When you're trying to figure out what to invest in, everyone has an opinion. Lists of recommendations abound -- but they don't necessarily apply, since our portfolios need different things (income via dividends, international holdings, aggressive growers, etc.).
But those lists can still be instructive, because they (in theory at least) can illustrate how someone goes about picking investments.
In 2005, Better Investing magazine published a report on "10 Top Mutual Funds Held By Our Readers." The organization behind the magazine is a longtime champion of investing clubs and helps members learn how to evaluate stocks effectively. Readers, therefore, are probably better-than-average investors.
And aggregate of their collective wisdom is likely to be quite smart. Their picks did, in fact, largely outperform the market, with the strongest boasting a 6.9% 10-year average annualized return compared to a 2.6% loss for the S&P 500.
So, what can we learn from this list?
Everybody knows
The list was, by and large, populated with names everyone has heard of: Fidelity Magellan (FMAGX), Dodge & Cox Stock (DODGX), Fidelity Contrafund (FCNTX), and Fidelity Low-Priced Stock (FLPSX), to name a few. It's a good reminder that you don't need to find obscure funds to do well.
But even more interesting was that the No. 2 fund on the list was the Vanguard S&P 500 Index Fund (VFINX). No less a luminary than Warren Buffett has been recommending broad-market index funds for most investors for years, and these savvy investors listened.
Big names might not be the most exciting investments on the table, but they aren't slouches, either.
Keeping the money
Perhaps most important was this common trait: All of the listed funds had expense ratios (annual fees) below 1%, while the average stock fund charges 1.44%. In fact, half of them were below 0.60%.
Those low fees are crucial to long-term performance. Imagine two funds each returning a pre-fee 12% on average over 20 years. If one charges a 1% fee and the other 1.5%, the former will see $10,000 grow to $80,600, while the latter will grow to only $73,660.
That difference of almost $7,000 stems from a seemingly tiny difference in fees of half a percentage point.
Only one of the funds listed sports a load -- American Funds Investment Company of America (AIVSX) charges 5.75% up-front. Despite this one-time fee, it sports a 0.57% expense ratio, a low $250 minimum investment, and a 3.3% dividend yield with promising top holdings including Schlumberger (NYSE:SLB), PepsiCo (NYSE:PEP), Target (NYSE:TGT), and Lowe's (NYSE:LOW).
Did you realize that even mutual funds can have dividend yields, and hefty ones, at that? Keeping the fees you pay low and the dividends you receive high can help you boost your returns over time.
Beware of niche investments
The list was rather free of niche funds like, for example, a Latin America-focused one, or one focused on energy. Scan most "best funds of the year" lists, and you'll typically see many funds that focus on some sector or region that has been on a tear lately. That doesn't generally help us find which funds will be doing well in the future.
The only fund on the list that even approximates a niche fund is the Vanguard Health Care (VGHCX), but I'd argue that it has a long-term strong performance, and its recent top holdings (Schering-Plough (NYSE:SGP), Pfizer (NYSE:PFE), and Amgen (NASDAQ:AMGN), among others) are all strong companies.
So, don't gravitate toward niche or sector-focused funds just because they've done well in the recent past -- find the fields that are likely to be strong going forward.
What to do next
So, what can we take away from the list of top funds from four years ago? If you're looking for great funds, follow the example of Better Investing's readers: Look for low fees and strong track records, and don't be afraid of looking at funds that everyone knows about.
Back in 2005, nearly half of the funds were closed, but in our recent environment, many closed funds have reopened. Right now is a particularly promising time to invest, and this list is a good beginning for further research. But if you'd like other suggestions for top-notch mutual funds, just take a 30-day free trial to our Motley Fool Champion Funds investing service. Just click here to get started -- there's no obligation to subscribe.
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Longtime Fool contributor Selena Maranjian owns shares of PepsiCo, Amgen, Dodge & Cox Stock, Contrafund, and an S&P 500 index fund. PepsiCo is a Motley Fool Income Investor pick. Pfizer is an Inside Value choice. The Motley Fool is Fools writing for Fools.
