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lemoneater (57.51)

Wandering in Mutual Land



November 11, 2011 – Comments (9)

For me mutual funds are an uncharted country. I've gradually come to navigate individual stocks in certain sectors with some confidence, but I could use a GPS in exploring mutual funds. 

Recently my company informed me that for my retirement fund they were going to switch from actively managed funds to passively managed funds. Supposedly there are fewer internal fees with a passively managed fund which has a goal of matching an index vs. an actively managed fund with a goal of beating the index. Somehow trying not to beat an index sounds counter intuitive to me, but I'm trying to keep an open mind. (Last year the target fund for my retirement age had a 12% loss so I can understand why Milliman might have decided to part ways with Russell--although given the volatile state of the market that level of loss didn't surprise me. Capital preservation does have a place in a retirement plan. We will have to see if Vanguard's strategy works better.)

In looking over the prospectus provided (which unfortunately wasn't as readable as travel guides often are) I noticed that one of these passively managed funds target funds for an earlier retirement date than mine had a 30% portifolio turnover last year. 30% turnover seems a rather hyper rate for a passive fund, but I have no sense of what is normal. Paradoxically the later the retirement date the lower the portifolio turnover. Perhaps if a fund has a higher toleration for volatility with a longer time frame to retirement less balancing is required and saves more in fees?

Also I was surprised that the most conservative fund (a Federated Capital Preservation Fund) which was recommended for those on the brink of retirement had holdings that were not widely spread across industries, but were primarily insurance company bonds. Somehow I wouldn't consider investing in insurers as necessarily the safest thing to do. Also the largest holding was 19% of the fund. What about diversification?

I welcome your thoughts to give a clear picture of what I'm looking at in this brand new kind of topography. 





9 Comments – Post Your Own

#1) On November 11, 2011 at 10:51 AM, 91x9x19 (< 20) wrote:

Mutual funds have inherent costs and risks.

They invest in all the things that you do on your own, stocks, bonds, cash, etc.  They are just the middleman, though, which passes on their costs to you.

The hope is that you are paying for results that are better than what you would have gained had you picked stocks yourself.

Passive funds are unmanaged and sometimes are just like ETFs that track a particular sector.

When I am forced to invest into mutual funds through work, I try to choose ones that have the lowest overall costs.  My second factor for evaluating the fund is what they target - what's their mission?

Finally, I look at their management.  

 I think most investors look to mutual funds because they are afraid of the stock market.  I believe that their fear comes from ignorance, and they pay for it.

I have no information about what is a 'normal' amount of turnover within a fund so I can offer no opinions on that.

Good luck.

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#2) On November 11, 2011 at 12:00 PM, buffalonate (48.15) wrote:

Only around 5% of mutual funds beat the stock market when you include fees and taxes.  If you must use a mutual funds you should get on Morningstar to look at the rankings for each mutual fund and make sure the expense ratio is no more than 1.2% or you are getting robbed. Mutual funds take about 1.5% of your money every year for worse performance than an index fund.  An index charges around .2% and a mutual fund charges around 1.5% for similar performance.  I personally prefer to invest most of my money in blue chip stocks and reinvest the dividends automatically.  That way no one has their hand in your pocket your entire life.   

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#3) On November 11, 2011 at 12:11 PM, lemoneater (57.51) wrote:

Thanks for your comment.

It's too bad that my retirement fund through work just allows me to choose between mutual funds not individual stocks. My personal portifolio of 30 stocks is 11% in the green and most of the funds seemed to be performing lower than that.

After the switchover this December, I will have more options on the weighting of the available funds. So I will try to figure out which of them has less portifolio turnover and a higher percentage of companies I trust. As someone who looks at both growth and dividends in stock selection, I feel somewhat hampered  in choosing a fund since it appears that the ingredients in making and weighting of a mutual fund can vary significantly making evaluating for growth or dividend a futile exercise. 

My main goal is to beat inflation, but it looks somewhat more challenging with mutual funds. 


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#4) On November 11, 2011 at 12:23 PM, lemoneater (57.51) wrote:

@ #2 Thanks for the recommendation to check out the funds on Morningstar. I have to say the prospectus had enough legalese that I was uncertain of actual costs particularly since I'm with an institution rather than acting entirely on an individual basis. 


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#5) On November 11, 2011 at 2:33 PM, outoffocus (23.81) wrote:

High portfolio turnover isnt as bad of a problem in your retirement account as it is in your personal account.  Its a problem with personal accounts because the fund typically distributes capital gains along with its dividends which could run up a hefty tax bill.  But since its a retirement account, you are not taxed on this capital gains every year. 

I guess its also helpful to find why there was 30% turnover and on what asset classes.  Could it be that a large portion of the bonds in the portfolio matured last year?

As far as beating inflation, you can either continue with your target date fund (if you choose a target date fund, there is essentially no reason to invest in any other fund.  The fund turnover may be a function of portfolio rebalancing in order to meet the target date objectives) or you can choose from different types of index funds (no more than 3-5) in various sectors (small cap, mid cap, blend, sector fund such as precious metals, and bonds) and just rebalance your portfolio every year (as you get closer to  your retirement, move more to bonds).

