Today, we share Dan Wiener’s second article in his series on ways investors can build their wealth by choosing the right mutual fund investments.
Dan and his co-editor, Jeff DeMaso, bring their Independent Adviser for Vanguard Investors subscribers the secrets Vanguard doesn’t share with the public. They use their expertise and analysis to get their readers a better return on their money.
Our goal at the InvestorPlace Digest is to help make you a wiser, wealthier investor. Dan’s knowledge and experience in the mutual fund marketplace will help you accomplish that.
The Market’s Quite Easy to Beat — And I’ll Prove It
By Dan Wiener, Editor
Independent Adviser for Vanguard Investors
When people learn that I do my investing at Vanguard …
And that I’m often quoted in the media as a “Vanguard expert” …
They often assume that I love index funds.
After all, that’s Vanguard’s claim to fame, right? Jack Bogle basically invented index funds when he launched “500 Index,” and that’s how The Vanguard Group came to be in the first place.
And still today, it’s a big business for Vanguard: Investors have put over $600 billion into its S&P 500 Index fund. Its Total Stock Market fund is even bigger, at $775 billion.
So, it’s true that index funds are incredibly popular. Just not with me.
After researching mutual funds — with a particular focus on Vanguardmutual funds — for 30 years, I’m forced to conclude that index funds are vastly overrated. And I’ll tell you why.
But before I do … I do want to acknowledge that the “Bogleheads” are right about one thing:
The market — and, thus, its index fund — generally outperforms the average money manager.
And I don’t deny that, by spreading this “gospel” far and wide, Jack Bogle and his company did investors a huge service. Where before we had to settle for funds that often delivered mediocre performance, yet charged “highway robbery” … now we can get great performance, at a low cost.
Just not necessarily from an index fund.
Remember, the beauty (and curse) of an index fund that tracks, say, the S&P 500 or the Dow is this:
Your returns will mirror that index exactly. (Minus the few hundred or thousand dollars you’ll be paying Vanguard for the privilege.)
That’s what makes them so appealing … at times. It’s no accident that investors’ appetite for index funds has largely coincided with the longest bull market in history.
But remember this, too:
If you rely on the S&P 500 for your retirement, you’re just not diversified.
That’s the biggest point I wanted to make to you all today. Because so many investors buy index funds BECAUSE they want diversification.
When I buy the S&P 500, I’m buying 500 stocks (but paying way less to do so) … right?
Well, be sure you read the fine print:
Yes, you are getting 500 stocks. (505, to be exact.) But because the S&P is “market-cap-weighted,” you’re getting way more of the bigger stocks.
And which might those be?
Mainly the tech giants. Especially those “FAANG” stocks we hear so much about on TV from Jim Cramer and those types.
And the longer the FAANGs remain popular … the more of your money is going to go into them, each year, if you’ve got it in an index like this.
Again, that’s fine … as long as the “gravy train” keeps rolling. But if you happen to retire — or otherwise depend on your investment earnings — at a time when these stocks are out of favor, then you’ll regret having overweighted your portfolio in tech.
That goes for any sector, by the way. I’d much rather invest with an active manager who employs smart diversification: owning enough of the right stocks, at the right time, to take advantage of all the best the market has to offer. Don Kilbride (of Vanguard’s Dividend Growth) and the PRIMECAP team come to mind.
But even more broadly … knowing that stocks will have good years and bad …
Still, the market is actually quite easy to beat.
You could simply look up which Vanguard fund had the best performance last year… buy it now …
And if you just do that, year after year — you’d come out way ahead.
At The Independent Adviser, I publish these results each year, in my “Hot Hands” feature.
Yes, just by buying last year’s hot fund — rinse and repeat — you get triple the returns of Total Stock Market.
Now, this is pretty aggressive. And I’m not saying you should drop everything and invest it all into this “Hot Hands” method. I don’t.
Plus, as you see, you won’t beat the market every year.
But I think it’s very telling that you’ll still come out ahead over time!
Why does this work? Because the good years are so good.
Because Hot Hands gets you into high-quality funds like PRIMECAP and Capital Opportunity, without the “dead weight” you’d get by owning the Total Stock Market.
Here’s the other thing you notice:
There are a few repeat performers that win out, again and again, over all the rest.
It just underscores everything I’ve learned in my 30-year career:
To be a successful investor, it’s all about quality, not quantity.
Now, Hot Hands is a cool model — but it’s very simplistic. A lot more goes into my fund selection.
Yes, I look at performance … but over much longer timeframes, and in the right context.
And out of 180 Vanguard funds, I can confidently narrow it down to just 17 Most Powerful Funds.
After what I’ve showed you today, you won’t be surprised to find that very few of them are index funds.
But this is Vanguard — so you can bet you’ll pay the lowest fees …
And in return, you’ll have some of the smartest people around managing your money. So, you can build wealth, without a lot of work. Zero, in fact.
That’s what it’s all about. In fact, that’s why index funds became so popular in the first place!
But if you want to make the most of every dollar … don’t settle for mediocrity. Take a look my 17 Most Powerful Funds, and see how their superior returns stack up, over time.
Dan Wiener, Editor
The Independent Adviser for Vanguard Investors