Comparisons to Other Mutual Funds Can Be Misleading

Marketing gimmicks in the financial services industry are rampant. Many investors are realizing that they cannot trust wall street as evidenced by the outflow of fund from actively managed funds and inflow to passively managed funds.The main street solution is to own equities, gloablly diversify and rebalance.

Mutual Fund Playas
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Since 100 percent of its retirement funds beat their 5-year Lipper average, investors could believe that T. Rowe Price has found a way to consistently “beat the market”. Is this accurate?Not if you understand how the use of benchmarks can be misleading.

Lipper mutual fund averages are benchmarks that measure the performance of funds in a given category against other funds in that category. The fact that all of the retirement funds managed by T. Rowe Price beat their Lipper averages means they were better than the average performance of the other funds measured by Lipper. While interesting, it tells you nothing about how those funds performed against their benchmark indexes.

Morningstar assigns a benchmark index to each mutual fund it rates. This is the index against which the performance of a given fund can be measured. These indexes are assigned by the Morningstar fund analyst team, based on its Morningstar category. It is the index the Morningstar analyst team believes is the most appropriate benchmark for the Morningstar category.

The performance of a fund against its appropriate index is a more accurate way to evaluate the performance of a mutual fund. Think of it this way. If the average 8th grader can run a 100 yard dash in 20 seconds and your child took 40 seconds, you might be concerned. However, if the only information you had was that your child was better than the average in his class (and the average in his class was 45 seconds), you might believe he was in great shape.

Using data from Morningstar (for example see here), Index Funds Advisors calculated the returns for the five-year period ending December 31, 2011 of the T. Rowe Price Retirement funds against their analyst assigned benchmark. This was the same period used by T. Rowe Price to measure performance against the Lipper average. We measured the performance of all 33 T. Rowe Price Retirement Funds. The results were surprising. None of them equaled (much less beat) their Morningstar analyst assigned benchmark. Underperformance ranged from 0.84 percent to 1.73 percent (annualized). Only twelve of these funds are available for direct purchase by individual investors.

The marketing machine of the major mutual fund families are continuously looking for ways to peddle their funds. Most of these methods are misleading to investors. Armies of lawyers for these funds make sure the wording of the marketing pieces will get their firm into court.

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An Investor Protection Plan

Does your brokerfollow the fiduciary standard or the suitability standard? Brokerage and insurance firms have been fighting the fiduciary standard with zeal. Why?

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Debunk Their “Expertise”A broker who loses a client to index funds typically responds with a dismissive statement indicating that he and his firm have the ability to select “market beating” fund managers. As discussed above, ask him to show you a peer reviewed article demonstrating the reliability of his methodology. In addition, ask him to provide you with a long term (10 years or more) analysis comparing the returns of the proprietary mutual funds of his firm (funds that have the name of the firm as part of the name of the fund) with their Morningstar assigned benchmark. After all, if they can pick superior managers, wouldn’t those managers be running their branded mutual funds? This is another report you are unlikely to receive.

There is an easier way to avoid becoming a victim. Don’t use any retail broker or adviser who tells you they have the ability to “beat the markets”.

If your broker or agent really could beat the market why would they need you? Another question to ask yourself is, if the big brokerage firms really knew who was going to be the best fund manager why do they have over 100 managers?

Please comment or call to discuss how this affects you and your portfolio.

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The Greater Fool Theory and Investing

Stock pickers success has nothing to do with skill and all to do with luck. To succeed in reaching your long term financial goals own the market, globally diversify and rebalance. The final piece is to remain disciplined to your strategy. The formal phrase is the investment policy statement. You will not know if you succeed unless you have a goal and a strategy. Remember predicting the future is for fools.

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You are Picking StocksPicking stocks refers to both the practice of buying individual stocks because you believe they are mispriced, or purchasing actively managed stock mutual funds, where the fund manager attempts to beat a designated benchmark. If you are engaging in either of these activities, you are a participant in the GFT.

