2.10: A Sample Mutual Fund

Video - Audio - YouTube (Material for this page starts on slide #72).

By now, you are most likely feeling quite overwhelmed. What a wealth of material about mutual funds and the mutual fund industry you have covered! You should be proud of yourself. But do you now feel ready to invest? Has any of this actually helped you at all with the most important question, namely ...

“Okay, So How Do I Pick a Mutual Fund?!”

With approximately 12,000 mutual funds to choose from, the typical investor is completely bewildered and often has no idea where to even begin the process of choosing a mutual fund. You have read and studied about mutual funds and it is likely that you are no better off, possibly even worse off than when you started. There is no way to sugar coat the issue. Choosing a mutual fund is incredibly difficult. Many individuals will seek a trusted investment professional for help. Others will succumb to the ubiquitous advertising campaigns of one or another mutual fund company. Serious-minded investors might take it upon themselves to research, investigate, choose, and then monitor their mutual fund choices. But even then, no one should fool themselves into thinking they are going to be able to do these rigorous processes for all the mutual funds available. By the time you researched all the mutual funds available, it would be time for your retirement! So how does one pick a mutual fund?

Our advice is to pick a mutual fund that invests in high-quality stocks or bonds, is well diversified across several industries and sectors of the economy, has a long-term perspective and a manager or, better yet, a global management team with many decades of experience, and most importantly, has been around for decades and performed consistently well in both good and bad markets. Be sure to place more emphasis on how well the mutual funds did during market upheavals. Anyone can do well when the markets are charging ahead. Although their investments will suffer along with all the others, the best managers will hold up well during the inevitable downturns. Also, you want to avoid companies that “shuffle” their managers every few years. Luckily, the industry is moving away from this tactic and giving their managers more time to prove themselves. Lastly, be mindful of fees and bend toward lower-cost funds but concentrate on the quality of the investment manager and their long-term results.

ICA: Investment Company of America, A Sample Mutual Fund

For a sample mutual to showcase, we chose the Investment Company of America, typically referred to as ICA. It is one of the nation’s oldest and most successful mutual funds. We want to emphasize that we are not recommending this fund to you as an investment. Rather, the idea is to demonstrate the characteristics of a high-quality, long-lived, successful mutual fund. ICA’s inception date was January 1, 1934. (It actually dates back to the mid-1920’s but the current investment manager took over the operation on December 31, 1933, in the depths of the Great Depression.) This means that ICA celebrated its 90^th birthday January 2024. Hence, there is a long history available to study.

On the class website, there are several commentaries that discuss the fund. One particular commentary walks through their entire history and the investment returns of the fund. ICA is a domestic, large-cap, growth and income stock mutual fund. This means that ICA invests primarily in large company stocks based in the United States that are growing and paying dividends. We have already discussed how volatile stock investing is, yes? In the commentary, you will see that the path to wealth was anything but smooth. However, even with the many bumps and stomach-churning plunges in value, investors who stayed the course were well rewarded. Often, the sharp fall in value of one or two years was followed by a significant rise in the one or two subsequent years. So how does one handle the inevitable downturns? The key is to keep a long-term perspective and take advantage of dollar-cost averaging.

Dollar-Cost Averaging

Dollar-cost averaging is a horrible name for a simple, but highly effective investment strategy. Dollar-cost averaging is a system of buying an investment at regular intervals with a fixed dollar amount. We discussed the automatic contribution plan, also known as a systematic investment plan. When an investor utilizes this method to invest, the investor is automatically taking advantage of dollar-cost averaging. Dollar-cost averaging takes the emotion out of investing. Every month is a good time to invest. In fact, with dollar-cost averaging, each day when you awake, there is always good news waiting for you. If the market is up ‒ good news! ‒ your account is worth more. If the market is down ‒ good news! ‒ next month, you will get more shares at a lower price when the $50 or $100 comes out of your paycheck or checking account. We will revisit this important technique later on. And remember, an automatic investment plan is practically the only way that most of us working class individuals will ever begin and continue the process of investing.

Hypothetical Illustrations

At the beginning of this chapter, we noted that those who needed motivation to read the chapter should jump to this section and review the accompanying commentaries. There was a very good reason for this. The news is good! Prudent, long-term investing has been very rewarding. To share this good news, most mutual fund companies have a system for running what are normally called hypotheticals or illustrations or hypothetical illustrations. The life insurance industry also extensively uses these tools. Hypotheticals are examples of returns of investments for lump sum principals or streams of investments or combinations of both. A stream of investments is another term for automatic contribution plan or dollar-cost averaging. Hypotheticals must be approved by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) and contain numerous disclaimers about past versus future performance.

