This column, like most articles about investing, usually tells you where to put your money—which stocks, bonds, sectors or asset classes are likely to yield superior returns in the future. What the pundits typically ignore is where not to put your money. Which investments should you shun? But I take up the challenge and identify four categories that you should avoid.
High-fee funds. Stay far away from mutual funds that charge exorbitant fees. A recent study found that 92% of mutual funds that focus on large U.S. companies failed to beat their benchmark, Standard & Poor’s 500-stock index, over the 15-year period that ended in 2016. The common media take on this story ran along the lines of “Index Funds Beat Managed Funds” or “Algorithms Vanquish Humans.” The real lesson is simpler: Because relatively few actively managed funds can top the benchmark (especially in the area of large-capitalization stocks), and because it’s difficult to guess which active funds will win, you should invest in funds that require you to forfeit the least for the privilege of owning them.
On average, actively managed large-cap U.S. stock funds charge 1.19% annually for expenses. But many good ones are considerably cheaper. Two of my longtime favorites in that category are Dodge & Cox Stock (symbol DODGX), which charges 0.52%, and Mairs & Power Growth (MPGFX), which charges 0.65%. (Both are members of the Kiplinger 25.) Another solid fund, Primecap Odyssey Stock (POSKX), charges 0.67%. Fidelity Contrafund(FCNTX), which I have called the best mutual fund on the planet, charges 0.68%.
The past is not necessarily predictive, so it is hard to decide whether an expense ratio of 0.6% or 0.7% is worth it. But the effect of fees on returns over time is sobering. Vanguard uses a calculator to illustrate this on its website. In plugging in numbers, I assumed Fund A charges 1.2% and returns 8% before expenses annually. Over 10 years, expenses devour 25.8% of total returns. Over 25 years, you give up 36.4%. By comparison, Fund B, which charges 0.6% and earns the same amount before fees, consumes 10.8% of profits in 10 years and 16.3% in 25 years. An index fund that charges 0.05% (again, with the same return) will eat up only 0.9% in 10 years and 1.5% in 25 years.