Individual and institutional stock pickers assume they can find mispriced (typically underpriced) stocks, hold them and sell them at a profit. If anyone could do this, you would think it would be Bruce Berkowitz, the much lauded manager of the Fairholme Fund. With much fanfare, on Jan. 12, 2010, Morningstar issued a press release naming him the “Domestic-Stock Fund Manager of the Decade.” It noted this was a new award recognizing fund managers who have achieved superior risk-adjusted results over the past 10 years and have an established record of serving shareholders well.”

How did the “Domestic Fund Manager of the Decade” perform in 2011? According to data provided by Morningstar Direct, his fund suffered a staggering loss of 32.4 percent!

Greater fools thought that Berkowitz had the Midas touch that would continue indefinitely. They assumed there would always be buyers at a higher price for stocks picked by him. They were wrong.

If you purchase any actively managed mutual fund, you are engaging in the GFT. One study (reported here) showed the Vanguard Index fund beat 75 percent of designated mutual funds before taxes for the period 1982-1991. The same study found that its after tax return beat 65 out of 71 mutual funds. When you buy these actively managed funds, you are the greater fool.

Stock picking and over weight in gold are two big mistakes investors make. Many are driven by fear and media hype. The best strategy is a risk adjusted globally diversified portfolio. This takes out the guess work as well as the anxiety.

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Morningstar’s Fund Manager of the Year: A Slippery Slope

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There are really only three simple rules to sinvesting successfully..own equities….globally diversify….rebalance. Looking at past performance to determine the best performers and looking for them to repeat is a futile exercise.

Past Performance is no… (You know the rest)Will Danoff, who managed the Fidelity Contrafund, was Domestic Equity Manager of the Year in 2007. In that year, he beat his benchmark by almost eight percent. In 2009, he underperformed his benchmark by almost the same percentage.

Mason Hawkins, who managed Longleaf Partners, won the award in 2006, when he beat his benchmark by 6.17 percent. He underperformed his benchmark by 6.22 percent in 2007 and by 13 percent in 2008.

Every one of the fund managers of the year had subsequent years of some underperformance. Perhaps the worst example is Jim Callinan, the manager of the RS Small Cap Growth fund, who was the 1999 Domestic Equity Manager of the Year. No wonder. His fund beat its benchmark by an unbelievable 140 percent! Then Jim fell off the wagon. In six of the seven ensuing years, he underperformed his benchmark. In the only year he beat it (2004), it was by a measly 0.85 percent.

The Lack of Evidence of Skill

Of the sixteen funds studied, only one fund manager evidenced skill based on a statistical test (the t-test) which determines if the fund’s outperformance was really attributable to skill (with a 95 percent or higher probability) or if it could be explained by luck. Even if you can find a fund manager who passes the test for a finite period of time, it is not a slam dunk that his skill will persist in the future.

Helpful Data from Morningstar

While Morningstar’s “Fund Manager of the Year” awards are likely to mislead investors, other data it provides is worthy of serious consideration. It reported 2011 inflows of passively managed long-term funds of $76.4 billion in 2011. In sharp contrast, actively managed funds had net outflows of $9.4 billion. Clearly, investors are getting the message. Still, the overall market share of actively managed funds, as reported by Morningstar, is 85.2 percent compared to 14.8 percent.

Plan participants need to understand the value of the fund managers in your plan. In a vast majority of cases these actively managed funds add no value. There is evidence that asset allocation is the main determinant of portfolio success.

Please comment or call to discuss how this affects you and your organization.

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Morningstar Should Be Ashamed of Its 401(k) Plan

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If you would like a pension fund like plan for your employees do not follow the Morningstarmethod. Many studies prove that model risk adjusted portfolios far out perform employees choosing their own fund mix.

I feel sorry for Morningstar’s employees. The fund selections represent everything that is wrong with 401(k) plans in this country. Here are some suggestions for Morningstar’s committee. They reflect finance 101. It’s sad the committee is so clueless about them:Your Employees Need Portfolios, not funds.

Very few employees have the ability to put together a risk-adjusted portfolio from a selection of a large number of fund options. Instead of giving them twenty-three funds to choose from, why not offer globally diversified portfolios of stock and bond funds at different risk levels, ranging from conservative to aggressive?

Get rid of all your actively managed mutual funds.

How can you possibly justify having twenty-one actively managed funds and only two index funds as investment options in your plan? You create a lot of the mutual fund data, do you simply ignore it when it comes to the welfare of your employees?

