Most investors know 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. 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 beat the market with funds. Instead, as with most things that really matter, you need to rely on reason -- and do 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 smart 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. 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, prospective fund investors should look for experienced managers who eat their own cooking. My rule of thumb is to look for fund 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 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 a double-digit margin. 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 just a simple collection of 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 growth stocks like Genentech
These stocks have performed all over the board, and if you're invested in one or two, you've probably 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 the four data points above will get you started down the path of smashing the market.
If you'd like to learn more, consider taking Champion Funds for a risk-free spin. You'll be able to learn from our back-issue archives, updates, and members-only boards -- and our complete list of recommended funds, too. Just click here to get started.
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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. He doesn't own any of the securities mentioned. Bank of America and UPS are Income Investor recommendations. The Fool has a strict disclosure policy.