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In the early days of SMI, circa 1990-1992, I had to spend a lot of time in the newsletter explaining the mutual fund industry and the differences between load and no-load funds. As Morningstar explains, the old black vs. white distinction between the two methods of distribution no longer apply:
Until [the mid-1990s], many funds were only available with loads and through brokers. Others were sold without loads, and you had to buy them directly from their fund companies—no broker involved and no outside help given. There was really no overlap across those two worlds, and disciples of each actually refused to do business with each other in many cases. Here's the thing, though: The debate never made much sense to begin with, it's over, and nobody actually won.
Why is the debate over? Because a majority of funds are now sold both ways via multiple share classes. This Morningstar article provides a handy history of how this happened and what the landscape looks like today. A good read for those who find the variety of fund share classes bewildering ("Why are there so many ways to buy the same fund?") Here's the wrap-up:
For the most part, though, the 1990s world of pure load versus pure no load is no more. Nearly all funds are bought through some kind of intermediary, even if that intermediary is an online platform [Note: In SMI's world, that would be Scottrade, Fidelity, or Schwab.]... Most investors are just trying to decide what kind of intermediary to use and at what price for which services.
We still maintain that sticking with no-load share classes makes the most sense for SMI readers. And since we're doing the research for you to select the funds, you're free to gravitate to the broker who will execute your instructions conveniently and cheaply. We try to help you pick the one that's best for you in our periodic broker reviews (
Members Only).
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7 Key Principles for Christian Investing
IRAs, 401(k)s and Social Security: A Retirement Planning Primer
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Inflation History: The Rise and Fall of the U.S. Dollar
When you have a constant need to create financial content, you read a lot. And you file a lot of what you read. You never know when a well-done interview, bit of research, or historical review might come in handy. (I just know that a week after I throw it away, I'll need it and won't remember the author or source.) Over time, it piles up, creating something of an organizational nightmare, requiring a periodic purging of the older material.
This is something I'm not particularly good at. I hate going through old files, looking for what might still be useful. It's very time-consuming because you have to briefly read the material you're sorting through. After a few hours you have a thinner, better organized file (one down, several dozen to go), which doesn't seem an adequate reward for the somewhat boring, unpleasant time invested. So, you may not be surprised to learn, I don't do it very often. No, not often at all.
Yesterday, the chaos reached the tipping point and I forced myself to begin the process. Almost immediately I got distracted. I came across a 1993 article from Kiplinger's Personal Finance magazine titled "Funds to Hold Forever" (a laughable idea if I ever heard one — that must be why I kept it). The article named six funds — four actively managed stock funds, one bond fund, and one Wilshire 5000 index fund.
I couldn't resist checking up on the four stock funds to see how investors would have done taking Kiplinger's advice in the late summer of 1993 and holding them the past 18 years (through May 31, 2011).
At first, they seemed to have done better than I expected. First, all four are still in existence, which is no small thing. And second, while they trailed the market, they didn't do so dramatically — they collectively returned, on average, 6.9% annually during the period compared to 8.3% for the market.
But of course, compounding over almost 18 years makes that seemingly small 1.4%/year difference into a pretty significant gap. $100,000 invested in the Wilshire 5000 would have grown to $412,000 compared to only $324,000 for a portfolio equally divided among the four funds. Hmmm...not so great after all.
As SMI readers know, we believe that attempting to pick good funds that can be held for the long haul is a fool's errand. That's why we "upgrade" among the current performance leaders. During the same almost-18 year period, SMI's Fund Upgrading portfolio returned 10.4% per year, which would have grown a starting portfolio of $100,000 to $575,000. That's $251,000 more than the portfolio made up of "funds to hold forever."
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Vanguard, now America's largest mutual-fund company, is making its lowest-fee fund class available to more investors. The Associated Press has the story:
[Vanguard] is reducing the minimum investment amount to qualify for its Admiral share class, which charges lower investment expenses than its Investor mutual fund shares.
The biggest cuts affect Vanguard's index funds.... Investors who previously needed to invest at least $100,000 to qualify for Admiral shares can now get in with just $10,000 for Vanguard index funds....
For example, Admiral shares of Vanguard's Total Stock Market Index Fund will charge $7 in annual expenses for every $1,000 invested, provided an investor has at least $10,000 in the fund. That's down from $18 in annual expenses for Investor shares....
For Vanguard's...actively managed funds, the new investment minimum for Admiral shares is $50,000 instead of $100,000.
The company "will be converting qualifying accounts to Admiral shares in coming months," the AP notes, a change that could affect almost 2 million Vanguard customers.
This latest policy change continues a series of pricing/availability modifications in the fund industry that have been good news for consumers. Earlier, Vanguard launched commission-free trades for Vanguard-branded ETFs and created new ETFs that mirror some of the company's top mutual funds, but with lower expenses. Schwab has made similar moves, as has Fidelity.