Also you can check out this video on investopedia: 

Hope that helps

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#6) On November 11, 2011 at 2:52 PM, FleaBagger (27.51) wrote:

The target funds gradually shift more and more of their assets from stocks to bonds and other "safe" fixed income investments every year, so that is why the high turnover. Given the current environment, though, it would be like a target fund in the late 90's shifting more and more of its portfolio into tech stocks for safety - jumping head-first into a pool that might be dry by the time you're off your feet. Will the bond bubble keep inflating after its recent diurnal signs of weakness? Will it pop, taking the soonest target funds and other bond funds down in a crash that hits those least able to recover? I wouldn't chance it. I would avoid target funds, since they might unexpectedly put more of your money in bonds than you want, and avoid bond funds like the plague, at least with >90% of your portfolio.

For a balanced portfolio with an awareness of today's prices, get foreign and domestic equities, foreign bonds (outside of Europe), and obtain precious metals or indexes of companies that mine them with at least 10-20% of your portfolio. Also, hold some cash, because stocks, bonds, and gold are all at or near long-term high valuations. This situation is partly because inflation hits assets before it hits consumer prices, and is partly just begging for a correction.

But stay away from dollar-denominated bonds, their funds, and all their cousins. 

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#7) On November 11, 2011 at 4:33 PM, rfaramir (28.63) wrote:

+1 rec for FleaBagger's advice.

"Somehow trying not to beat an index sounds counter intuitive to me"

You're not looking at the whole picture. It's paying an active manager to beat an index versus paying a computer operator to match an index. The former comes with high fees and some low probability of beating the index. The latter comes with low fees and zero probability of beating the index, but it should match it minus the small amount of fees.

As to your dilemma, it's a good one to have. Most people invest in mutual funds because they do not trust themselves to invest well in individual stocks. For them, being forced to pick individual stocks would be scary and probably detrimental. You have the opposite situtation. You are comfortable and capable at stock-picking but are forced to merely choose among mutual funds. You problem is being faced with too much mediocrity and safety compared to your capabilities and desires.

As just a guess at a good strategy, I'd suggest looking at the top holdings of each of the lowest cost mutual funds and choosing among the funds based on your knowledge of the stocks. They have to report these periodically: good news is you get to see them, bad news is they don't have to stick with them over time. I think this would play to your strength.

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#8) On November 11, 2011 at 8:11 PM, rd80 (95.06) wrote:

Not sure I can add much to the good comments so far, but here goes...

1.  I think it's much more difficult to pick a mutual fund than to pick a stock. There aren't fundamentals to review, all you really have is the fund track record - which may or may not have been with same management team - and ratings by firms like Morningstar and Lipper. 

2.  Active vs passive.  Passive, index tracking mutual funds tend to have much lower expense ratios than actively managed funds - largely because there's no stock picking research.  However, the comparison isn't always apples to apples since a fund might have slightly different objectives than its benchmark index.  For example, a fund might have a defensive, conservative investing profile - in an up market, it would underperform broad market indices, but should outperform in a bear.  An investor who wants lower volatility might be better with a convervative, active fund than with an index fund.   I suspect most fund managers would beat an index IF the expense ratios were the same, but throw in a 1-2% cost headwind, and beating the index over a long period gets very difficult.

3.  Target funds.  I've read that these are generally not a great choice.  First, the mix is generic and can't take your individual situation and other assets into account.  Then, some of them end up layering fees on fees - they're usually made up of other mutual funds so you get the target fund fee plus the fees from the underlying funds.

4.  After looking at the Morningstar info on a fund, the next thing to check is the expense ratio.  Even a difference of a few tenths of a percent is significant over a long period of time.  If you're leaning toward a higher fee fund, ask yourself - what about this fund makes it worth paying a higher management fee?

5.  Check the research material at your regular brokerage firm.  They may have reports or evaluations of the funds that aren't readily available in other places.

6.  Good luck. 

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#9) On November 14, 2011 at 2:42 PM, lemoneater (57.51) wrote:

I wish I could rec the comments! :)

outoffocus, thanks for the insight on how portifolio turnover is not as crucial in a retirement fund because I'm not being taxed on capital gains every year. 

I'm leaning towards not going with the target fund although it is a simple one-step solution because I enjoy tinkering and want to consider the weighting in light of our personal stock portifolio. However, I'm curious to check out the recommended mix of investments for my age. At a quick glance, I did see more stocks than bonds so that follows what you said since I'm farther from retirement than many of my co-workers.

Thanks for the video link. I forget to check Investopedia.

Fleabagger, thanks for your caution about target funds. There is nothing like a moving target! Since I prefer more control, I don't think I will use the target provided although I plan to study it particularly to see how it handles diversification and weighting. 

They give the choice of one foreign fund, I should get more details after Milliman completes the switch in December. As for precious metals, I didn't see a fund targeting them. (I'd be better off asking my husband for nice jewelry for Christmas :) I'm glad that I have separate investments from this retirement fund. (Although in a crisis, I think cans of soup might be more liquid than gold.)

rfaramir, thanks for your kind comments. The circumstance of us having a small bequest from a relative and the fact that savings accounts have really pathetic interest rates has catapulted me into the diy investing world.  I'm more grateful than I can say for my CAPS friends who demystify much that puzzles me.

Yes, I certainly will check out the top holdings. At least this year they are publically traded funds with actual tickers vs. last year when they were private. 


1. Now I don't feel so bad about my bewilderment on mtual funds.

2. My company has already chosen passive funds, but at least I have a better understanding of the term.

3. I don't think I'll pick the target unless its fee and mix is superior to my other choices.

4. The fee's the thing.

5. Schwab has very thorough research tools which I will use along with MF of course!

6. Thanks!



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