Please review the hypothetical illustrations for 30 years at $100 per month and 40 years at $100 per month. These are impressive results. However, the real eye-opener is the scenario where the investor started contributing $100 per month 40 years ago. Then every year, the investor increased their monthly contribution by $10, two fewer trips to FiveBucks, ah, Sixbucks, no, Starbucks! Hopefully, you will never look at another cup of expensive coffee the same way. The last two illustrations show what is typical when an investor waits until their 40’s before they start investing. They must put away far more each month and even then, the investor does not have the blessings of time. Mirroring the manifold disclaimers in the hypotheticals, this is backward-looking data. As you will see and hear over and over again, past results are not guarantees of future returns. No one can predict the future. However, this is a pretty darned good endorsement of prudent, long-term investing.

We also want to emphasize that ICA is just one mutual fund. There are many others with similar results and many with even better returns. But with 12,000 mutual funds to choose from, we have to start somewhere. One other issue about the use of ICA is important to note. We used ICA because of its long lifespan as well as its success. However, if we were going to recommend a single mutual fund to the typical younger investor, we would suggest a global fund over a domestic fund. Recall that ICA is a domestic, large-cap, growth and income fund. The issue here is that there are no global, large-cap, growth and income funds that have a 40-year lifespan. The first global, large-cap, growth and income funds started appearing in the late 1980’s.

Just in case you still might be tempted to believe that you must run out right away and invest in ICA, please note that there are many other mutual funds that have been around for decades and done well in both good and bad markets. Below is a list of mutual funds that have greater than 50 years of experience as of December 31, 2023. All of them have returned 10% or better. The news is good. Choose a well-run mutual fund (or maybe two or three), contribute consistently through good times and bad, don’t panic when the markets tumble, and ‒ assuming the world does not end ‒ your mutual fund or funds will bore you to wealth.

Notice that all of these funds are either growth, growth and income, or equity income stock funds. All except two are domestic. These are the oldest types of mutual funds. As explained, many other types of mutual funds with similar or better returns simply don’t have as long a lifespan and don’t make the list. We emphasize that there is no one-size-fits-all in the mutual fund industry. Many investors will want much more aggressive choices or much more risk-averse choices than what are available on this list. You decide. Do you want to eat well or do you want to sleep well? Hopefully, you are starting to see that dollar-cost averaging will help you gain control of your emotions and when the inevitable downturn occurs, you will see it as an opportunity to let your automatic contribution take full advantage of the reduced prices. You might even decide to make an extra contribution or two because stocks are on sale. Welcome to prudent, long-term investing. You should do well over the long term, Dear Students. And, oh, by the way, you’re welcome.

Mutual funds with 50 or more years of excellent returns as of December 31, 2023

Investments With Over 50 Years Of Excellent Returns	Annual Return	Inception Date
AMCAP Fund	11.25%	5/1/1967
American Mutual Fund	10.20%	2/21/1950
Fidelity Contrafund	12.62%	5/17/1967
Fidelity Equity-Income Fund	11.12%	5/16/1966
Fidelity Fund	10.27%	4/30/1930
Fidelity Magellan Fund	15.59%	5/3/1964
Fidelity Trend Fund	12.09%	6/16/1958
Franklin Growth Fund	10.37%	3/31/1948
Franklin Mutual Shares Fund	11.21%	7/1/1949
The Growth Fund of America	13.31%	12/1/1973
The Income Fund of America	10.30%	8/31/1973
Invesco Global Fund	11.08%	12/22/1969
The Investment Company of America	11.99%	1/1/1934
MFS Investors Growth Stock Fund	10.56%	1/1/1935
New Perspective Fund	11.93%	3/13/1973
T. Rowe Price Growth Stock	10.98%	4/11/1950
T. Rowe Price New Horizons Fund	11.58%	6/3/1960
T. Rowe Price Small-cap Stock Fund	12.69%	6/1/1956
The Dreyfus Fund (now BNY Mellon Large Cap Securities)	10.57%	5/24/1951
Templeton Growth Fund (Franklin)	11.14%	11/29/1954
Vanguard Windsor	11.29%	10/23/1958
Washington Mutual Investors Fund	11.71%	7/31/1952

