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Tom Madell, Ph.D., is the publisher of Mutual Fund/ETF Research Newsletter, a free newsletter which began publication in 1999. It has become one of the most popular mutual fund/ETF newsletters on the internet, as shown on the Google Directory page for Mutual Funds News and Media Newsletter... More
  • My Long-Term Fund Choices for the Next Five Years
    This article presents which specific funds I believe are among your best bets for holding over the next five years or even longer, and why. While it may not be common practice for investors these days to hold their funds for that long, I believe that the great majority of your portfolio should be anchored in such long-term holdings. This is because studies have shown darting in and out of investments is more likely than not to be a losing strategy.
    While specific funds, just like the overall markets, go through periods of highs and lows, growth of your portfolio is likely more dependent on holding proven outperforming investments over a significant period of time, as opposed to attempting to flee such funds whenever they and the markets suffer from their inevitable dips. While minor tweakings of a portfolio in response to significant economic changes still make some sense, we have found that a far more profitable strategy is to try to identify a handful of specific funds which are among the many potential goods ones available and sticking with them for long enough to allow their superior qualities to shine.
    In selecting certain funds for long-term growth of one's assets, it is important to try to find "all-weather" funds. These funds are funds that you can be confident of holding regardless of whether particular aspects of the economy are relatively weak or strong. While my quarterly Model Portfolio funds, along with their associated allocation percentages, are often chosen in an attempt to maximize performance when considering somewhat shorter economic and cyclical considerations, our long-term recommended funds must meet the test of a high degree of comparative strength regardless of the constant churning of the markets and its many sub-categories.

    I have narrowed down our recommendations to a dozen funds. Of course, there are dozens more funds that might be equally good or even better. But I have found from my personal experience of over 25 years in following funds that the funds listed below have qualities and management teams that should serve their investors very well. By way of disclosure, I personally have a position in each of these funds but otherwise do not have any financial connection to them which might lead me to recommend them.

    Before we present our choices, I want assure possibly skeptical readers that such a list, prepared with many years of obvious investment uncertainties ahead, does indeed have the potential to serve an investor well. After all, five or more years is a long time during which a fund which currently looks so promising can certainly change in terms of
    1. a previously successful manager being unable to repeat his former success, and/or leaving the fund,
    2. investment "style" changes (e.g. no longer focusing on the categories of investments you expected when you purchased it), or
    3. even entirely being phased out of existence, or merged with another fund.
    But in spite of such occurrences, long-term investors can still make out well. In fact, 10 years ago, my Newsletter published a similar list of our long-term recommended funds. (Note: You can see these old recommendations at by going to my website, and clicking on the Dec. ’11 Newsletter which has a more detailed version of this article.)
    Of the 12 stock funds we presented, in addition to the benchmark Vanguard 500 Index Fund (VFINX), 11 still exist (one was merged into a different fund). All but one of the 11 outperformed the benchmark on an annualized basis over the last ten years (the one that trailed did so by only a fraction of a percent). The average margin of outperformance was approximately 3% per year over the period, with one fund ahead by more than 7% per year.
    All four of our then recommended bond funds beat the ten-year annualized return for our benchmark, the Vanguard Total Bond Market Index Fund (VBMFX), by approximately 1.7% per year. (One fund was a muni bond fund whose computed return reflected the after-tax return.)
    Here, then, are our choices as core holdings over the next 5+ years, the reasons we have selected these funds, and data showing how each fund has done over the years (annualized through 11-30-11). The stock funds represent a cross-section of investment categories. We recommend that an investor should hold funds from 3 or more investment categories for proper diversification.
    Stock Funds
    Vanguard 500 Index Fund (VFINX). (Current investment style - Large Blend.) While this fund represents the basic benchmark that we aim to beat, it likely still should be included in many investors' portfolios. Why? Because it still tends to do better than most other funds over long periods. That said, over the last decade, as a group, the large company stocks included in this Index have not done well. But given the current subpar growth environment which is likely to continue, investors who actually invest in individual stocks (as opposed to mutual funds), will more likely want to be in the strong, well-known US companies which make up this Index. Thus, over the last year, the S&P 500 has outperformed all of the other major investment categories and we suspect this may continue for the foreseeable future.
    1 Yr: 7.7%
    3 Yr: 14.0%
    5 Yr: -0.3%
    10 Yr: 2.8%
    15 Yr: 5.2%
    Note: All returns in tables show average per year gains.

