Tag Archives: etfs

The Hazards Of Over-Diversification In Investment Advice

One thing I have learned over the course of my career is there are never any shortage of opinions or strategies on how you should be investing your nest egg. Everywhere you look there are hedge funds, mutual funds, ETFs, advisors, newsletters, insurance companies, and other fringe “experts” touting their methods. There is no doubt that each approach will have their own benefits and drawbacks. Opportunities and risks will be characterized by security selection, position size, timing, and costs. However, the problem that many investors run into is when they try to implement several divergent paths simultaneously. I had an investor email me the other day and say that they are subscribing to several newsletters in tandem with placing multiple accounts with different investment advisors. He wanted to know more about how we use ETFs – in effect shopping for one more opinion on what he should do with his money . I know his intentions were quite genuine. He is likely thinking that this structure is highly diversified and allows him to cover numerous bases with his investment portfolio. However, the reality is that he is trying to drink from a fire hose of information and absorbing opinions from a wide range of conflicting sources. Some questions immediately come to mind when I think about this common dilemma: How do you decide the weighting of each advisors’ opinion or strategy? What systems are you actually using and which ones are just there for “market research”? Are you increasing your overall costs by implementing all these services continually? Do each of these services enhance your total return or are they just giving you something to do? Are you just needlessly searching for the holy grail of strategists that will outperform in every market environment? (hint: they don’t exist) In any group of 4 or 5 advisors, there are probably going to be at least one that is taking a contrarian viewpoint and possibly even implementing that in their recommendations. That means you are likely absorbing opposing views that will erode your confidence in sticking with a simple and reliable plan . Let me tell you from experience what will happen. You see one guy tell you to buy bonds as a core allocation and shock absorber for your portfolio. The next guy tells you that rising rates are going to destroy the foundation of the American economy. The only reasonable course of action then is to do absolutely nothing – and you will. Sitting in cash fretting about which person to believe and then only likely implementing the correct answer long after the move has been made. The funny thing is that both of these recommendations will likely be right at some point. The problem is that we only know which one (and when) with the clarity of hindsight. Or worse, you end up going long bonds in one account and short bonds in another account, which effectively offsets both trades. There is nothing quite like the experience of paying to go nowhere. The same can be said of stocks as well. I read three articles last week talking about how consumer staples stocks were risky because of their high relative valuations. This morning I woke up to an explanation of how consumer staples are historically some of the best stocks to own during the summer months. It’s that kind of conflicting advice that permeates this industry. One argument is fundamentally driven, while the other is data-driven. Both have their own merits. Who do you believe? There Is An Easier Way My best advice is to pare down the number of advisors with a substantial influence on your portfolio. One or two professionals that have proven their worth through your experience or research should be enough to guide you through the best and worst of times. This should also include tuning out the noise of the media and allowing a specific philosophy a reasonable time to work. I’m not here to advocate for the “best strategy” because everyone has a different philosophy, risk tolerance, goals, and experience. There are many different ways you can make money in the market as long as you realize the benefits and drawbacks of your specific method. My personal view is that you should be focusing on a relatively simple framework using low-cost ETFs as core holdings. You can easily customize a well-honed list of funds to your specific needs and make small adjustments over time as conditions warrant. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.

How To Predict Fund Performance (Podcast)

