I’ve been hurt by mutual funds, and I’ve been helped. (Sound familiar?) Looking back over nearly 40 years of experience, though, I can say that only a few actively managed equity funds — funds run by a real, live person, not a computer — perform well enough to justify hanging on to them over the long haul.
That may seem like discouraging news, but it’s actually a blessing in disguise. To make money in the stock market with mutual funds, you don’t need to assemble a portfolio of dozens of funds. You don’t need to trade in and out constantly. All you need is a handful of funds with a structure and a strategy that set them up for long-term success.
By structure, I mean both cost structure and management structure. To keep costs down, I insist, almost without exception, on no-load funds — those that impose no up-front charge to buy shares (and preferably, no redemption fee on the way out, either). I also favor funds with operating costs below the peer average. As a rule of thumb, a fund that invests primarily in U.S. stocks shouldn’t charge more than about $1 a year per $100 invested.
There are two basic forms of management structure in the fund business. Some funds are run by an individual, others by a team. Either structure can work. If you choose a fund with a single manager, however, he or she should be part of a larger organization that can quickly tap a successor, if necessary.
The Key to Making More, Losing Less
Strategy is really what separates the long-term winners from the also-rans. You can often learn important details about a fund’s strategy by reading shareholder reports, media interviews with the portfolio manager, etc. But there’s an easier way: Study the results.
I’m not talking about crude performance numbers. Any fool can roll up big gains in a speculative boom like the Internet mania of 1999. I look for funds that beat the market and beat their peers, yes; but also with less risk than the market and their peers.
The acid test was 2008. The S&P 500, with dividends reinvested, lost a nightmarish 37% that year. A fund with an effective value-and-safety strategy should have lost 5%-10% less than the market during that episode.
Morningstar and Yahoo! Finance provide this information free of charge. If you unearth a fund that has generated superior returns over the past five years while losing substantially less than the market in 2008, you’ve got powerful evidence of a strategy that will succeed over the long run.
4 Low-Risk, High-Performance Mutual Funds
All four are no-load funds available without a transaction fee through leading discount brokers. A couple of the funds also feature a low initial minimum of $1,000 — ideal if you’re just starting out as an investor.
Ave Maria Rising Dividends (MUTF:AVEDX); 888-726-9331; $1,000 minimum. AVEDX invests at least 80% of its net assets in the common stocks of dividend-paying companies that are expected to raise their dividends over time and whose practices don’t conflict with Catholic teaching. The fund has two co-managers and has trounced the market as well as Large-Cap Blend peers with less risk over the past five years. It made up all its 2008 losses by the first quarter of 2010. Dividend yield: 1.4%; 3-year annualized return as of 8/20/12: 15.9%.
FMI Large Cap (MUTF:FMIHX); 800-811-5311; $1,000 minimum). FMIHX’s concentrated portfolio emphasizes high-quality, entrenched franchises. The fund is team managed and is appropriate for investors of all ages and income brackets. It has a 10-year history of outpacing both the market and Large-Cap Blend rivals, with less risk. And like AVEDX, FMIHZ recouped all of its 2008 losses by the first quarter of 2010. Dividend yield: 1.04%; 3-year annualized return as of 8/20/12: 13.5%.
Northern Income Equity (MUTF:NOIEX); 800-595-9111; $2,500 minimum. The most conservative of the four funds, NOIEX seeks to provide a high level of current income with long-term capital appreciation as a secondary objective. NOIEX’s unusual portfolio combines common stocks and convertible securities for improved yield. The fund is managed by seasoned portfolio manager Jackie Benson, who is backed by a large organization, enhancing the likelihood of strategic continuity. NOIEX topped the market as well as Large-Cap Value peers, with less risk, over past the 10 years. It recovered all 2008 losses by the fourth quarter of 2010. Dividend yield: 2%; 3-year annualized return as of 8/20/12: 13.5%.
Parnassus Equity Income (MUTF:PRBLX); 800-899-3505; $2,000 minimum. PRBLX seeks to achieve both capital appreciation and current income by investing primarily in a diversified portfolio of equity securities. This socially conscious fund avoids “sin stocks,” favors companies with strong records on environmental stewardship, hiring of women/minorities and charitable giving. It is co-managed and has a 10-year record of beating both the market and the Large-Cap Blend category. PRBLX has the best reward-risk ratio, through full market cycle (mid-2007 to present), of all funds on this list. It regained all of its 2008 losses by the first quarter of 2010. Dividend yield: 1.12%; 3-year annualized return as of 8/20/12: 13.7%.