    Yacktman Fund (YACKX). (Current investment style - Large Blend, however may switch to emphasize other categories such as Large Value.) This fund has one of the best track records available - over the last 10 calendar years, it has outperformed the S&P 500 Index by an average of about 8% per year. The same primary fund manager has been in place since its 1992 inception. The fund is also one of the most tax-efficient actively managed funds available as a result of low position turnover and thus excellent within a taxable account. It currently holds a near 0% position in international stocks, has a near 10% position in cash, and has over a 50% allocation to stocks considered defensive, that is, tending to show more stable performance in economic slowdowns.
    1 Yr: 10.7
    3 Yr: 24.7
    5 Yr: 8.0
    10 Yr:10.8
    15 Yr: 9.2

    Vanguard Windsor II (VWNFX) (Current investment style - Large Value. Note: This is one of the major fund categories that our site's empirical research has shown has the best potential for outperforming over the next 5 years.) The fund has the original long-time manager in place since the fund's inception (1985). However, it also has several additional independent managers to provide a high degree of diversification. While not likely to be considered a "great" fund, its returns have been consistently good on a long-term basis.
    1 Yr: 8.5
    3 Yr: 13.4
    5 Yr: -1.1
    10 Yr: 4.3
    15 Yr: 6.1

    Fidelity Contrafund (FCNTX). (Current investment style - Large Growth, to an extreme.) Fund manager has been in place since 1990. One of the best long-term track records for its category over the last 10 years. Low risk ("beta") compared to similar funds which means volatility is less than the overall market's. High long-term tax-efficiency for taxable investors meaning returns are not heavily dented by large distributions.
    1 Yr: 4.9
    3 Yr: 15.7
    5 Yr: 2.8
    10 Yr: 7.3
    15 Yr: 8.2
    Fidelity Low Price Stock (FLPSX) (Current investment style - Mid-Cap Blend, although has a history of investing in value-oriented small-cap stocks.) Manager has been in place since inception (1989), although temporarily on leave, due back at beginning of 2012. Fund has a remarkable record of outperforming the S&P 500, although best years of big outperformances were between 2000 and 2005. Currently has a large position in non-US stocks (33%). Manager will raise cash when he deems it necessary. High long-term tax-efficiency in past although some potential capital gains exposure to previous gains for new taxable account investors.
    1 Yr: 6.9
    3 Yr: 22.3
    5 Yr: 2.4
    10 Yr: 9.2
    15 Yr:11.0

    Vanguard Small Cap Growth Index (VISGX). (Investment category - Small Growth.) We recommend this fund as a good choice for those who definitely want to be in US-only, small-cap stocks with a growth orientation (as opposed to FLPSX above). High long-term tax-efficiency and negative capital gains exposure meaning new investors will not get hit with gains distributions achieved before they bought into the fund and may get temporary breaks on upcoming capital gains distributions.
    1 Yr: 6.8
    3 Yr: 24.7
    5 Yr: 3.7
    10 Yr: 8.2
    15 Yr: NA
    Note: Founded 5/21/98

    Vanguard REIT Index (VGSIX)
    (Investment category - Real Estate). Our research shows this category is a definite hold over the next several years. In fact, the same research shows that real estate funds appear to have the best potential of all other major stock fund categories which is the main reason we are including it. The fund has done considerably better than the S&P 500 Index over the last two years.
    1 Yr: 8.5
    3 Yr: 26.5
    5 Yr: -2.3
    10 Yr: 10.0
    15 Yr: 9.3

    Vanguard International Growth (VWIGX) (Current investment style - Foreign Large Growth, however, in past, it has also adopted the Foreign Large Blend style.) Currently, has about a 25% position in emerging market stocks, allowing one to own a single foreign fund getting exposure to both developed and emerging markets. Long-term performance record is near top 10% against similar category foreign funds over the past 5 years. Separate sub-portfolios independently managed by multiple advisors for greater diversification. Good tax-efficiency and negative capital gains exposure.
    1 Yr: -4.2
    3 Yr: 16.3
    5 Yr: -0.8
    10 Yr: 6.2
    15 Yr: 4.8

    Tweedy, Browne Global Value Fund (TBGVX) (Current investment style - Foreign Large Blend.) This is a conservatively-oriented international fund that has in the past emphasized a value approach and has, up through 2008, been more of a small to mid-cap foreign fund. The fund hedges foreign currencies so that, unlike most foreign funds, you do not either lose or gain if the US dollar rises or drops in value. Lately, as a result of instability and high volatility of investments around the world, investors have actually been more prone to favor the US dollar; this has kept a hedged fund such as TBGVX from losing as much as most unhedged funds, such as VWIGX (above). Also, TBGVX has only a small position in emerging market stocks which have done poorly over the past two years. In fact, its long-term performance record is one of the best available for funds of its type. We therefore recommend it for relatively conservative investors and/or to diversify your foreign investments as opposed to investing only in a single foreign fund. Fund also has long-time managers since 1993 inception. Finally, fund’s past tax efficiency over the long-term is extremely high. However, investors buying in now have an elevated capital gains exposure, meaning at some point, when the managers sell some of their positions, there will be bigger than average distributions generated.
    1 Yr: 0.3
    3 Yr: 15.0
    5 Yr: 0.6
    10 Yr: 6.3
    15 Yr: 8.3

