42. The Best Investment Advice

My friend Barrett pointed me out to this interesting New York Times article, The Best Investing Advice? Maybe Not the Conventional Method. DAL Investments analyzed the returns on 306 mutual funds for The New York Times.

The 306 funds in the study were founded before 1989 and still exist, which in my opinion already tilts the analysis in favor of active funds: fund managers routinely close under-performing funds. Selecting only funds that survived for 22 years creates a bias by removing all the ones that were deemed two dismal to attract customers. (Watch out next time you read an ad that says something like "all of our 12 funds have outperformed the S&P 500 index in the last 10 years". Perhaps they started with a 100 funds 10 years ago.)

Still, even with this sample, none of the funds beat the index consistently; none of the "star managers" picked up the right strategy every year; they all had good years, bad years and catastrophic years; and at the end, their average performance was just that - average, or less than that. Of course, looking back at the funds you can find the "best performing one" and the "best fund manager" - but that would be true for monkeys drawing darts at the Wall Street Journal stock charts. The fund with the lowest expenses, the Fidelity Spartan 500 Index fund, was ranked 161^th, with average annual return of 7.58%, more of less in the middle of the pack.

Although DAL did not find a direct correlation between expenses and returns, it is interesting (but not surprising to readers of this column) that the two worst-performing funds, the Stonebridge Institutional Small-Cap Growth Fund and Midas Magic, did charge the highest fees in the study at 3.4 and 3.84 percent. Their annual returns were 2.66% and 0.58%. On the other hand, they did make the fund managers gloriously rich - so at least someone was happy.

More careful analysis (such as done by John Bogle) that accounts for the selection bias shows that 60-70% of funds underperform the index they try to beat. For me, average is still good. But if you like more risk taking and betting on new and exciting strategies, this article contains an interesting option: a fund that follows "hot trends", selling "losing funds" and buying "winners". Of course, you'll pay through the teeth with expenses and short-term capital gain tax. But you should trust DAL - I'm sure that their recommendation to invest in this fund has nothing to do with the identity of the fund manager. Wonder who this is? Read the article! As for me, I'll stick with my index funds.