Characteristics of Successful Long-Term Mutual Funds

One study by the Capital Group some years ago attempted to survey the vast array of mutual funds and find the most common characteristics of long-term, successful mutual funds. They found that almost all had three characteristics in common. The first attribute was that the funds had lower than average annual operating expenses. Please make sure you review the presentation that compares the commission-based hypothetical illustrations with the assets under management-based hypothetical illustrations on the class website. You will see just how much an extra 1% or so in fees can eat into your long-term results. The second most common property was that the mutual fund managers had substantial amounts of their own money invested in the funds. In the industry, this is referred to as “eating one's own cooking.” The third most common trait was that the funds demonstrated substantial downside resilience. They held up comparatively well when the markets fell. One of the statistics we want you to research in your Mutual Fund Annual Report Assignment is the upside/downside ratio. It is one of the most important measures in Your Humble Author's opinion. Downside resilience helps us sleep reasonably well when the inevitable market downturn occurs.

Mutual Fund Returns versus Investors’ Returns

We have seen how well some mutual funds have done over decades. The question to ask is how well the typical mutual fund investor has done. One would expect there to be an easy answer to this question. Mutual fund investors have done the same as their mutual funds, of course. How could it be any different? We are sad to report that mutual fund investors have done much worse over time than the mutual funds they invest in.

“Wait a minute!” you say, “That does not make any sense whatsoever. How could a mutual fund investor do worse than the mutual fund that they invest in.” Actually, it does make sense. It makes perfect sense and is entirely predictable given human emotions and what we have learned. Do you remember Mr. Warren Buffett’s observation? “Investing is simply … but it ain’t easy!” Many investors allow their emotions to control their actions. “The market’s up! Ooh, ooh, ooh! Is it too late to get in!?” When you hear this question asked often by your friends, family members, neighbors, and colleagues, the answer is invariably, “Yes, it’s too late to get in.” Many uninformed investors pile into mutual funds during the market’s upward swings and typically start pouring mountains of money into mutual funds just before or at the peak in the market. For whatever reasons, the market will then head lower and you will then hear, “The market’s down! Ooh, ooh, ooh! Is it too late to get out?!” When you hear this from those around you, the answer is again invariably, “Yes, it’s too late to get out.” This is where you come into the picture. You are going to have the “talk them off the ledge” chat with them. You are going to explain to them that these times of panic are historically the best times to invest for the long term. You are going to be their Investment Guru and explain the wonders of long-term investing via dollar-cost averaging. It is a weighty responsibility. We are counting on you. You can do it!

The green bars in the above graphic shows the mutual fund inflows and outflows. The yellow line is the global stock market’s performance. Notice how in 2000, mutual fund inflows were immense. This coincides with the beginning of the bursting of the Internet bubble and the end of a decade with close to 20% annual returns. The United States market then went on to lose close to 50% from March of 2000 to October of 2002. Notice that ill-informed investors finally started pulling their money out of mutual funds precisely at the end of the 2½-year downturn … just in time for the market to come roaring back. The inflows followed suit, that is, until the greatest downturn in stock prices since the Great Depression occurred in 2008. What did many mutual fund investors do? Of course, they pulled out their money during the downturn. This time, it wasn’t until 2013 when they started to pile back into stock mutual funds.

There is an old saying in the mutual fund industry: “Most mutual fund investors do worse than the mutual funds they invest in.” The data shows this to be true. Many uninformed mutual fund investors buy high and then sell low. You are not going to be one of them.

The Bottom Line on Mutual Funds

The bottom line of mutual funds is to choose a fund family and stick with them. Reevaluate your fund or funds periodically. Every six months or every year is more than enough. Make changes judiciously and sparingly, giving your funds enough time to prove themselves through good times and bad. As you approach retirement, migrate from stock funds to bond funds but do not give up on stocks entirely. (We will discuss portfolio diversification and asset allocation in detail later on.) Use automatic investment plans to take advantage of dollar-cost averaging. Contribute $50 or $100 or whatever you can afford every month. But for the most part, forget about them!

Do not be one of the mutual fund investors that does worse than your mutual funds. Allow your mutual fund or funds to bore you to wealth. In the world of investments, boring is good!