I have opened and closed many mutual funds and a few ETFs starting over 30 years ago. And a few of those funds I have even managed to hold on to right up to this day. So, 30 years of making investment decisions must have taught me something, right? Yes, especially since my assets have grown exponentially over that period.
This is not to say that all of my choices always turned out to be the best - not by a long shot. But, as a whole, perhaps I have, in all humility, aptly earned the distinction bestowed upon me of being one of five mutual fund experts worth following for expert commentary by Michael Johnston, co-founder of ETFdb.com, one of the best websites for ETF investors. (Please click here to see the list of experts and the reasons they were selected.)
Summarizing over 30 years of fund investment successes and failures in a brief article such as this will not be an easy task. But I will try to tax my memory, and in some cases, my investment records, to extract a limited number of ideas and strategies that I would say truly made a difference in accumulating wealth (or in going in the opposite direction), not necessarily presented in order from most important to least.
Focus Point #1: Buy and Hold May Be a Great Strategy But It Doesn't Always Work.
I have owned the Vanguard Index 500 Fund (VFINX) continuously since Jan. 1987. Not a bad move since over that period, it has returned approximately 10.2% annualized. (Note: all data mentioned in this article is through June 30, 2017). This means that a $10K investment would have grown to over $190K (disregarding any taxes due.) This is not a misprint; the power of compounding is truly amazing.
But what if, over approximately the same period, I owned the Vanguard U.S. Growth Fund (VWUSX) instead. Now, my annualized return would have been reduced to about 8%, with growth of $10K coming in at $106K. So, while a fund with a return about 8% might still seem to have been worth hanging on to, over a very long period such as this, your current accumulation would have been hugely different in spite of only a little more than a 2% difference in return in this instance (190K vs. 106K).
While it is true that VWUSX is a managed fund and VFINX obviously isn't, I don't think one can use this as a total explanation of the former's underperformance. The fact remains that any investment focus, such as Large Cap Blend stocks (Vanguard Index 500 Fund) vs. Large Cap Growth stocks (Vanguard U.S. Growth Fund) or management style (i.e., passive index vs. actively managed fund), can go in and out of favor for many years on end.
Thus, although from 1987 through 1999, the two funds had grown at very similar rates, between 2000 and 2006, VWUSX ran significantly behind each and every year except in 2005, resulting in its cumulative return trailing VFINX's by about 50% as of the end of 2006 ($45.7K vs. $90.4K). In spite of subsequently having some good comparative years vs. VFINX, the margin or cumulative underperformance only increased up to the present.
Clearly then, if one chooses not to react when a fund underperforms over a number of years, the long-term result from continuously owning that fund can be far worse than if one instead keeps an eye out for systematic underperformance and adjusts their holdings accordingly in the remainder of the period. In this example, given the long-term shortfall of VWUSX, it could never catch up to VFINX and is unlikely to do so indefinitely at this point.
Focus Point #2: Buy Mainly, Although Not Necessarily Exclusively, Vanguard Funds (When At All Possible).
I have owned funds from many of the most well-known fund companies. But down through the years, my best investment results have almost always come from Vanguard.
I'm not sure exactly why this is true. Of course, many Vanguard funds have lower expense ratios and usually trade less than rival fund groups, which certainly helps. But it almost subjectively seems (to me, at least) that Vanguard funds are there to help you make money; many other fund companies, on the other hand, tend to appear to be there mainly to help them make money off of you.
Many investors have told me they don't have Vanguard funds in their company plan lineup. Or, others say they have their money invested with a non-Vanguard brokerage that only allows the purchase of Vanguard funds through that investment company, which probably means that the same Vanguard funds are going to have higher expenses and fees than if you purchased them directly from Vanguard.
To this I say, you always have the option of saving up some extra cash and investing it yourself outside of a company plan directly at Vanguard. And when you retire, or do a rollover, you should exercise the option of moving that money to Vanguard instead of keeping it elsewhere.
But, as good as many Vanguard funds are, there are always times when Vanguard either does not have a certain kind of fund at all or that may be best suited for the years' ahead, or its available funds may be prove to be underperforming. (An example ot this was shown in Focus Point #1.) Therefore, I suggest that one should not assume that just because a fund is offered by Vanguard, and may have very a low expense ratio, does not mean it is going to be the best choice for you.
