Fund Upgrading FAQ
WHAT IS THE SMI FUND UPGRADING STRATEGY?
In Upgrading, we rank over a thousand mutual funds by type each month, and determine which ones have been performing the best recently. We hold the top funds in each category until they stop outperforming, then replace them with other funds showing stronger recent performance.
Upgrading works because, as economic conditions change, market leadership rotates among companies of different sizes, and among different investment approaches. While market conditions are constantly changing, fund managers rarely do. Managers that excel under one set of market conditions often are only average (or worse) under a different set of conditions. Rather than buy a fund and hold it through both the periods that favor the manager's approach and the periods that don't, Upgrading continually guides us to funds that are in favor right now. Visit the Fund Upgrading page for an overview of the Upgrading process.
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HOW HAS UPGRADING PERFORMED?
Upgrading has achieved a consistent advantage over the market since SMI began featuring it in 1996. While it hasn't topped the market every year, it has established a track record of superior performance in both bull and bear markets. These charts show the annual and cumulative advantage of Upgrading in recent years, and a year-by-year performance history is also available for your inspection.
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HOW DO I KNOW WHEN TO CHANGE FUNDS?
If your Upgrading account is with a fund supermarket where you have access to most of our recommended funds, it's easy. You simply look at our Recommended Funds page 
in each monthly issue of SMI, and whenever one of the funds you own is replaced (Upgraded) you sell it in your account and buy the replacement fund. Very easy.
If you're following Upgrading in a 401(k) or other retirement plan that limits the availability of the funds you can use, you'll need to rely on either the Fund Performance Rankings updated every month on our website (for web members) or the printed version that comes with the newsletter quarterly. In the Fund Performance Rankings you'll find over 1,000 mutual funds ranked by risk category. When one of your funds drops below a certain point—we use the top 25% internally—you sell it and buy the best performing replacement you have access to. The number and quality of fund options in your plan may cause you to adjust how quickly you sell an under-performing fund. Also, because many plans are weak in a particular risk category, you may need to supplement your strategy by using a separate account like an IRA to invest in the category that your plan is weak in. For example, if there is no good small-company growth fund in your retirement plan, you might be able to use a separate IRA account to buy a fund in that category, thus rounding out your Upgrading allocations.
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HOW MUCH SHOULD I INVEST IN EACH FUND?
Before you select any funds, the SMI new reader materials will help you determine your season of life and tolerance for risk. Armed with this appropriate personal allocation, SMI will show you the percentage of your portfolio we recommend investing in each type of stock/bond mutual fund. Multiply the total dollar amount you plan to invest by the percentage listed for each risk category, and you'll find the amount to invest in each fund. Upgrading: Easy as 1-2-3 page walks SMI subscribers through the entire initial process, while visitors to our site can get an overview of the process here.
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HOW DOES SMI SELECT THE RECOMMENDED FUNDS?
Each month, SMI ranks over 1,000 no-load funds according to our nine risk categories. As part of this process, we calculate a momentum score for each fund based on its recent performance. This score places more weight on recent performance (over the past month) with increasingly less importance on less recent returns, going back 12 months. This helps smooth out short-term performance swings, and helps us identify the funds that are most likely to outperform in the near future.
When a recommended fund falls out of the top 25% of its risk category peer group, we replace it with a new fund in that category. The new fund is selected primarily on the basis of its momentum score, although there are other factors that will occasionally cause us to recommend a fund with a slightly lower momentum score than the category leader. For example, if a fund recently changed managers, we might skip over it despite it having the highest momentum score in its risk category.
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HOW LONG IS EACH FUND HELD?
A fund is held until it falls out of the top 25% of its risk category. On average, recommended funds are held about nine months. Some are held less than that, some much longer. If a fund drops quickly in our rankings, we'll sell it as quickly as is warranted. As a result, funds are often sold before they reach the 12 month holding period required for preferential tax treatment, though not frequently within the six month "NTF early sale penalty" limit some brokerages impose. Even that happens occasionally though, and is simply an occasional cost of this particular investing strategy. As you can see though, by holding each fund an average of nine months, Upgrading is definitely not a frequent trading strategy.
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WHAT DOES THE "$" SYMBOL MEAN ON SOME OF THE RECOMMENDATIONS TO SELL?