In this article, AP personal finance writer Mark Jewell refers to Vanguard as "the Wal-Mart of investing. It manages more money than any other mutual fund company, so it has tremendous pricing power. When it makes a move, competitors feel pressure to follow suit."
So stay tuned.
A five-star mutual fund isn't like a five-star movie. A great film from 2007 is still a great film. But a mutual fund that was stellar a few years ago may be a laggard today.
Even so, many investors select funds the way they select films. The look to the "star" system to make a decision. (The star system for mutual funds [PDF] was developed in the 1980s by Morningstar and revised in 2002.)
As Marketwatch reports, "looking to the stars" almost guarantees underperformance.
In meeting after meeting earlier this year, [Tim Courtney] and his colleagues at Burns Advisory Group had recommended mutual funds to prospective clients, only to be hit with the same response almost every time: Why are you telling me to invest in a three-star rated fund?
That sums up the way many investors allocate money to funds — look at products that have four- or five-star ratings from investment researcher Morningstar Inc., take that as a seal of quality, and hope for the best. Such decisions are perhaps even more common in volatile markets, when anxious investors view top-ranked funds as somehow better-equipped to handle adversity....
The trouble is that investors seem to forget that star ratings are backward-looking, based on a fund's past performance, and studies have shown the ratings have no predictive value....
Courtney and his colleagues went back to Dec. 31, 1999 and studied the subsequent 10-year performance of five-star rated funds. What he found might convince investors to kick their star-rating habit.
Of the 248 stock funds with five-star ratings at the start of the period, just four still kept that rank after 10 years. And the 218 domestic stock funds with the rating typically lagged their category averages over the period — not just the benchmarks, but other mutual funds....
In other words, it's not just that five-star funds don't, on average, continue to lead their peers — they actually do worse in subsequent years.
At SMI, we don't let stars get in our eyes. Instead, our Fund Upgrading methodology gauges how a fund is performing now by looking at its most recent performance (within the past 12 months). This is fundamentally different from Morningstar's star system, which focuses on longer-term (3-, 5-, and 10-year past performance). Upgrading leads us to the best current performers, regardless of how many stars these particular funds have by their names in the Morningstar database.
Consider this overview of our current universe of 20 mutual-fund recommendations:
- Five-star funds: 3
- Four-star funds: 6
- Three-star funds: 4
- Two-star funds: 7
As you can see, 17 (85%) of our current Upgrading recommendations rate fewer than five stars — 11 of them (55%) rate fewer than four stars.
The star system is no doubt well-intended, but it leads far too many people to make decisions that yield inferior results. Research has shown that recent past performance tends to persist into the immediate future. It has also shown that longer-term past performance has little — if any — predictive value.
Those stars may be pretty, but they aren't likely to help you choose better funds. Upgrading, on the other hand, is likely to help you choose better funds. And SMI's approach has beaten the market in 10 out of the past 11 years.
Learn more about Fund Upgrading and SMI's other time-tested strategies. And for details on how to become a Sound Mind Investing print subscriber and/or web member, click the sign-up button below.
It's no secret that interest rates for money market funds are scraping bottom. Even the top recommendation in our current money rates table (subscription required) is paying a scant 0.30%. Vanguard Prime, one of the best-known and most popular MMFs available, is yielding a barely noticeable 0.05%.
So is it time to abandon the money-fund ship and move your savings elsewhere?
Russel Kinnel, editor of Morningstar's FundInvestor newsletter (and director of the company's mutual fund research), is advising MMF investors to hang on rather than bailing on MMFs and moving to short-term or ultrashort bond funds.
We're still wary of ultrashort funds [following the implosion of several such funds in 2007 and 2008]. Short-term bond funds can work if some losses in the short run are acceptable — for example, if you are parking money between investments, plan to hold for a year or two, or just want a conservative bond holding in your long-term asset-allocation scheme....
But for other uses, such as emergencies or upcoming big-ticket expenditures, I'd stay with money market funds. Think about what will happen when interest rates start to rise. Bond funds will initially lose money because their superlow-yielding bonds will be discounted in the face of new higher-paying bonds. On the other hand, money market funds will quickly start to have higher yields, yet they won't lose money when rates go back up.
Kinnel concedes that MMFs aren't exciting, "but money market funds are there to serve in an emergency. Insurance always costs you money, and that's how I'd look at money markets."
Another practical matter is simply: Is it worth the trouble to switch? A Los Angeles Times story (titled, "Look, Ma, Nearly No Yield") quotes Peter Crane, head of money-fund research firm Crane Data: "My general rule is, if you're not going to make $100 more [in interest] by switching, don't bother."
Although 2009 was the toughest year on record for money funds, the MMFs recommended by SMI outperformed the overall field (for the 12th year in a row). Details are available for SMI web members in our February Level 2 article.
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