Part II

ON INVESTMENT CHOICES

The investment choices now offered by mutual funds are many and varied. Before we look at all the options, I first show how The now-proven principles of passively managed, low-cost market index funds have worked in actual experience. I then turn to an examination of equity fund investment styles in terms of their investment orientation toward value, growth, or a blend of the two, combined with their emphasis on stocks of corporations with large, medium, or small market capitalizations. Variations in equity fund returns and risks shrink drastically when compared, not with all types of funds, but with the returns of peers and market indexes following similar styles. The same conclusion holds true in my examination of the returns of bond funds following different styles, presented in the next chapter. All three of these chapters raise serious questions about the efficacy of active, often costly, management, and conclude that few fund portfolio managers have demonstrated the ability to earn excess returns sufficient to overcome high mutual fund costs.

The merits of global equity strategies are evaluated next. I present a skeptical view of the need for U.S. investors to put their money to work abroad, but for those who are unpersuaded, I suggest optimal methods of doing so. Finally, I describe the futility of seeking to identify superior funds in advance, and of actively moving holdings from one fund to another. Here, I rely on an examination of the major academic studies, the records of funds that have provided highly superior returns in the past, the records of advisory firms making fund selection recommendations, and the actual investment performance of professional advisers who select mutual funds. Each of these analyses suggests that the holy grail of superior performance is unlikely to be found by fund investors choosing actively managed funds. Rather, it is to be found in commonsense principles.