An excellent example of a non-Vanguard fund that I profited highly from for many, many years, and still do, is the PIMCO Total Return Fund Instit (PTTRX). I have owned this bond fund, first through my 401(k), and then after retirement, through the Vanguard Brokerage.
If we look at the same period as above (Jan. '87 thru June '17), we see that the PIMCO fund returned 7.4% annualized. This compares to Vanguard's well-known bond index fund, the Total Bond Market Index (VBMFX), which returned 6.2%. Cumulatively, over that 30 plus year period, $10K would have grown to $86K in the former and only $62K in the latter. Further, if we look at the yearly returns between 1987 and 2014, PTTRX beat VBMFX in 21 out of 28 years including 2017 year-to-date, and for 11 straight years from 1995 and 2005.
But those familiar with PTTRX may realize that between 1987 and late 2014, it was run by a so-called legendary fund manager, Bill Gross. But even after Gross left, the fund has beaten VBMFX in two of the following three years (2017 result is year-to-date).
While true that PTTRX is not available in many company plans that investors are locked into, there have been alternatives such as buying it from the Vanguard Brokerage which has a 25K minimum to invest, or instead, buying the Harbor Bond Fund Instit. (HABDX) which has close to as good a track record as PTTRX, with the same fund managers, for only a 1K minimum investment.
As you can clearly see over the last 30 years, merely recognizing that PTTRX or its near equivalent, HABDX, were generally better choices than VBMFX in spite of their higher expense ratios, would have earned you a significant increment over the more obvious choice of VBMFX.
Focus Point #3: Don't Ever React Solely To Merely a Single Piece of Potentially Relevent Investment Information When Making Investment Decisions.
Far too many investors seem to latch on to some key data point in deciding whether to buy or sell a fund at a given point. One obvious case in point: We all seem to rely too heavily merely on how the fund has performed, sometimes just over the last month or two, or even over multi-year time periods.
While it is apparent that most everyone wants to own a fund that has been doing well, we often fail to take account of the fact that investing is far too complicated to be determined by a single factor alone. In other words, it usually pays to consider a variety of factors when buying or selling. So, for example, if you pick a fund to buy or add to that is "hot" and can often been found at the top of charts showing the best one year performers in its category, the result may have occurred because the manager is taking on a high degree of risk. Once that hot streak ends, the same fund may very well turn out in a list of the worst performers the following year.
Unfortunately, from my perspective, the mass of investors tend to often have too narrow a focus and tend to react at times almost reflectively, often making possibly incorrect assumptions. So, for example, whenever some read that interest rates have been raised (or even appear likely to be raised) by one central bank or another, they typically tend to draw the inference that this will not only be bad for bonds, but likely, for most stocks as well. But an interest rate rise, even if it does happen, does not necessarily justify these conclusions. And just because the mass of investors are reacting in a certain way, does not mean these investors are correct, nor that you should do the same as they are doing.
An even more extreme example happens when the majority of investors conclude that the stock market is falling precipitously and is likely to fall even further. While this hasn't happened for a while now, one only need to think back to 2007, and before that, to 2000. At such times, given this happenstance, it is not surprising that investors begin selling en masse.
What's wrong with that? It's only that such falls, even if they wind up lasting several years, tend to always get reversed. So the investor who sells when the stock market has already dropped significantly is usually going to do worse than if they had just waited out the fall until an eventual recovery. In fact, some of these panicky investors then sometimes "swear off" the market, causing them to not only get out but perhaps never get back in once the bear market has long become history.
As pointed out in Focus Point #1, buy and hold may be a great strategy if you have chosen some sound funds in the first place, allowing you to ignore some of the myriad things, some important, some not so, that many other investors choose to react to. But when you do choose to react, try base your decisions on at least one, if not more, other factors than what the majority of others seem to be reacting to. So, for example, if there is a bear market, don't just look at potential "paper losses." Rather, you might want to research how a particular fund did in previous bear markets.
Suppose you had invested in a Financial sector ETF, the iShares U.S. Financials (IYF), at the beginning of 2006. While the fund would have outperformed VFINX in 2006 by several percent, when the 2007 bear market hit, it collapsed returning -18.1% in 2007 and -50.3% in 2008. The following three years, it also underperformed VFINX, especially in 2011 when underperformed by over 15%.
