I like picking stocks. I've taken time to learn how to do it well, I've picked some great winners over the years, and I've beaten the S&P 500 more often than not.
That shouldn't come as much of a surprise -- this is The Motley Fool, after all, a company founded on the premise that ordinary people could learn to beat professional investment managers at their own game.
But this might come as a surprise: I also own mutual funds. Not just index funds and ETFs, but a couple of actively managed funds as well. What's more, I think many stock-picking enthusiasts could benefit from having a few well-chosen funds in their portfolios.
The case for funds
There are three reasons I'll choose to buy a mutual fund over a stock:
- To get exposure to parts of the market (typically overseas) I don't know that much about and can't spend time researching properly, but that I need for diversification;
- To stay fully invested when I'm low on good stock investing ideas;
- Because I've found a great fund that fits my portfolio.
These days, I usually choose ETFs or index funds for the first two -- they'll beat most active funds most of the time, and I don't have to put much effort into researching them. But every now and then I run across an active fund I can't resist. Usually, these are low-fee funds with a veteran manager working in one particular corner of the market -- and some have done very well.
The problems with funds
Now here's the caveat: A lot of actively managed stock funds -- the vast majority -- aren't worth your time and money. Compared to a portfolio of stocks you build on your own, an actively managed mutual fund starts with serious built-in disadvantages:
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Size. Managing a billion dollars or more is completely different from managing a six-figure retirement portfolio. As individual investors, we can take sizeable positions in small-cap stocks without driving the price up, and we can even buy micro-cap stocks in quantities big enough to have a significant impact on our overall portfolio. It's hard to do that with a billion-dollar fund, and even harder as the fund gets bigger.
For example, check out Big Bertha's -- I mean, Fidelity Magellan's (FMAGX) annual report. There are a few small stocks in there, but their size and influence on the fund's returns are dwarfed by the fund's enormous stakes in big names like Nokia (NYSE:NOK), Monsanto (NYSE:MON), and Staples (NASDAQ:SPLS) -- and as you'd expect with a fund full of big-name stocks, its performance in recent years has tracked the S&P 500's pretty closely. - Fees. Fund fees have come down considerably in recent years, but they can still take a bite out of performance. This is especially true with international funds, where fee ratios frequently exceed 1% even at lower-cost firms like Fidelity and T. Rowe Price (NASDAQ:TROW). That may not sound like much, but compound it over 30 years and ... well, you get the idea.
It's no wonder that the vast majority of active stock funds lag the S&P 500 over longer periods. But "vast majority" doesn't equal "all." There are a few funds that manage to crank out eye-popping returns year after year despite these disadvantages. Those are the ones I love to find.
Two of my favorite funds
I've been a big fan of Fidelity Leveraged Company Stock Fund (FLVCX) since it was launched, and I was pleased when the Fool's Champion Funds newsletter recommended it in June of 2007. (It's a paid service, but you can read the full article with a 30-day free trial, so click with confidence.) This fund is an unusual beast, investing in companies with sizeable debt loads -- including Peabody Energy (NYSE:BTU), Celanese (NYSE:CE), and ON Semiconductor (NASDAQ:ONNN) -- but its track record is excellent.
I've had a chunk of my retirement portfolio in this fund for several years now. It has been a strong performer through all kinds of market conditions. Unless it gets derailed by rising interest rates -- see the Champion Funds article for an explanation of that concern -- or Fidelity replaces the portfolio manager, I expect to hold it indefinitely.
Speaking of Champion Funds, the new issue recommended another of my favorite funds. This one's a gem, a little-known small-cap value fund that could become a superstar when the market turns. I recently wrote about the challenge of small-cap value investing, and I'm about to put my money where my mouth is -- I'm going to add this fund to my retirement portfolio. I encourage you to check it out now, before the bulls come out of hiding. Click here to find out more -- full access is free for 30 days.
