Consistent consistency with mutual funds
Written by Gary Silverman, CFP®
“What’s the best mutual fund to get into?” It’s a question I hear fairly often. And, as most of my regular readers know already, my answer is going to be…wait on it…”It depends.” But how do you choose a mutual fund? Most people check out how well the fund did the previous year, or three years, or however long they want to look.
That method, checking how the mutual fund did over the last year or two, is fraught with problems. The main one being that mutual funds tend not to be consistent. They might follow up two good years with a horrendous one. Most people I know don’t like that horrendous year no matter how many good years come before it.
So folks get a little wiser and instead of looking for how a fund did any one year or even the last five, they start looking for fund consistency. They search out funds that year in and year out provide the performance they want. What they find might not make them all that happy.
A recent study by Morningstar found one bit of good news: active mutual funds were able to put two winning years together fairly consistently. That news is tempered by the fact that very few mutual fund managers beat their respective indexes 4, 5, or 6 years in a row (none did better than 6). Worse yet, statistically the percent that did were less than you’d expect to occur by mere luck.
The article then looks at the Oracle of Omaha, Warren Buffett. Sure enough, just like the fund managers, Buffet also does not beat the stock market consistently. In the last 20 years he’s had one 3-year winning streak. The rest of the time he beats the market one or two years then gets beaten the next.
Yet there is another thing that the average large-cap mutual fund has in common with Buffet. It beats its relevant index across long time periods. It just doesn’t do it consistently. Every fund manager (and every index by that matter) has a particular style—a way of choosing their investments—that they follow. Sometimes the market is good to that style and sometimes it isn’t. That is where the inconsistency comes from…not necessarily from some shortcoming of the fund or index.
Rather than throw your hands up in distress, consider two ways of playing with this information. One way I use it is to let the inconsistent returns be my friend. For example: Find two or three different funds whose styles which look out-of-synch with each other. That way, when one is doing badly the other two might be doing better. An easier way is to just ignore the inconsistencies and ride out the bad times and enjoy the good ones.
This article was published in the Wichita Falls Times Record News on December 6, 2015.