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5 Classic Mistakes Investors Make & How to Avoid Them
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  • The Truth about Mutual Funds: Fees Vs. Returns

    There’s a lot frustration and disappointment with mutual funds. For many retail investors, it feels like mutual funds have been a huge let down and haven’t delivered returns.

    This has resulted in a great number of investors questioning the value of having their money professionally managed. Here, we take a deeper look at equity mutual fund managers’ earnings compared to the value they have delivered for investors.

    Note: We’re purely focusing on mutual funds that invest in stocks or a hybrid of stocks and bonds. These funds will be referred to as ‘Equity Mutual Funds’ in this post. This analysis doesn’t include bond funds or money market funds.

    Mutual Fund Manager’s Earnings

    Mutual funds generate income from a few different streams, including:

    Equity Mutual Funds - History of Fees

    • transaction costs for buying or selling shares of the mutual fund
    • advisory fees
    • marketing and distribution expenses

    These fees are typically passed along to investors by funds taking a percentage of assets under management. These tend to range between 1% and 2% and, for equity mutual funds, have been on a steady decline over the past 20 years (see graph above). While this is good, the ratio of fees to the value mutual funds have delivered may be unbalanced.

    From 2000-2010, equity mutual funds earned $603.53 billion in fees.

    (Click here to Tweet the above factoid)

    Let’s dig a little deeper by looking at the value that mutual funds have delivered for investors.

    Investor Returns

    Mutual Fund Returns (2000-2010)

    In the graph on the right, you can see the returns that stock funds have delivered for investors from 2000 to 2010. In total, this resulted in an average return of 5.45% ($1,483 billion) per year, over this time period. We chose to look at this figure instead of the compounded return because individual investors often move from one fund to another.

    The average return is actually pretty good considering that during the same period, the S&P 500 delivered a 2.34% average return per year. Now, let’s compare the ratio of fees to returns to see if equity mutual funds returns are worth the fees that come with them.

    Note: The equity mutual fund annual return is after management fees have been paid from the fund.

    Are Equity Mutual Funds Worth it?

    From 2000-2010,
    Fees ($603.53B) +
    Returns ($1,483B) =
    Total Returns ($2,086.53B)
    Fees took up 29% of Total Returns.

    Click to Tweet: “Mutual Fund fees ate up 29% of Total Investor Returns between 2000 and 2010.”

    On the surface, it seems like equity mutual funds are worth it, even if mutual fund managers are taking a lion’s share of the returns.

    However, the reality is that to take advantage of any market outperformance you would have to own a piece of every equity mutual fund out there. For the individual investor, that’s nearly impossible and they’ll never see those strong returns as choosing a fund that will consistently deliver is extremely difficult.

    Caveat Emptor: Consistency is Tough to Find

    The performance of individual equity mutual funds has hardly been predictable. In fact, 50-60% of equity mutual funds underperform the market each year (source). What’s interesting about that is that it’s not the same group funds that are consistently underperforming the market. It changes significantly year to year. This shows that a fund that’s outperforming this year can easily be significantly underperforming the market next year. Therefore, it makes picking funds based on past performance an exercise in futility.

    This is highlighted by Standard & Poors in their most recent Persistence Scorecard. The report [PDF] showed that only 9.72% of large-cap funds, 6.08% of mid-cap funds and 3.27% of small-cap funds consistently outperformed half of all the equity mutual funds over five consecutive 12-month periods.

    This means that less than 10% of equity mutual funds were able to consistently outperform or get close to outperforming the market over a 5 year period. This is a very worrying picture as mutual fund investors often choose their funds based on past performance, when it’s clearly not a reliable indicator.

    The Verdict

    On the whole, equity mutual fund returns have been strong, even with fees being high. However, retail investors most likely haven’t benefited from these returns as the performance of individual funds have been inconsistent. As a result, they have every right to be frustrated and quite frankly, it shows that there’s a broken system. It’s no wonder ETFs are quickly becoming a large part of people’s portfolios.

    If you read this far, you should follow us on TwitterLike us on Facebook or follow our RSS feed.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: SPY, QQQ, DIA
    Jan 20 12:59 PM | Link | Comment!
  • 5 Classic Mistakes Individual Investors Make & How to Avoid Them

    1. Thinking that Stocks are a Better Investment Because the Market has Recovered

    “Risk is always relative to the price paid.” – Seth Klarman

    Stocks are no less risky because the S&P 500 has recovered from its lows. The stock market’s past performance is in no way indicative of the risk of investing in it.

    When determining the risk of an investment, investors need to understand its underlying value. The difference between price and value determine an investment’s risk. This difference is also known as the margin of safety of an investment.

    If a stock’s price is lower than its value, it has a margin of safety thereby lowering its risk. For comparison, a stock whose price is higher than its value has no margin of safety and is therefore higher risk.

    2. Investing Without a Compass

    Many investors buy stocks without knowing the underlying value of the security they’re investing in.

    It’s dangerous because they’re not “investing”. They’re speculating. They might as well put their money on black and hope the roulette gods will be kind to them.

    Speculators risk buying overvalued stocks and selling undervalued stocks. It’s a recipe for financial disaster.

    The solution is investing with a compass.

    They can do this by either learning how to do valuations (Resource) or use a tool like ours (Shameless Plug). It’s the only realistic way to buy low and sell high, and grow your money.

    3. Being Impatient

    “Investing is where you find a few great companies and then sit on your ass.” – Charlie Munger

    It’s a rite of passage for every investor, and we’re sure many professionals make this same mistake: They pay attention to the day-to-day fluctuations of the market.

