Using SMI's Fund Performance Rankings
to Select Funds for Your 401(k)

If you participate in a 401(k) plan at work, your mutual fund choices might be limited to the offerings of one or two fund organizations. In that case, you would frequently be unable to invest in the funds in our model portfolios.

No problem—you can use the SMI "Fund Performance Rankings"  (FPR) to create a portfolio of the best performing funds available to you.

The process is two-fold. First, you initially assemble a portfolio of funds that achieves the balance between stocks and bonds that you have decided is appropriate for your situation. (See Upgrading: Easy as 1-2-3. )

Bear in mind that the portfolio mix you select, say 80% stocks and 20% bonds, should apply to your holdings taken as a whole (including IRAs and other investment accounts) and not just the funds in your 401(k) plan.

Here's how we put together such a portfolio for Fidelity investors. First, we printed the latest FPR, and used a highlighter to mark the Fidelity funds in SMI's five primary stock risk categories, as shown on our Fund Upgrading  page. (We omitted the funds with "Select" in the name—these are Fidelity's sector funds, meaning they invest in just one industry or sector of the economy.)

Next, we identified the top-ranked Fidelity fund in each category. Unless a load was involved, they are the ones we chose. Our picks are explained briefly in the table below.

In Category 1, an index fund was chosen. This isn't because we prefer index funds, it's simply because it was the highest-ranked Fidelity fund available in the category (and in fact was the only Fidelity fund available in the top quartile). But we don't mind owning index funds in Upgrading—if an index fund is in the category's "sweet spot" at the moment, that's fine with us.

In Category 4, the small/growth group, the only top-quartile Fidelity fund was a "C-share" loaded fund. Because that fund is an "advisor" class fund, there's a good chance it wouldn't be available in a company retirement plan anyway, so we kept looking until we got to the New Millenium fund down below the quartile.

It's not unusual for a fund organization to not offer funds in every category, or at least not have a top quartile performer in every category.

If you can't find satistfactory fund, consider selecting a stock fund from another category that shares the same value/growth orientation. That would mean looking in Category 2—the large/growth group—to fill this Category 4 small/growth fund slot.

In this case, with an alternative fund not far below the quartile, we didn't choose to do that, though we likely would have if the highest-ranked fund in the category had been even lower, say below the median.

However, a better way to find a fund to fill a weak slot in your 401(k) lineup is available if you have investment accounts outside of your company plan. By combining your non-401(k) accounts with your company plan, you can have a well-balanced and effective Upgrading portfolio.

In the situation at hand, for example, you might choose to divide your 401(k) money among stock risk categories where Fidelity has solid performers (1, 2, 3, and 5). Then use your other accounts to round out your investing in any remaining SMI stock categories (Category 4) in non-Fidelity funds. (Adding a currently recommended fund from our Fund Upgrading  list—in this case, like Janus Orion—can turn a good Upgrading retirement portfolio into a great one.)

Once that's done, you can divide your bond index-fund investments (if any) between your various accounts as needed.

Once your portfolio is selected, you move to the second phase—monitoring its performance. As we've discussed many times, having a selling discipline that tells you when it's time to replace a lagging performer with a new fund is essential to a successful long-term strategy. The selling discipline we recommend is based on the "top quartile" strategy we follow for SMI's Upgrading portfolio.

We'll demonstrate using Category 2, the large-cap growth group, as shown in the Fund Performance Rankings . Find the "Quartile" marker in bold. At present, Fidelity Independence is comfortably above that marker. This means it's ranked in the top 25% of the category.

When it falls out of the top 25%, that is, below the "Quartile" marker, you should consider selling it. Pick a replacement by following the buy strategy described above—it will lead you to the fund that is currently highest ranked among the funds available to you in that category.

On occasion, you will have to be flexible. What if, for example, you own a fund that has fallen below the "Quartile" marker but none of your available funds are ranked above the marker, leaving you without a replacement?

In that case, you would pick the highest-ranked fund available to you as the replacement. If the fund you currently own is the highest ranked fund in that category, then don't sell after all—it's the best you can do given your limited options.

Admittedly, the Upgrading process described here is rather simple. (The 401(k) Fund Tracker  tool available to all SMI Web Members makes this process easier to set up and monitor by gathering all your fund options together for you in one report.) But as simple as it may be, it has the virtue of putting the performance of your available fund options into context and, over time, will keep you invested in the performance leaders.

And, due to the value of having an effective selling strategy in place, it can yield some surprisingly good results—as our model portfolios based on Upgrading have demonstrated.

For further discussion on this topic, see our follow-up article Choosing Funds in Your 401(k) When Your Options Are Few.

Mark Biller is Sound Mind Investing's Executive Editor. His writings on a broad range of financial topics have been featured in a variety of national print and electronic media, and he has appeared as a financial commentator for various national and local radio programs. Mark is also the Senior Portfolio Manager of the SMI Funds.

• SMI's IRAs and 401(k)'s page
• 401(k) Fund Tracker tool 
• Fund Performance Rankings 
• Fund Upgrading 
• Upgrading: Easy as 1-2-3 
• Short-term View: Tough Quarter! Long-term View: Outstanding!

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