Do You Want Better Results Trading Funds? Here’s How…
“Let me embrace thee, sour adversity, for wise men say it is the wisest course.” – Shakespeare, The Third Part of King Henry The Sixth
Anyone who has ever been sold a lemon at a used car dealership can tell you what a bitter taste the experience truly was.
While I may not be a automotive expert, I do consider myself an expert in is mutual funds and the stock market. For over three decades the Fabian family has helped investors protect and grow their money by following the trends in the stock market.
Another way we’ve helped investors over the past three decades is by identifying the lemons they may have in their portfolio. Much like a car, a lemon in the investment context is a security that is always breaking down, always in need of repair, and almost never performs the way you thought it would – despite its often hefty price tag.
Because many investors use mutual funds as their primary investment vehicles, I developed what I call the Lemon List. This is a list of the sourest mutual funds out there today. And what do I mean by sour? Let me explain.
The Harsh Taste of a Sour Fund
In the context of mutual fund investing, a sour – or lemon fund – is a fund whose performance has failed to measure up to the standard. However, what we mean by “performance” and “standard” need a bit of explaining before we can continue.
When I say a mutual fund’s performance, I am talking about its average annual return over a given time period. When measuring the performance of a mutual fund, we look at its one-year annual return, its three-year average annual return, and its five-year average annual return.
Looking at mutual fund performance over one year, three years and five years allows us to really see which funds are performing well over several distinct time periods. It also allows us to see which funds are in need of a tune up.
When it comes to the standard by which each fund is judged, you have to compare apples to apples. Or, in this case, you have to compare individual mutual fund performance with that of its benchmark.
We define a mutual fund’s benchmark as the average performance of all of the funds in that mutual fund’s category. In this context, a category means a mutual fund’s objective.
If the objective of a fund is to invest in large-cap growth equities, then that fund will be compared to the average performance of all of the funds with the objective of large-cap growth equities.
Basically, we are comparing specific funds to their category averages. If a fund fails to perform better than the average of all the funds in that category, then we put that fund on the Fabian Lemon List.
Another way to say it is the following: In order for a fund to make it onto the Lemon List, it must under perform its category (objective) average for each of the time frames measured; one year, three years and five years.
Understanding Mutual Funds: The 5 Things You Need to Know
When it comes to really knowing what they own, it’s been my experience that many investors are woefully lacking. There is no reason why this should be the case, particularly with the vast amount of easily accessible and free information available online.
Ask yourself the following questions when it comes to your mutual funds:
1) What is the type or style of the fund? Do you know you the objective of your funds?
2) What is the cost (expense ratio) of the fund?
3) What is its relative performance of your funds?
4) What was the bear market performance of the fund?
5) How does it compare to like exchange-traded funds (ETFs)?
Information Gathering 101
When it comes to answering most of the above questions, your greatest ally is your computer. With just a few simple mouse clicks, you can garner a wealth of information on any mutual fund you own.
Simply follow these easy steps to gain most of the information you need about your mutual funds and ETFs.
Go to: https://finance.yahoo.com
Enter the ticker symbol for the fund or ETF.
To find cost: Click on the “Profile” link and the expense ratio is in the lower right hand corner.
To find performance: Click on the “Performance” link which lists information in table format.
Bear Market: Click on the “Historical Prices” tab and export the data during the last bear market from March 2000 to September 2002. Then calculate the percentage difference between the high in 2000 and the low in 2002.
Sounds easy enough, but I know what you really crave is not just data, but tools you can use to replace any lemon funds you have with funds that are sweet to the taste – and in my opinion, there is nothing sweeter than the taste of ETFs.
From Lemons Into Lemonade
Exchange-traded funds are basically a basket of stocks that usually track a specific index or sector. To put it another way, ETFs are like a homologous species of mutual funds that allow investors to buy into a specific area of the market without all of the hassles, management fees and trading restrictions imposed by traditional mutual funds. You could say that basically, ETFs are a kind of mutual fund without any of the accompanying downsides. The best part about ETFs is the tremendous benefits of ownership. These benefits include much lower fees than mutual funds; greater liquidity; vast selection and instant diversification.
So, now that you know how bullish I am about ETFs, how do you go about turning those sour lemon funds into sweet tasting ETFs?
Well, the essence of turning lemons into lemonade is really quite simple. If you have a lemon fund, all you really need to do is replace it with the ETF that fits your fund’s category.
Let’s take a look at how this is done in the real world. One lemon fund that hit our list in Q1, 2008, was the Fidelity Growth and Income (FGRIX), a fund with a category objective of “large-cap core equity.” As of March 30, 2008, the fund posted a one-year performance of -9.27%. Over three years FGRIX returned 1.73%, and for five years the fund gained 6.55%.
This performance isn’t too bad, until you consider the ETF alternative for large-cap core equity funds. If you would have replaced FGRIX with its ETF alternative – the SPDR S&P 500 (SPY) – your one-year return would have been -5.23%, while your three-year gain would have been 5.75%. Over five years you would have seen an 11.24% return.
As you can see, the performance of SPY trounced that of FGRIX. This superior performance also came at a deep discount. The expense ration for SPY is just 0.08%, while the cost of FGRIX is 0.67%. On a $100,000 investment that translates into just $80 to own SPY, while FGRIX would have cost you $670.
The bottom line here is that you would be much better served by transferring your money from the lemon fund FGRIX to lemonade ETF SPY.
This process of switching from lemons funds into lemonade ETFs holds true for any lemon fund you own, as nearly all fall into one of the categories listed in our Lemon List, which includes the fund objectives and their ETF alternatives.
Here’s the simple formula: Find out if your fund is a lemon; locate its objective; locate its ETF alternative, and get your money into that ETF. That’s how you turn lemons into lemonade.
How sweet it is!
Doug Fabian is Editor of the Successful Investing newsletter, and President of Fabian Wealth Strategies, a fee-only investment advisor specializing in exchange-traded funds. Once a mutual fund advocate, Doug is now recommending ETFs to subscribers of his advisory services; for his managed accounts, and for his own personal accounts. To see if your fund is on the Lemon List, visit www.mutualfundlemonlist.com