How Not To Select A Good Mutual Fund

I was looking through the Barnes & Noble bargain bin and found a book called “How to do just about everything”. Okay, how to unplug a toilet… how to carve a turkey… hey, a personal finance section! Wow, quite awful. After coming home and looking up the book, I found out it was by eHow.com. I should have known. Check out this gem on How to Select a Good Mutual Fund (eHow link), which offers the following advice:

2. Determine how many mutual funds you will invest in. Three to five funds is generally considered an adequate amount of diversification.

Yes, let’s determine diversification by the actual number of funds. One… two… three… done! Never mind that I could easily have more diversification in one mutual fund than in 15 separate niche funds. This is like deciding the best book is the one with the most pages. At least later on it says to vary the size of companies in the funds. However, there is no mention of real diversification between stocks vs. bonds, domestic vs. international, passive vs. active management, etc. What else?

5. Choose high-performance funds by using Internet resources and newspapers to pick those funds that have had the best performance over at least the last three years.

Huh? I don’t know how the advice could get much worse than this. Picking whichever funds that had the best performance over the last three years will virtually guarantee that you will have below average returns going forward. Check out these articles on the persistence of mutual fund returns based on studies of actual mutual fund return data over decades. “The majority of well-done studies tend to support a lack of persistence for all but the worst performing equity mutual funds.”

Don’t chase performance! Again, we see no mention of better indicators like expense ratio, turnover ratio, tax-efficiency, manager ownership of shares, etc.

Content Mills Warning
So how does such a poor article get prominent placement in search engines, not to mention published in a book? eHow is a content mill that encourages people to churn out large numbers of articles with low quality standards, promising them a cut of all future ad revenue. Google has recently penalized them for their low-quality articles as well.

In addition, eHow has a history of treating their freelance writers poorly, and their most recent move was to cut off their share of ad revenue completely, offering them either a lowball buyout or nothing. I’m sure they have some good articles, but in general I would say you’re better off avoiding them, especially for money-related topics.

Comments

  1. Why would passive vs. active be considered diversification?

  2. Mutual funds are growing obsolete. ETFs, ETPs, and ETNs are the new wave of investment vehicles. There are increasingly greater varieties with different levels – active, indexed, leveraged, inverse, etc…

    If I were to pick a resource to help guide me select from these products, it would have to be Morningstar. I get their ETF Investor newsletter for free from the public library and their paid subscription now includes an ETF New Launch Center to cover the latest notable ETFs (not interested in paying). ETFdb.com is not so bad either.

    Aside from my 403b, I’m in the process of converting a majority of my portfolio from mutual funds to ETFs while trying to go with selections that are not necessarily chosen by everyone else ($20 billion into Vanguard ETFs in June). With so many ETFs, it seems like some have to shut down due to light investor interest so investors need to be aware of trading volume as well.

  3. I don’t think mutual funds necessarily are growing obsolete, although ETFs are definitely gaining in popularity. I still enjoy the ability to buy at NAV without worrying about bid/ask spreads or NAV premiums when buying (discounts when selling). Vanguard’s Admiral shares of mutual funds are about the same expense ratio of their ETF versions, and the holdings are identical.

  4. @Brian – I think passive/active is a pretty important defining characteristic when selecting a mutual fund. A passive fund will try to follow a benchmark index closely. An actively managed fund will try to use manager skill to beat that benchmark over time. You may want the former, or the latter. If costs are low, such benchmark-beating “alpha” is a lot easier to accomplish that vs. if costs are high. You have to look more closely at an actively managed fund to see what their methods are, who the manager is, etc.

  5. People use content mills mainly because they need to make money. Too bad though ehow is a poorly run site.

    If ehow was better run and they had set quality standards and guidelines I’m sure their articles would be much better.

    Good thing Google penalized them, who wants to read junk.

  6. Jonathan, nice to know that about eHow. It’s amazing how much absolute rubbish is out there.

    @Ron: ETF stands for Exchange Traded Fund. An ETF is a mutual fund, it’s just “Exchange Traded”. It’s actually quite a minor difference. You can buy or sell an exchange traded fund during the day whereas traditional mutual funds can only be bought or sold at the end-of-day price. So the statement that “mutual funds are growing obsolete” in favor of ETF by definition is not correct. Even if all mutual funds converted to ETF’s they would still be mutual funds.

  7. @Warren – I’m not too interested in being schooled by you. If you would prefer to label mutual funds as “non-exchange-traded”, I don’t really care. If you insist on saying that mutual funds and ETFs are kinda, sorta, very similar, you have every right to do so. We live in a free country and you are entitled to your opinion. With all due respect, I don’t share your opinion.

    The way I see it, there are only four Vanguard bond ETFs that I am interested in; I’m not too impressed by their stock ETFs. My predictions are that in 5 years, there will be no 12b-1 fees, there will no longer be load mutual funds, very few mutual funds will be left, and Morningstar will go bankrupt; perhaps acquired by eHow. @Warren – you may call any of my ideas a hunch, gifted insight, or sheer stupidity. You are free to opine in whatever manner makes you happy.

  8. First there was spam email. Next, spam content like e-how.
    The latest is spam e-books, particularly via the Amazon Kindle – http://www.ecommercetimes.com/story/72696.html?wlc=1310307579

    Is the internet just accelerating the dumbing down of America and the whole world? Will we have to rely on Google to filter out all the garbage?

  9. I think Google has met its worst enemies: the content mills. Their articles are produced by real human beings. They have good sentence structures. They seem to be on topic, except the substance is just junk. Without understanding the subject, Google’s computers will have a hard time differentiating the quality of an article from a content mill and the quality of what you write on this blog. They can punish eHow today but many others will pop up in the future.

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