While not conclusive, this might suggest the Financial sector, including diversified funds that are overweight in the sector, will not a be particularly good funds to own during the next bear market. So, while the majority of investors might have read and believe that a rising rate environment is good for financial stocks, and are somewhat encouraged about the sector now that the Fed is raising rates, seeking out additional information on bear market performance of this sector might give you an opposing view, suggesting becoming more skeptical about this sector if a bear market becomes a bigger probability of happening than appears at this moment.
Focus Point #4: Always Maintain A Strong Bias Toward Stocks, But Don't Discount How Bonds Can Be A Relatively Big Money Maker Too.
There is little arguing with the fact that stocks, held long term, will provide the biggest bang for your buck as compared to your other fund choices. It follows, then, that many investors write off bonds as always being a poor choice even they don't feel comfortable putting all their money into stocks. While it appears that putting all your investable money into stocks may make sense if you can deal with the ups and downs of the stock market which involves riding through what nearly always turn out to be temporary drops, it seems to behoove the facts to keep large amounts of money in cash, except perhaps on a temporary basis when no investment category looks particularly appealing, or keeping some money in cash if you soon envision upcoming expenses or as an "emergency" fund.
Perhaps one big reason that investors may choose to ignore bond funds is out of a lack of understanding of how bond funds operate. Most bond funds pay a dividend. And the higher interest rates go, the higher that dividend usually is.
If interest rates are low, as they have been for many, many years now, that dividend may look paltry. Since the dividend typically provides the biggest part of the return from bond funds, investors may correctly assume that returns from bond funds will not be all that good so long as these rates stay low. But when interest rates start to rise, as they have been somewhat doing lately, there may actually be a better opportunity, eventually at least, to get better returns from bonds. But most investors maintain the bias that rising rates will hurt bond returns. Why? Because in spite of rising dividends, the bond fund owner may be subject to capital losses, just as stock investors can suffer from, if the price they paid for shares in the fund go down. But since dividends are the more important source of the return for bond funds, investors should not reflexively fear interest rates going up since total return will tend to added to more than it will get subtracted from as a result of potential capital losses.
So while bond investing, like any other kind of investing, has some complexities and unknowns, it should certainly be viewed as a winning proposition, just as stocks are, although not to as large an extent, especially as compared to merely parking money in cash. But just like money parked in cash as as means of avoiding putting too much of your assets in stocks, money stored away in bonds typically can be used in stock market corrections to add to your stock positions if stocks falter and seem to be at a better entry point than before the correction. Most bond funds do not swing a great deal in price, and may even go up somewhat in a stock market correction, meaning that exchanging from that bond fund into stocks should not subject one to having to take much, if any, of a loss due to a price drop for that bond fund.
For someone who truly wants to maximize their returns in bond funds, the formula, which follows from what I've already said, becomes fairly straightforward. Your bond fund total return will tend to be the greatest when interest rates appear to be peaking (i.e. relatively high dividends) with the possibility, looking forward, of rates dropping (i.e. potential capital gains) because the bonds in the fund's portfolio are now more desirable as a result of paying higher dividends, than newer bonds paying lower ones. But granted, this "ideal" bond buying scenario does not come up very often. With interest rates still historically extremely low, we are probably at least a few years away from interest rates being any where near peaking.
But does this mean that the typical investor should not be invested or investing in bonds? As already mentioned interest rates have been low now for quite a while. Did bond fund investors therefore do poorly in their bond investments over these years? If one looks at the 5 year annualized return for the average U.S. bond fund, one sees a total return of 2.5% per year (through June 30th). So how did a typical money market fund do in comparison? Even one of the highest paying ones, the Vanguard Money Market Prime Fund, returned only 0.2%, annualized over the same period. Clearly, money held in a money market fund over the last 5 years hasn't even equalled the rate of inflation, meaning one has actually lost purchasing power in such a fund.
