Best way to invest in mutual funds?

[Chazumi]

I'm debt free except for my house (which is actually a rental property with the mortgage being covered by the tenants), and would like to start investing in mutual funds.

What is the best way to do this?

I would like to start investing about 500 a month into mutual funds (500 into 4 different types actually), when I do a google search I mostly find Vanguard, Etrade, stuff like that.

Anybody have any good experience buying mutual funds from a certain location or company or do you just somehow buy into your own?

 

[JerichoHill]

Given that I'm the resident personal finance writer as well as resident economist, I'll answer this simply.

There is no reason to buy 4 different mutual funds. A mutual fund is supposed to be diverse as is, especially given your small investment amount.

Start with Vanguard. They are easy. They have good funds with low fees. These are index funds, which is what you want (Active funds are more expensive and really shouldn't be used by new investors). Get a nice market index (SP500, Russell, etc). Put all 2K in it. Call them. They will send you a form. Simple. You can get fancy when you get used to the basics. No one learns to ride on an 18 speed bike.



For investing for new folks, just go to
www.coffeecents.org. Its a program I teach to college kids in my area. Still in work,but you can download the PPTs, and there are good links for readings that are quite good.

 

[Whomp]

First question is what's the timeframe? If it is very long term then here's some things to consider.

"Active share" managers (80%+) outperform their benchmark by around 1.5% annually net of fees. Closet index mutual funds (60% or less "active share" and nearly half of all mutual funds) underperform their benchmark by around 1.5% net of fees. This is consistent in bull and bear stock markets.

That being said I would buy Fairholme Fund first ($250 min. Investment). The S&P 500 is down -1.82% annually over 10 years, -0.92% over 5 yrs. and -8.67% annually over the last 3 yrs. versus FAIRX which has averaged 12.46%, 7.84% and 2.08% annually over the same period.

Once that's a reasonable amount I would explore other asset classes and markets.

 

[JerichoHill]

First question is what's the timeframe? If it is very long term then here's some things to consider.

"Active share" managers (80%+) outperform their benchmark by around 1.5% annually net of fees. Closet index mutual funds (60% or less "active share" and nearly half of all mutual funds) underperform their benchmark by around 1.5% net of fees. This is consistent in bull and bear stock markets.

That being said I would buy Fairholme Fund first ($250 min. Investment). The S&P 500 is down -1.82% annually over 10 years, -0.92% over 5 yrs. and -8.67% annually over the last 3 yrs. versus FAIRX which has averaged 12.46%, 7.84% and 2.08% annually over the same period.

Once that's a reasonable amount I would explore other asset classes and markets.

Whomp,

This flies in the face of what I thought was a fairly established fact, that most active funds do not beat the market in any given year.

This is a link directly from Standard and Poors which contradicts your above statement (see 2010 midterm for latest update).
http://www.standardandpoors.com/indices/spiva/en/us

Further articles here:
http://www.fool.com/investing/mutual-funds/2009/04/23/investments-that-dont-stand-a-chance.aspx
http://www.smartmoney.com/investing/mutual-funds/actively-managed-funds-losing-more-assets/

Where are you getting your figures from?

 

[Whomp]

I suggest that you read Yale researchers Petajisto and Cremers study on "active share". Funds with the highest active share significantly outperfrom their closest index (or the index with the lowest active share compared to the fund since it's the closest fit).

Keep believing what you will about indexing but it's not true when you are searching quality high "active share" managers like Bruce Berkowitz. In fact, Morningstar took up where Cremers and Petajisto left off and confirm their findings.

Here's the thing to bear in mind. In 1980, only 2% of funds were closet indexers (60% or less active share). Today, that figure is about half of funds. That's where most proponents of indexing are getting their stats on active managers. The Defined benefit market and advent of 401(k) plans likely had more to do with this than anything else. DB plans are learning quickly about "active share" due to their underperformance with closet indexers and sector rotation funds.

 

[JerichoHill]

I note that their study period includes a long bull market and a short bear market. I would first be concerned about their study period selection, that just jumps out from a quick glance at their tables. Standard errors seem large relative to coefficient sizes for many estimates. Does "net of fees" also include taxation implications from high activity?

I would believe that an increasing concentration of a fund type (index) from a small share to a larger share would introduce more junk.

I've likely said it before but we may have crossed wires. I'm not a particular fan of *just* indexing. I think its useful for someone who is starting out to get into a product that is easy to follow and understand (thus enabling the individual to invest more in the future, a behavioral aspect lost in many investment advice books). Most people will not put the time into doing active research, so they shouldn't be in active portfolios. I maintain my own personal "active" portfolio of individual stocks in addition to a "passive" 401K (pure index) and a few "active" funds which pierce markets I cannot easily access on my own (You probably can guess a few). For the equity assets, the 401K is approx. 40%

 

[Whomp]

As I said Morningstar continued their research so it tracks a bull and bear. One of the greatest bull and bears of all time I might add.

In fact, when we look at bear marker comparisons the index looks even worse.
2000 SPX -9.1% vs FAIRX + 46.5%
2001 -11.9% vs +6.2%
2002 -22.6 vs -1.6%
2008 -37% vs -29.7%
2010 +3.8% vs +8.3%
In fact, the only year the fund lagged the index over the last decade was 2003 when the index was up 28.7% and FAIRX was up 24%. I will take those numbers all day long especially from a Graham and Dodd manager like Berkowitz. This is just one manager of the very select few I prefer over any index. You are correct that you have to sort through the chaff to find real stock pickers.