A "$" symbol following the name of the fund being sold lets you know that we still think well of the fund and its management. If the holding has been profitable and is held in a taxable account, you might wish to retain such a fund until reaching the twelve-month holding period required for preferable tax treatment. However, be aware that SMI will no longer report on the fund, so you'll need to remember to sell it and Upgrade when your desired holding period is reached. Our research indicates new fund recommendations outperform their replacements by roughly 1% per month, so factor that in when deciding whether to hold an old recommendation.
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DOES IT COST A LOT TO SWITCH FUNDS?
No, it doesn't. In fact, with an account at one of the better fund supermarkets (like Scottrade, TD Waterhouse, or Fidelity), Upgrading is a fairly low-cost way to invest. Certainly it's not as cheap as some strategies, like indexing. But because so many of SMI's recommended funds are offered on an NTF (no transaction fee) basis, most of our fund switches cost you nothing. Upgraders pay normal trading commissions on the funds labeled "Yes" on SMI's Recommended Funds page , and pay early-exit penalties occasionally when they sell an NTF fund they've held less than 3-6 months (varies by brokerage). But because our average holding period is roughly 9 months, these penalties are infrequent.
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WHERE'S THE BEST PLACE TO HAVE MY UPGRADING ACCOUNT?
There are several good options available. Firstrade is a good option for small accounts and for those whose top priority is minimizing fees. SMI also recommends Schwab, TD Ameritrade and Fidelity. All of these brokers offer a broad range of mutual funds, with many of them available on an NTF (no transaction fee) basis. TD Ameritrade and Schwab only require NTF funds to be held 90 days to avoid NTF early-exit penalties, whereas that limit is 180 days at Fidelity and Firstrade. Your specific investing approach will largely dictate which broker is the best option for you, as there are a broad range of costs/features available. We encourage you to investigate these choices in more detail by reading SMI's 2008 Broker Review: Choosing the Broker That's Right For You.
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SHOULD I HOLD MORE THAN ONE FUND IN EACH RISK CATEGORY?
This is definitely a matter of personal preference. SMI recommends owning as many of the four recommended funds as your account size allows. However, it is certainly not necessary to purchase more than one in each risk category. Of far greater importance is that buy and sell instructions are executed promptly each month. If holding more funds makes you less prompt in tending to your monthly upgrading duties, you should scale back the number of funds owned.
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HOW DO I KNOW WHICH FUND TO SELECT IN EACH CATEGORY?
The easiest way is to simply choose the highest rated one that is available at your brokerage. Recommended funds are labeled 1-4 in each category every month, so purchase #1 if it is available to you, and if not, purchase #2. Only those pursuing a more customized fit for their portfolio need to go beyond this step.
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HOW DO I KNOW WHICH FUND IS THE MOST LIKELY TO BE REPLACED SOON?
The #4 rated fund in each category is the most likely to be replaced. So when purchasing a new fund, keep this in mind. You can also look at the momentum scores for each of the four funds for clues. If they are all very close, the 1-4 rankings may not be as significant as if there are one or two funds with very high momentum scores, with a large gap between them and the other recommended funds in that category.
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MY 401(k) DOESN'T INCLUDE ALL OF YOUR RECOMMENDED FUNDS. CAN I STILL FOLLOW THE UPGRADING STRATEGY?
If you're following Upgrading in a 401(k) or other retirement plan that limits the availability of the funds you can use, you'll need to rely on either the Fund Performance Rankings updated every month on our website (for web members) or the printed version that comes with the newsletter quarterly. In the Fund Performance Rankings (FPR) you'll find over 1,000 mutual funds ranked by risk category. When one of your funds drops below a certain point—we use the top 25% internally—you sell it and buy the best performing replacement you have access to. The number and quality of fund options in your plan may cause you to adjust how quickly you sell an under-performing fund. Also, because many plans are weak in a particular risk category, you may need to supplement your strategy by using a separate account like an IRA to invest in the category that your plan is weak in. For example, if there is no good small-company growth fund in your retirement plan, you might be able to use a separate IRA account to buy a fund in that category, thus rounding out your Upgrading allocations.
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HOW OFTEN SHOULD I REBALANCE MY PORTFOLIO?
Once per year is adequate for most people. Perhaps each January when you get SMI's new asset allocation guidelines would be a convenient time, as you'll likely be doing some buying and selling then anyway. If you're dollar cost averaging or otherwise adding new money to the account, you can use your new deposits to accomplish an "ongoing rebalancing" effort if you wish. That simply means that you would use your new money to buy more shares in the categories that have fallen below your target asset allocation percentages.
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