    Bond Funds
    PIMCO Total Return Inst (PTTRX) (Current investment style - Intermediate-Term Bond.) This fund is available in many 401(k) or tax-deferred plans. If it is not available there, you can invest in it through a brokerage account such as through Vanguard if you meet a 25K minimum investment. Or, you can invest in the Harbor Bond Fund (HABDX), which is essentially the same fund with slightly higher expenses and a 1K minimum. The strength of this fund rests with its manager, Bill Gross, onboard since its inception in 1987. Further, the PIMCO shop sports weekly "war room" meetings which have been reported as a key feature of its attempts to stay at the top of the bond investment world. Apparently, views change regularly as the fund reports a yearly turnover rate of over 400%. The fund's long-term performance results have been top-rate, in the top 1% of similar funds over the past 15 years. However, recently, performance has hit a "soft spot" pushing its one year return to a mere 1.8%, which is near the bottom tenth of its competition. Frankly, we're not sure what has harmed performance so badly over the last year, but we suspect it had not only to do with avoidance of US treasuries but too high an allocation to cash at times during this year (but not now). In any case, we continue to recommend the fund on the assumption it will right itself soon. But it should no longer be seen as a “single solution” fund as it might have been in the past.
    1 Yr: 1.8
    3 Yr: 9.6
    5 Yr: 7.5
    10 Yr: 6.6
    15 Yr: 7.0

    PIMCO Real Return Inst (PRRIX). (Current investment style - Inflation-Protected Bonds.) It has the same availability restrictions as for PTTRX. If not available to you elsewhere, you can also invest in essentially the same fund, Harbor Real Return (HARRX), with a 1K minimum. The fund has a good long-term track record with a highly qualified manager who has been with the fund for about 4 years. You might wonder why we would include this fund as an "all-weather fund" given its focus on government inflation-protected bonds. If one does not particularly expect inflation to be an issue in the years ahead, it might make more sense to invest in ordinary treasury bonds. However, since ordinary treasury bonds seem to have little return potential looking forward (interest rates already at multi-generational lows), we think that this fund offers better potential. Apparently, many investors remain worried about inflation down the road and continue to favor this category, which may enhance its performance.
    1 Yr: 9.2
    3 Yr: 15.2
    5 Yr: 7.7
    10 Yr: 7.7
    15 Yr: NA
    Note: Founded 1/29/1997

    Vanguard Total Bond Market Index Fund (VBMFX)
    . (Current investment style - Intermediate-Term Bond.) The main thing that can be said about this fund is that it will give you exposure to the broad bond market at minimal cost. Its results have been quite consistent year after year and it tends to beat the average bond fund. For example, over the last 5 years, it has achieved the annualized return shown below, while the average taxable US bond fund has returned only 4.0%. The downside is that it is invested heavily (70%) in US government bonds which will suffer if interest rates head upward in the years ahead which seems likely.
    1 Yr: 5.2
    3 Yr: 7.4
    5 Yr: 6.1
    10 Yr: 5.3
    15 Yr: 6.0

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: I have a long-term position in all funds mentioned.
    Dec 02 3:52 PM | Link | Comment!
  • Why Successful Investing Is 90% Psychological

    I used to think that successful investing mainly involved how astute one was at analyzing economic and financial matters and only involved psychology to a small degree. I am now convinced that it is the other way around: Successful investing involves only a small amount of economic and financial insight, but rather is mainly determined by one's willingness to use psychology as a means of gaining a huge advantage over most other investors.

    But what exactly do I mean by "psychology" as it applies to investing and how does it differ from the types of analyses that most investors use?

    By psychology, I am not necessarily referring to principles learned in an academic study of psychology. Rather, almost anyone can understand and apply the principles of psychology that I am referring to, even without any formal background in the subject.

    Investor "Mindsets"

    As I use the word, psychology refers to an analysis of the mindsets of the typical investor. Mindsets are nothing more than a commonly held set of beliefs that investors bring with them as they decide if, when, where (which investments), and how (e.g. conservative vs. aggressive, buy-and-hold vs. a more active approach) they will invest in the market. Such beliefs are usually acquired through prior experience in investing, what is presented in the media, or exposure to something akin to "folk wisdom" propagated down through the years.