By Ronald Delegge The phrase “past performance is not an indicator of future performance” is a frequently written and spoken legal disclaimer for virtually all investments sold by Wall Street. Yet, hardly anyone from individual investors all the way to investment sales people really act like they believe it. Asset flows inevitably gravitate into funds with the hottest historical performance. And if a fund happens to be christened with a 4 or 5-star rating, the money really pours in. In fact, the very first thing that retail investors and professionals infatuate themselves with is historical performance. The herd mentality with picking mutual funds goes something like this: “The _____________ (fill in the blank) fund has easily outperformed the S&P 500 (NYSEARCA: VOO ) over the past ____________ (fill in the blank) years. It’s a proven winner!” And that’s generally how buy decisions are made. Never mind how the fund’s benchmark is irrelevant or how much risk the fund actually takes or how much the fund charges. None of these petty details matter to the historical performance enamored investor. Yet, people who focus exclusively on past performance are doomed to future underperformance. It’s one of those predictable ironies, that’s confirmed in new research from Morningstar. The study highlights the mistake of emphasizing historical performance. “While we think it makes sense to consider a variety of factors when choosing funds, our research continues to find that fund fees are a strong and dependable predictor of future success,” said Russel Kinnel, chair of Morningstar’s North America ratings committee. In other words, historical performance isn’t a determining factor in future returns. Kinnel added, “We found that the cheapest funds were at least two to three times more likely to succeed than the priciest funds. Strikingly, our finding held across virtually every asset class and time period we examined, which clearly indicates that investors should keep cost in mind no matter what type of fund they are considering.” (You can listen to Ron DeLegge’s full podcast interview with Russel Kinnel on the Index Investing Show. ) Highlights of the Morningstar study include: The lowest-cost U.S. stock funds succeeded three times as often as the highest-cost funds. The least-expensive quintile had a total return success rate of 62%, compared with 48% for the second-cheapest quintile, 39% for the middle quintile, 30% for the second-priciest quintile, and 20% for the most-expensive quintile. International-equity funds had a 51% success ratio for the least-expensive quintile compared with 21% for the most-expensive quintile. Among taxable-bond funds (NYSEARCA: BND ), the least-expensive quintile delivered a 59% success rate versus 17% for the most-expensive quintile. Municipal bond funds (NYSEARCA: MUB ) showed a similar pattern, with a 56% success rate for the least-expensive quintile and 16% for the most-expensive quintile. Disclosure: No positions Link to the original post on ETFguide.com

How To Find The Best Sector Mutual Funds: Q1’16

Finding the best mutual funds is an increasingly difficult task in a world with so many to choose from. How can you pick with so many choices available? Don’t Trust Mutual Fund Labels There are at least 242 different Financials mutual funds and at least 647 mutual funds across ten sectors. Do investors need 64+ choices on average per sector? How different can the mutual funds be? Those 242 Financials mutual funds are very different. With anywhere from 22 to 571 holdings, many of these Financials mutual funds have drastically different portfolios, creating drastically different investment implications. The same is true for the mutual funds in any other sector, as each offers a very different mix of good and bad stocks. Consumer Staples ranks first for stock selection. Utilities ranks last. Details on the Best & Worst mutual funds in each sector are here . A Recipe for Paralysis By Analysis We think the large number of Financials (or any other) sector mutual funds hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many mutual funds. Analyzing mutual funds, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each mutual fund. As stated above, that can be as many as 571 stocks, and sometimes even more, for one mutual fund. Any investor focused on fulfilling fiduciary duties recognizes that analyzing the holdings of a mutual fund is critical to finding the best mutual fund. Figure 1 shows our top rated mutual fund for each sector. Figure 1: The Best Mutual Fund in Each Sector Click to enlarge Sources: New Constructs, LLC and company filings The Fidelity Select Communications Equipment Portfolio (MUTF: FSDCX ) ranks first, the Davis Financial Fund (MUTF: DVFYX ) ranks second, and the Fidelity Select Health Care Services Portfolio (MUTF: FSHCX ) ranks third. The ICON Natural Resources Fund (MUTF: ICBMX ) ranks last. How to Avoid “The Danger Within” Why do you need to know the holdings of mutual funds before you buy? You need to be sure you do not buy a fund that might blow up. Buying a fund without analyzing its holdings is like buying a stock without analyzing its business and finances. No matter how cheap, if it holds bad stocks, the mutual fund’s performance will be bad. Don’t just take my word for it, see what Barron’s says on this matter. PERFORMANCE OF FUND’S HOLDINGS = PERFORMANCE OF FUND If Only Investors Could Find Funds Rated by Their Holdings… The Davis Financial Fund (DFVYX) is the top-rated Financials mutual fund and the overall best fund of the 571 sector mutual funds that we cover. The worst mutual fund in Figure 1 is the American Century Quantitative Equity Utilities Fund (MUTF: BULIX ), which gets a Dangerous rating. One would think mutual fund providers could do better for this sector. Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.