns of a major index. As one example, he singled out a Wells Fargo foreign stock fund. Not only does it sport huge fees (a 5.75% front-end load and an annual expense fee of 1.5%) and a management team that's been on the job for only two and a half years, but 98% of its performance is tied to that of the MSCI EAFE, an international equity index. In other words, if you just invested in that index, you'd earn nearly the same return and could pay far less in fees. Consider, for example, this exchange-traded fund as an alternative: iSharesMSCI EAFE Index Fund (AMEX:EFA). Carrying no load and trading like a stock, its expense ratio is just 0.36%.
Green flags
Flip those red flags over, and you'll find their green side. Look for relatively low fees, sensible strategies, and managers earning their keep by making good calls. Learn more in these (free) articles by Shannon:
- Buy Quality on the Cheap
- Less Risk, More Reward
- Building the Perfect Portfolio
- The Price Isn't Right
Shannon must be doing something right, because his picks have more than doubled the market's return (as of the last time I checked), gaining an average of 21% versus 10% in the same time period. He covers all kinds of funds, too. One recommendation, a Fidelity fund, focuses on large-cap growth companies and has advanced about 19% in roughly a year on the backs of top holdings (as of the end of 2005) like Google (NASDAQ:GOOG) and Motorola (NYSE:MOT). Another recommendation, focusing on small-cap value stocks, is up more than 35% in a little over a year, and its recent top holdings featured Goodyear Tire & Rubber (NYSE:GT) and Intergraph (NASDAQ:INGR).
Let us help you find winners
We'd love to introduce you to some terrific funds (and teach you more about separating studs from duds) via our MotleyFoolChampion Funds newsletter. Try it for free, and you'll be able to access all past issues and see a list of which funds Shannon Zimmerman has recommended.
Here's to a happier portfolio! (And hey -- consider forwarding this article to anyone you think might be interested in stud funds. Just click on the "Email this Page" link near the bottom of the page.)
Selena Maranjian 's favorite discussion boards include Book Club , Eclectic Library, Television Banter, and Card & Board Games. She owns shares of no companies mentioned in this article. For more about Selena, viewher bio and her profile. You might also be interested in these books she has written or co-written:The Motley Fool Money GuideandThe Motley Fool Investment Guide for Teens. The Motley Fool is Fools writing for Fools.