    But how helpful are the most prevalent mindsets in guiding investors and actually promoting success? I would argue they are not particularly beneficial at all. If not, it therefore behooves investors to examine their own beliefs and those of the majority of funds investors in an attempt to understand plausible, but in reality, primarily misguided mindset thinking. Those who do will find themselves potentially able to profit as a result being able to detect the performance-damaging tendencies within those mindsets.

    Which mindsets are most common? Here is my list:

    1. The degree of strength of the economy, as well the stock market itself, should be one's primary guideline for decisions as to when to buy or sell stocks.
    2. Yields available from cash, CDs, or bonds should be a good guide as to not only when to keep your money in these investments, but also when to forgo these investments in favor of stocks.
    3. A current high degree of volatility of stocks may suggest not investing in stocks for the foreseeable future.
    4. Similar but not the same as 3, proximity to "market crashes" should be a good reason to defer investing in stocks for a considerable period, if not forever.
    5. Similar but not the same as 1, you should be able get a good sense of how the stock market has been doing by attending regularly to reports on the performance of the most widely reported stock index, the Dow Jones Industrial Average.

    For those who might be taking just a rapid glance at this article, let me be perfectly clear upfront: Adhering to any or all of the above beliefs can seriously impair your chances of being successful as an investor.

    If I have already begun to step on a few toes by suggesting that widely held beliefs among the majority of investors may have serious flaws, that is indeed my intention.

    It should be noted, first and foremost, that each of the above 5 mindsets tend to imply that success as a funds investor relies to a great deal upon whether you have given at least some attention to, and correctly interpreted the "economic tea leaves" and their presumed implications, thereby enabling you to decide upon a prudent course of investment action.

    Let's elaborate on each of the above mindsets to see why in many, but certainly not in all cases, I question relying heavily on any one or more of these beliefs when making one's investment decisions.

    Strength of the Economy and Stocks

    The strength of the economy and the stock market itself may be an effective guide, but perhaps not much more than 50% of the time. Why? Many of the biggest downturns in the markets occur after the economy and stocks have been doing well for a number of years. And, easily, many of the biggest upturns occur after a recession and a concurrent bear market. Thus, using these measures as data points tend to be most successful in the early stages of an downturn or upturn, but will likely fail in the latter stages. Even so, how is it possible to know how long such downturns and upturns will last to identify such stages?

    A corollary of the above belief is the notion that strong economic growth equates with good stock returns, and vice versa. A recent article in the Wall Street Journal should dispel investors' confidence in that regard. It reports research going back over 100 years focusing on stock returns in 16 major countries including the U.S. The findings: Rates of growth as measured by gross domestic product are not readily discernible as a predictor of stock returns. Thus, last year's stampede by investors into emerging market funds based on superior growth prospects has not yet been rewarded by superior returns and may actually severely underperform US stocks for a considerable period.

    Forgo Stocks When Rates Are High, and Vice Versa

    Many investors believe that so long as they can get a reasonably high return from bonds, CDs, and money market accounts, they do not need to take on a considerably higher degree of risk by focusing on the stock market instead. But in times such as now when rates are near record lows, they believe that their available relatively less risky returns are so much lower than normal that sticking with these investments no longer makes sense. Thus, they tend to become stock market "converts." While such thinking can initially help investors to improve their returns from what they perceive to be unacceptably low rates, it may run the risk of increasing exposure to stocks when rates are near cyclical lows. If so and rates start to rise more than expected, this might not prove to be such a good entry point after all.

    In truth, level of rates of return available may be much more immaterial than most people think. Usually when interest rates are high, unlike now, inflation tends to be high as well. Say you could make 6% in a money market or bond fund. If so, many people might think why gamble on the stock market. But if rates turn considerably higher than today's low rates, inflation is likely going to be considerably higher than now too. So if inflation simultaneously rises to say 4.5%, when you subtract out inflation from what you thought was a respectable 6% return, your "real" return may now become about the same as when available rates are at 2.5% and inflation is at 1%, that is, 1.5%. Thus, the 6% "available" environment may be no different than the 2.5% "available" one because one's inflation-adjusted return (i.e. spending power) is the same. Conclusion: While the income-seeking investor may feel worse off when rates are low, there may actually be little practical difference as compared to when rates (and inflation) are both higher as well; therefore, one should think twice before becoming a stock convert just because rates are low.

