I wanted to share with readers a fund that has performed well on a risk-adjusted basis through the years and is also a fund that I tend to use as a default when I am unsure where to invest. For the sake of this article, risk is defined as deviation from an expected outcome. The expected outcome is an 8% annualized return. The different funds are the options taken to achieve the expected outcome.
Here is the hypothetical situation. Pretend you are Joe Schmo, walking to work on a bright morning on January 1, 2007. You arrive and sitting at your desk are five long-term (beyond 10 year) investment options for your starting capital of $250,000. Your expectation based on what peers tell you is that the stock market averages an 8% return each year. Go through each option and decide whether or not this is what you would select to achieve the 8% a year you desire.
Option A: The S&P 500 Broad Exposure ETF (SPY)
Commonly quoted, the is a diversified exposure to the U.S. stock market and is often viewed as a sign of overall economic health. Many funds track against the S&P 500 as a standard benchmark even though they may take on additional risk to achieve greater returns. Since you believe everything that you hear with little skepticism - you may blindly choose this because this is the general market referred to and it may reach your 8% a year dream with the lowest possible risk.
Option B: Fidelity Growth Company (FDGRX)
This is an actively traded mutual fund under the fund management of Steven S Wymer who has taken care of this fund since 1997. The fund has a $2,500 minimum investment, annual expense ratio of 0.88%, and holds $36 billion in assets. There are no hidden fees or special items - this is a solid growth fund that has been around for quite some time. The turnover rate is low at 18%, meaning you won't have much of a tax burden by holding this over extended periods.
Option C: American Funds Growth Fund of America - A (AGTHX)
This fund is actively managed by 12 fund managers with over $130 billion in assets, a 0.65% expense ratio, and can invest internationally up to a maximum of 25% of the assets of the portfolio (which I find ironic considering the fund has America in its name). The fee schedule indicates that for an investment of $250,000 there is a 2.5% load fee.
Option D: Vanguard Wellington Admiral (VWENX)
This is an actively managed large cap value fund mixed with fixed income securities. The balance is essentially 70% dividend stocks and 30% fixed income (investment grade corporate bonds, T-bills, and mortgage-backed securities). The fund has $82 billion in assets, a 0.18% annual expense ratio, and a $50,000 minimum investment. The portfolio managers are Edward P Bousa, CFA (since 2002) and John C Keogh (since 2006).
Option E: Guggenheim S&P 500 Pure Growth ETF (RPG)
This is a passive ETF that targets the fastest growing third of the S&P 500. This fund does not tilt towards growth by market cap, rather, by growth characteristics. Therefore, this fund is slightly more aggressive then its large cap growth counterparts. The fund has just shy of 2 billion in assets, a 0.35% expense ratio, and is currently most heavily weighted in the technology sector.
Based on these above choices - which fund would you pick to achieve the 8% targeted return?
The results are in! Each annual return backs out all fees if you were to have actually invested in the fund (excluding taxes).
Passive Management wins - right?
Well, it turns out that you were unable to meet that 8% per year that everyone talks about. However, any of the choices yielded you a solid annual return and your capital has appreciated. The winner is the Guggenheim S&P pure growth ETF. If you picked this fund to get closer to the 8% desired return, you took on additional risk over the general market with an aggressive tilt, and your investment has paid off. Over the long-term this ETF would be tough to beat, and this ETF is a vehicle to be considered for use in equitizing cash for a competitive investor.
If everyone believed that it is impossible to beat passive investments on a risk adjusted basis, people would all move into passive investments and no money would be actively managed. Thus, prices would no longer reflect intrinsic values and profit opportunities would have the potential to outperform passive counterparts. Money would flow back into active management and poof - the passive versus active debate moves on to another round. So while this exercise proved that passive investing strategies can be lucrative, consider the short window of time this analysis was performed under and also the fact that some portfolio managers have been able to produce risk-adjusted returns well above passive investing.
Ever heard of Peter Lynch? Between 1977 and 1990 he averaged over a 29% annual return. Under the same circumstances presented above - from 2007 - 2016, if Peter Lynch had averaged 29% per year, that would be over $3 million ending balance compared to the 8% a year hypothetical situation which arrived at $539K. More impressively, he still has all of his hair.
Option D - Vanguard Wellington Admiral: This fund appears to be an underperformer at first, until you consider that the mix of this fund is only 70% equity. Based on the risk taken the returns have been terrific. In fact, over a period of 20+ years this investment may average 6 - 7 %, which is close to a steady and stable 8% per year. While many funds in this grouping jumped down over 35% in the economic collapse of 2008, this fund lost 22%. Due to this, more capital was preserved and this set up a good staging ground for the recovery. Warren Buffet was also a big proponent of mixing stocks with fixed income securities and not being 100% invested in either at any given time.
Option C - American Funds Growth of America: This actively managed fund has a load fee which means that right out of the gate the fund has a hurdle to make up for. The opportunity cost of the load fee is more than the load fee itself over the life of the investment. Instead of paying the fee upfront, that money could have been appreciating. This fund is managed by a large team and has international exposure. However, the results are clear that this fund should be on the chopping block.
Option B - Fidelity Growth Fund: This is a core pick if you prefer active management over passive management. During this time frame of 2007 - 2016 only one bear market was experienced. Many investors believe that active managers perform better in a bear market, and worse relative to passive investments when there is a bull market. Considering the market is in a bull market more often than it's in a bear market, I personally would pass over this fund in favor of a lower expense and strong growth characteristics.
Option A - S&P 500 ETF: This is another good option for equitizing cash if you are undecided on a more specific bet. The equal sector weighting is preferred by some when you want exposure to the market but have a neutral mind towards growth and value or sector weightings. Keep in mind the S&P 500 is a market cap weighted index so the fund is still going to be skewed towards the largest companies.
Don't be the Joe Schmo that took one glance at the fund options, made a decision, and moved on to the next item in his daily life. As you notice, the world of investing is filled with options in how to achieve your desired result. Choosing one option is at the opportunity cost of other potential options which will enable you to reach your result with less risk. Be free to step into various categories of investments, mutual funds, ETFs, growth, value, etc., and see which one suits your goals best.
The investment of time now into doing your due diligence is well worth the effort over the years where your investments are able to generate returns. Take the time to examine your funds, look for fees like load fees (which are too late now because most likely you already paid them) and also high expense ratios. Look at who is managing your fund, download a prospectus and read through it - they really aren't that long!
Take the time now, it could be hundreds of thousands of dollars in the future. Best of luck in reaching your financial goals.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.