Savvy investors like to point out that the typical mutual fund loses out to the broader market over the long haul. Legg Mason Value Trust
Those savvy types are right, of course. Thanks to low costs and superb tax efficiency, passively managed index trackers do have built-in advantages that the typical fund -- with much higher overhead and a tendency to flip stocks at a gains-draining clip -- can't possibly match.
Beware. There's less here than meets eye. For starters, whoever said you have to invest in the "typical" fund? After all, the "typical" individual stock is a bad bet, too. Yet people still buy stocks. And if finding the Value Trusts of the world ain't exactly easy like Sunday morning, it's not an impossible dream, either -- in fact, from here on out we'll be trying to do just that in our brand-new Motley Fool Champion Funds newsletter, edited by yours truly (get in on the ground floor with a free trial).
Just ask owners of Fidelity Low-Priced Stock
Or consider Vanguard Primecap
Not too shabby.
What it takes
Unfortunately, both funds are currently closed. Fortunately, while digging up market-beating mutual funds isn't easy, it isn't voodoo, either. To make the grade (and stack the odds in our favor), a fund needs a clutch of key attributes -- the kinds of things that any smarter-than-your-average-bear investor should (cringe) bear in mind.
Low costs are essential. Funds with loads or luxury price tags go directly to the reject pile. Beyond that, I'm on the hunt for funds that come equipped with seasoned managers who have successful track records of beating the S&P 500 over time with a sound stock-picking strategy.
Top-down types who make big and risky bets on the markets need not apply. And funds with managers whose approach to picking stocks changes with Mr. Market's moods also don't make the cut. When it comes to fund investing, the answer, my friends, isn't blowing in the wind.
Moreover, while I'm a big fan of diversification, I generally steer clear of funds that water down their managers' best ideas with hundreds of picks to "control" risk. That way lies mediocrity, and we'd all do better to just stick with a cheap index fund.Scandalous scandal
These days, anyone searching for the best and brightest had better be carrying Diogenes' lantern. New York Attorney General Eliot Spitzer's ongoing investigation confirms our worst fears about the fund industry, and if many implicated shops appear to be shaping up, it's far too soon to let bygones be bygones. Good grief, Spitzer's investigation first hit the headlines little more than six months ago.
Let others take a nuanced approach to letting the culprits out of the penalty box. For my money, any shop that's been implicated in the scandal doesn't deserve your money -- certainly not any more of it. These tainted firms will have to prove over time that they've clamped down on the permissive corporate cultures that permitted serious trading abuses to occur. Good intentions are great, but investors should insist on real results before trusting any of these guys again.A silver lining
For all that, I'm pretty optimistic about the prospects for industrywide reform. Mandatory redemption fees (which discourage market timing), strict curbs on those nefarious "soft-dollar arrangements," and greater disclosure of how fund managers are compensated are all on the table. And investors may soon be able to learn if their manager "eats his own cooking" by investing in the funds he runs -- a great gauge of whether a manager's interests are truly aligned with his shareholders'.
Even better is that, while we're all waiting impatiently for the fund industry to reform itself, there's no need to sit idly by. Solid, market-beating funds -- champion funds -- are out there for the picking. You just have to know where to look.
See you in the winner's circle!
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