    Volatility as a Deterrent

    It can certainly appear to make good sense to avoid a highly volatile market. Why expose yourself to the possibility of even greater losses than might typically be the case? But volatility, while certainly "scary," should mainly be of concern if you are short-term oriented, rather than a long-term investor. Thus, it should be of little practical significance to you if your investment goes down, say 20%, in the next 6 months if you intend to be a holder for the next 5 years or more. Assuming the average long-term return for stocks is about 9% annually, this knowledge should be a better guide to making investment decisions than being overly concerned where stocks might go in the short run.

    Why else do investors react so negatively to volatility to the extent of possibly avoiding exposure to stocks even during a long-term rising market as we have been witnessing since early 2009? Studies have shown that people have a much greater aversion to losing money than they do to the prospect of making it. Thus, even in spite of a doubling in stock prices lately, many investors will stay out of stocks because they may envision the possibility of the pain short-term losses which they are not confident they can withstand and just ride out. But if one adopts a more positive mindset, it becomes apparent that one can never make anything by investing over the longer term without exposing oneself to price drops over the shorter term which do not have to realized (i.e. "paper losses" turned into real losses).

    "I Will Not Be There During Another Market Crash"

    It is a well-known fact that a large number investors will remain spooked for many years following a "market crash." But realistically, such an event or even multiple crashes such as during the prior decade should have little bearing on a truly rational investor's actions. Why? Because past performance is not a reliable indication of what lies ahead. In fact, as suggested above, buying after a crash usually turns out to be far more profitable than buying after a huge market run-up.

    Since a crash is actually a rare event (in spite of what happened in the last decade), it likely makes sense to view the occurrence of one as an event that may actually diminish the prospect of future ones (at least for quite a while). A good analogy might be the occurrence of a highly destructive earthquake on the California San Andreas fault. While rare, scientists believe that a huge quake serves to relieve the built up pressure within the earth. As a result, Californians who actually get through a "big one" may wind up better off even though they may not feel that way immediately. Market crashes, like earthquakes, do serve their "purpose" - they remove excesses and return things to a more sustainable state.

    "The Stock Market"

    Over and over, one hears the phrase "the stock market." For example, look at this question: How did "the stock market" do last year and over the last decade? For most investors, there would be a single answer to each part of the question: Moderately good last year, but pretty meager over the last decade. But do these answers really capture the wide array of possible outcomes for investors? The answer is "not hardly at all." Why not? Because it is difficult to come up with a single index of how "the stock market" has been doing. And if one's thoughts are narrowed by the phrase "the stock market," this may foster failing to recognize outstanding, but less obvious opportunities, in what is in reality "a "multi-faceted stock market." Of course, the same is true for the phrase "the bond market."

    Consider this: Last year (2010), the Dow Jones Industrial Average was up 14.1%. However, over the entire decade, the annualized total return was only 3.2%. If you use these numbers to guide your investing decisions, it might suggest that while investing in stocks was reasonably profitable last year, when considered over a 10 year span (that included 2010's results), you could easily conclude it was hardly worth bothering. But such a "wholistic" appraisal of stock returns misses the fact that investors had many opportunities to do considerably better. Investors in small, mid-cap funds, and real estate funds had returns averaging about 26-27% last year, while those in gold-oriented funds 43.6%. And over the decade, investors in emerging market funds, Asia/Pacific, natural resources, and gold funds earned anywhere from 9 to 25% per year. Thus, rather than merely viewing the stock market as a single entity that is doing either well or not so well, it makes far more sense to be aware that there are actually many markets, each with their own investment prospects.

    Conclusion: Thought Processes Are Crucial Determinants of Investor Success

    All of the above "mindsets" or ways of thinking can have a significant bearing, predominantly negative, on the results that any given investor will achieve. This is because each may lead to an appraisal of what appears to make the most sense, when a closer look might suggest little of the expected relationship, or even the opposite, as what the mindset predisposes us to believe.

    In fact, you might say that much of what one does when investing, and why one does it, can be regarded as "psychological," that is, highly influenced by your own predispositions. This would suggest that the opportunity for improving one's overall chances of, as well as degree of, success lies far more within one's own hands than most investors realize.

    In other words, if you would like to be more successful as an investor, examine what you and others are thinking inside their own heads, that is, "psychology," rather than mainly assuming that you can do better only if you learn more about the world of finance, economics, and an assortment of fund data. This is also a far better "mindset" than assuming that little can be done to improve investment success or that it is mainly determined by luck or chance, and therefore, doing little to try to improve it.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Feb 27 6:43 PM | Link | Comment!
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