    This often causes investors to be impatient and sell too early. This could be after the stock has dropped 5% or it’s suddenly run up 15% over the course of a week. Seasoned investors ignore these fluctuations and are patient.

    Patience in investing has two ingredients: 1. Discipline; and 2. Understanding the Intrinsic Value of Stocks.

    When you’re able to combine those two, it’s easier to ignore the day-to-day fluctuations and focus on the long-term horizon.

    For a detailed look at the benefits of buy and hold, see this extensive PDF from Legg Mason Capital Management (Link).

    4. Valuing Wall St.’s Opinion

    The press usually treats the words of Wall Street analysts as the words of God, reporting each day which firms have upgraded or downgraded particular stocks.

    This often causes individual investors to pay attention to Wall Street’s opinion. However, this can be detrimental to their financial health.

    First, over 60% of active fund managers underperform the market (SPIVA). That’s 60% of active fund managers who are at risk of being replaced by an S&P 500 ETF.

    Second, the opinions of Wall Street analysts can often be contrarian indicators.

    Since March 2009, analysts’ favourite stocks have underperformed the market. Whereas, stocks they liked least outperformed the market by 88%. (Bloomberg)

    Lastly, analysts have their firms’ interest at heart, not yours. Their recommendations are often driven by business relationships between their employer and the target company (Harvard Faculty Research).

    5. Trying to Time the Market

    “We have a lot of fun as the bubble blows up, and we all think we are going to get out five minutes before midnight [like Cinderella], but there are no clocks on the wall.”

    – Warren Buffett

    The idea that investors can time the market is certainly seductive. We’ve all tried it at least once, but because “there are no clocks on the wall,” it’s virtually impossible to do with any level of precision. 

    The only variant that works is being, “fearful when others are greedy and greedy when others are fearful.” (Warren Buffett)

    When everyone’s shouting, “This time it’s different,” and acting like the world as we know it is going to end, that’s probably a good time to start buying.

    When authors start writing books about the Dow Jones going to the moon, that’s probably time to start selling.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Jul 18 4:35 PM | Link | Comment!
  • 4 Undervalued Stocks with Consistent Dividends

    The following stocks are highly undervalued according to their Growth Rate (FCF), using a 15% discount rate, and offer investors consistent dividends.  

    Stocks are ranked in order of their Vuru Grade, which ranks stocks based on the quality of the company and its valuation. It has consistently outperformed the market over the past 3, 5, and 10 year periods.

    We hope you’ll use this list as a starting point for your analysis.


    McGraw-hill Ryerson Ltd (MHR.TO)

    MHR.TO publishes and distributes educational and professional products in print and digital formats. They serve post-secondary institutions, elementary and secondary schools and professional readers.


    ·      Excellent CROIC (61.98% in 2010)

    ·      Growing Positive Free Cash Flow (6.53m in 2004 and 22.64m in 2010)

    ·      Gross Margins Increasing (51.01% in 2001 and 61.93% in 2010)


    ·      Overvalued according to Net Current Asset Price

    ·      Highly Competitive Industry (9.39% Net Income Margin in 2010)

    Current Price: $44.00

    Growth Price: $138.66

    Undervalued by 215.13%

    Vuru Grade 90.16. See Full Report Here.


    Educational Development Corporation (EDUC)

    EDUC is a US based trade publisher of educational children’s books. They distribute books through independent consultants who hold book shows at individual homes, book fairs, direct sales and Internet sales.


    ·      Steadily Growing Dividends Yield (0.49% Div. Yield in 2002 and 9.44% Div. Yield in 2011)

    ·      Non-Capital Intensive (18.15% of Profits Spent on Capital Expenditures)



    ·      Declining Return on Equity in the Last 4 Years (15.37% ROE in 2007 to 7.97% ROE in 2011)

    ·      Competitive Industry with Thin Net Income Margins (4.29% Net Income Margin in 2011)

    Current Price: $5.50

    Growth Price: $7.82

    Undervalued by 42.17%

    Vuru Grade 89.73. See Full Report Here.


    Nokia Corporation (NOK)

    Nokia’s mobile division develops mobile products, applications and content. Their other divisions also provide digital map information and other location-based content as well as mobile and fixed network infrastructure.


    ·      Rising Dividend Yield (1.54% in 2001 to 3.97% in 2010)

    ·      Excellent CROIC since 2001

    ·      Satisfactory Pricing Power (30% Gross Margin in 2010)


    ·      Weakening Balance Sheet

    ·      Increasingly Competitive Industry (Net Income Margin 4.36% in 2010)

    Current Price: $6.42

    Growth Price: $12.44

    Undervalued by 93.72%

    Vuru Grade 88.43. See Full Report Here.


    Warwick Valley Telephone Company (WWVY)

    Warwick provides telephone service to customers in New York and New Jersey. They also provide voice over internet protocol, internet and video services in partnership with DIRECTV, INC..


    ·      Strong Balance Sheet (TL-to-TA 0.31 in 2010)

    ·      Growing Positive Free Cash Flow (8.88m in 2004 to 10.80 in 2010)

    ·      Consistently Strong Pricing Power (50.96% Gross Margin in 2010)


    ·      Overvalued According to Stability Price

    ·      Highly Capital Intensive Business (72.84% of Profits Spent on Capital Expenditures)

    Current Price: $14.70

    Growth Price: $20.06

    Undervalued by 36.48%

    Vuru Grade 88.09. See Full Report Here.



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Jul 06 2:41 PM | Link | Comment!
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