The likelihood of your actively managed funds outperforming their benchmarks over a ten year period is statistically extremely small. Only about five percent of actively managed funds equal their benchmarks over a decade. It’s hard to believe your committee is using past performance as a benchmark. There is precious little data indicating that stellar performance persists. I assume you are familiar with the SEC mandated caveat that “past performance is no guarantee of future results.”

I’m sure your committee believes it’s doing something useful when it engages in the kind of analysis detailed in your article. It really is just wasting time, feeling important and populating your 401(k) plan with expensive funds likely to enrich mutual funds and reduce the returns of participants.

Success in saving for retirement, as well as all INVESTORS, is about managed portfolios not picking the right funds. We are saving for retirement not looking for the latest or hot investment.

Please comment or call to discuss how this affects you and your organization.

  • Plan “Symptoms” that it’s time for a Review (
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The Mutual Fund Industry Is A Huge Scam That Costs Investors Billions Of Dollars A Year

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The best financial advisorsadd value by developing a strategic investment portfolio for each client and keep the client focused on their long term goals. We must protect our future self from our current self. Discipline, with the right strategy, will lead to a successful retirement.

Specifically, year in year out, investors buy funds that have been given 4 and 5 stars by Morningstar and withdraw money from funds that have been given 1 and 2 stars. They do this despite the fact that even Morningstaradmits that the ratings aren’t predictive–that 4 and 5 star funds aren’t likely to do any better in the future than 1 and 2 star funds.What is predictive?


The lower the cost of a fund, the more likely it is to do well in the future (relative to other funds). The higher the cost, meanwhile, the less likely the fund is to do well.  This is one reason that index funds outperform “actively managed funds” (funds with managers paid to pick good stocks and sell bad ones) year after year: The manager’s salary is deducted from the fund’s returns, and most managers aren’t good enough to offset the cost of their salaries and their employer’s profits.

Why don’t financial advisors tell their clients these simple facts?

Because financial advisors like to believe (or pretend) that they can add more value than that–that their acumen and relationships and experience will allow them to select funds that do “better than average.” (Even though index funds do distinctly better than average.) And also because financial advisors are often incented (paid) to recommend certain funds over other funds–and the commissions on high-cost funds are generally higher than those on low-cost index funds.

The best solution for investors saving for retirement is a globally diversified portfolio with low cost funds. More specifically, a portfolio with the risk characteristics relevant to their age and time horizon.

Please comment or call to discuss how this affects you and your company retirement plan.

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Investors Get It Wrong — Again

Warren Buffett with Fisher College of Business...
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Time and time again investors listen to the financial media and make changes based on fear and greed. Remember the financial institutions make mon ey when you move your money. They don’t really care whether you make money or not.

The latest example of investors behaving badly comes from Morningstar. Once again, the past few years saw investors going the wrong way, moving assets from equity funds into bond funds, causing them to miss out on one of the greatest bull marketsever. The following data presents the behavioral gap for the one- and three-year periods ending December 2010:

  • Domestic equity funds — 2.0 percent and 1.3 percent per year, respectively
  • International equity funds — 0.6 percent and 0.8 percent per year, respectively
  • Taxable bond funds — 1.4 percent and 0.5 percent per year, respectively
  • Municipal bond funds — 1.1 percent and 1.5 percent per year, respectively

Investor activity cost tens of billions a year. The only category where the gap was relatively minor was for balanced funds. For both one-year and three-year periods, the gaps were 0.1 percent per year. Perhaps this is an advantage of balanced funds — investors in these funds tend to pay less attention, which the evidence demonstrates is a good thing.

The evidence demonstrates very clearly that investors would benefit greatly from learning from Warren Buffett, who stated in Berkshire Hathaway’s 1991 annual report: “We continue to make more money when snoring than when active.” In other words, at least when it comes to investing, inactivity is usually the better strategy. Remember this the next time you’re tempted to alter your asset allocation in reaction to the market’s latest move.

This is evidence that investors need an adviser’s help to reach their goals. It is not about picking the right mutual fund, annuity or other financial product but rather developing and following a disciplined strategy.

Please comment or call to discuss how this affects you.

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