And, since the Fed began raising interest rates in late Dec. 2015, and has raised them another 3 times since, you might, according to the common belief of most investors, assume that investors should perhaps have used that first increase, with the warning of more to come, as a time to start exiting their bond funds. But according to total return data, during the period between Jan 2016 and June 2017, the Vanguard Total Bond Market Index Fund has returned 3.2% annualized, even better than when rates were stable and effectively being held to near zero. Other bond funds, such as for example, the PIMCO Total Return Fund Instit mentioned above, did even better returning 4.1% annualized. Over the same period, the typical cash investment returned only 0.3% annualized.
While bond funds will not always show positive returns as compared to money market funds, which almost always will no matter how meager the return, the track record for both managed or index-based bond funds has been exceedingly good. Over the last 31 years, since 1987 including 2017 year-to-date, VBMFX has only had a negative yearly return 3 times, as has PTTRX. As with stock funds, any losses are usually fairly quickly reversed. And while the generally excellent returns of bond funds over the last 31 years are unlikely to be as good going forward since the period has been regarded as as an extremely bullish one for bonds, investors should not fear bond funds; they will almost always do better than cash regardless of when you are investing.
In conclusion, bond funds which come in a great variety of types, are your best opportunity to make money for any money that you have available to invest but choose not to put into the stock market.
Focus Point #5: Don't Assume That You Will Be Able to Avoid the Next Bear Market.
Many investors, including even myself sometimes, are influenced by the notion that through careful watchfulness, they will be able to avoid, or at least minimize the damage to their portfolio by actions designed to avoid a possible upcoming correction, or worse yet, a bear market. But my many years of investing experience suggests that not only are these events extremely difficult to correctly anticipate, but this proclivity may prevent you from investing when you probably still should be.
If one could be successful using such an avoidance strategy, one would not only have to avoid a plunge in stock prices, but would have to do it consistently every time. For example, while you might be correct in one instance in withholding investing, or reducing a position, you would have to do so more than 50% of the time you used this approach. Why? If one time such an approach worked for you, but another time it didn't, you would likely be no better off because while once you prevented a loss, the second time, you possibly saw the held-back investment continue to do well. Overall, then, the two decisions tend to nullify each other.
Of course, another problem with attempting to avoid a potential plunge is this: Even if you correctly got out of part or all of an investment (or choose not to make a new one), as an investor, you still have to be correct as to when it is now "safe" to get back in. So, is a 20% drop a safe point to re-enter, or will the drop continue much further, as we saw in the bear markets beginning in 2000 and 2007? To truly be successful in attempting this strategy, you have to be correct at both the exit and re-entry points, more difficult obviously then just getting the exit point correct.
So, rather than relying too heavily on the idea that you can control the risk of entering before a bear market hits, you might want to carefully assess your overall risk tolerance in terms of how much you want to have in stocks, and don't deviate too sharply from that percentage regardless of what you read about or hear about as possible triggers to the next bear market.
Of course, if you are practicing solely a buy and hold approach, and making few if any changes to your portfolio asset allocation on your own, after several years or even quarters of good stock returns, your investments and possible allocations to stocks may have risen quite a bit. It makes sense then to periodically re-determine whether your commitment to stocks may now be higher than you may be comfortable with. Therefore, keeping fairly close to a percentage as just described may argue for reducing your stock commitment in such cases. But such would not be because you can likely successfully figure out when the next bear market will hit. It would just be because perhaps at some point, too much of a good thing such as stocks, becomes a risk you might sensibly not want to expose yourself to.
I have found that for me, a far better strategy than trying to avoid the next bear market is something that many investors may find hard to swallow: While I don't hope for a bear market, knowing that I likely can't avoid one when it hits makes me much more sanguine about such a possibility. If stock prices start to plunge, or even settle into merely a slow grind lower, I mainly view it as an opportunity to wait patiently for a potentially new entry point.
Although one can never be absolutely sure when a significantly lower price for your favorite stock fund may pay off significantly to invest in now (although not not likely in the immediate future but in the years ahead), knowledge of long-term fund investing shows that it almost always pays off to invest at a significantly discounted price, maybe 10, 20, or even more percent below recent highs. The more diversified the fund is, the more true this seems to be, as for example, when investing in a highly discounted but undiversified sector fund such as Energy, it is much harder to predict if and when that eventual springback will occur.
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: I have positions in PTTRX, VBMFX, and VFINX