In investing, nearly everyone knows that you can't possibly beat the market with mutual funds. Roughly three out of four of the suckers lose to the S&P over the long haul, so what hope can fund investors possibly have?
Abandon hope, all ye who enter here ...
The good news is that you don't need to rely on hope to get the market-beating job done with funds. Instead, as with most things that really matter, you need to rely on reason -- and on doing your homework.
By using the same kind of research and analysis techniques on funds that stock jocks (you know who you are) use on equities, you can truly smash the market. Of course, the "data points" (as the pros like to say) are different. A savvy fund investor will want to factor in:
- Fees. As I've said time and time again, with mutual funds, you generally get what you don't pay for. So search for funds with below-average expense ratios, and avoid load funds like the plague.
- Tax efficiency. Assuming that you're investing in a non-tax-sheltered account, a fund with high turnover is likely to increase your tax obligations. All else being equal, it's smart to look for a manager with a buy-to-hold strategy.
- Management. Just as insider ownership is vital to small- or mid-cap stock investing, an experienced fund manager who eats his or her own cooking is an indicator that prospective investors should look for. My rule of thumb, by the way, is to look for managers with at least five years of experience at the ship they're running.
- Strategy. Along those same lines, the fund's manager should have a proven strategy that's been battle-tested over numerous market cycles.
These four data points are a solid starting homework assignment. Star ratings and Lipper scores are purely backward-looking measures, after all. And if the skipper who earned those marks is no longer on the scene, there's a strong probability that you shouldn't be, either.
You say it can't be done?
Fund geek that I am, I firmly believe that all investors -- stock jocks included -- should anchor their overall portfolios with a choice collection of mutual funds before assuming the much greater risk that comes with investing in individual equities. And, for the record, I believe that investors can beat the market with choice mutual funds.
At Motley Fool Champion Funds -- the Fool newsletter service that I head up -- we've been doing just that. Indeed, since first opening for business back in March 2004, our list of recommendations has outperformed the market by more than 11 percentage points. And because when you invest in high-caliber mutual funds, you're investing in a well-diversified portfolio, that showing has come amid far less volatility than you'd get with a simple collection of just individual stock picks.
Find the fund for you
One size, however, does not fit all. With that in mind, our Champion Funds recommendations list and model portfolios offer funds that should appeal to investors of all stripes.
Indeed, our picks hail from all over the valuation and market-cap spectrum. We have ace funds, for example, that favor racy mid-caps such as Advanced Micro Devices
These stocks' performances have been all over the board over the past year, and if you're invested in one or two, you've seen a lot of volatility. But put them together in one fund or one portfolio with many other stocks, and you'll get a much smoother upward trajectory.
The Foolish bottom line
Funds can beat the market and help you achieve your investment goals with less volatility. They can also help you expand your investing portfolio without ever leaving your circle of competence. Following those four data points above will get you started down the path of smashing the market.
If you'd like to learn more, click here for a free 30-day guest pass to Champion Funds. There's no obligation to subscribe, and in addition to our archives, updates, and members-only boards, your pass provides access to our complete list of recommended funds, too.
This article was originally published on May 11, 2006. It has been updated.
Shannon Zimmerman is the lead analyst for the Fool's Champion Funds newsletter service and doesn't own any of the securities mentioned. Pfizer is an Inside Value recommendation. The Fool has a strict disclosure policy.