Mutual Funds vs. Index Funds.

[Nutria]

A lot of people say "historical performance is not indicative of future results." This is very true. ...

However, if I am looking at a mutual fund that has a 50 year track record of 15% annual returns, I can be pretty confident that that track record may continue going forward. I am much more confident with that mutual fund than a mutual fund with a 10 year track record of 3% annual returns.

Think of it this way. Let's say that you go to a doctor's office and have the choice between two doctors: one who is right 95% of the time, and one who is right 75% of the time. Which would you choose? Probably the 95% doc. There is no certainty that you will have no issues with the doctor, but historical performance is a great indicator (and may be the only one that you have).

Perhaps that is a bad analogy.

Correct. It's a horrible analogy because it assumes knowledge that we have zero possibility of knowing.

The point is that experience breeds confidence. And historical performance is experience.

Except when the time line used for that historical evidence are much longer than reasonable for a specific person's investing life, nor takes into account the cyclical nature of the equity markets.

[dczech09]

Would you please share the fund info?

The good mutual fund is TRULX and the mediocre index fund is POMIX.

TRULX is a mutual fund with a historical performance of 15.02%. Its expense ratio just changed to 1.15% after a lower ratio deal ended. The expense ratio may go down yet again, which would be nice.

POMIX is an index fund with a historical performance of 6.33%. Its expense ratio is 0.30%. I believe it once was 0.15%, but it is now 0.30%.

I own shares in TRULX. I bought it because its superior historical performance. I also own shares in PRGFX which has a historical performance of 10.68% since April of 1950 (over 60 years) and an expense ratio of 0.67%.

I am willing to pay a higher expense ratio on a mutual fund if it has a propensity to clobber its index fund counterparts.

[dczech09]

Correct. It's a horrible analogy because it assumes knowledge that we have zero possibility of knowing.

I admit the analogy was bad. But the message is what was key.

Except when the time line used for that historical evidence are much longer than reasonable for a specific person's investing life, nor takes into account the cyclical nature of the equity markets.

I disagree. A historical performance of 50 years should give someone with an investment horizon of 30 years MORE confidence. And yes equity markets are cyclical by nature, but historical performances already factor in the cyclical nature. Historical performances are (typically) based on what a set amount of money (say $1,000) would have grown to in a given period of time. This takes into consideration the beating that an investment would have taken in a downturn.

Historical performance is a pretty standardized way of analyzing different investments. And when comparing two options on the grounds of historical performance (methodologies for calculation kept equal) we are going to favor the option with the superior performance, particularly in net of expenses.

At the end of the day, we are always pitting two investments against each other (in this thread, mutual funds and index funds). We use many pieces of information to evaluate, and historical performance is one of those metrics. That is all that I have been getting at.

[Nutria]

I disagree. A historical performance of 50 years should give someone with an investment horizon of 30 years MORE confidence. And yes equity markets are cyclical by nature, but historical performances already factor in the cyclical nature. Historical performances are (typically) based on what a set amount of money (say $1,000) would have grown to in a given period of time. This takes into consideration the beating that an investment would have taken in a downturn.

I own shares in TRULX. I bought it because its superior historical performance.

The problem is that if this 13.9% net ROI were so great, all money managers everywhere would flock to this fund. But they haven't.

Why, I ask myself. After a moment of Googling, I discovered the answer: TRULX isn't even seven years old.

That's no history!!!!

[corn18]

The good mutual fund is TRULX and the mediocre index fund is POMIX.

TRULX is a mutual fund with a historical performance of 15.02%. Its expense ratio just changed to 1.15% after a lower ratio deal ended. The expense ratio may go down yet again, which would be nice.

POMIX is an index fund with a historical performance of 6.33%. Its expense ratio is 0.30%. I believe it once was 0.15%, but it is now 0.30%.

I own shares in TRULX. I bought it because its superior historical performance. I also own shares in PRGFX which has a historical performance of 10.68% since April of 1950 (over 60 years) and an expense ratio of 0.67%.

I am willing to pay a higher expense ratio on a mutual fund if it has a propensity to clobber its index fund counterparts.

TRULX = T. Rowe Price U.S. Large-Cap Core Fund, expense ratio = .91%

As Nutria mentions, this fund has only been around 7 years and according to T. Rowe Price's website, it's performance over that time has exactly matched the S&P 500.

PRGFX = T. Rowe Price Growth Stock Fund ER= .67%

This fund has been around since 1950 and according to T. Rowe Price's website, it's performance over that time has been slightly less than the S&P 500.

In both cases, you could have just purchased VFINX Vanguard S&P 500 Index Fund and came out ahead and the ER is .16%.

[dczech09]

The problem is that if this 13.9% net ROI were so great, all money managers everywhere would flock to this fund. But they haven't.

Why, I ask myself. After a moment of Googling, I discovered the answer: TRULX isn't even seven years old.

That's no history!!!!

Which is why I mentioned another option that has a longer track record of over 60 years. Lesser return than my first option mentioned, but still outperforms the index fund option posed.

TRULX = T. Rowe Price U.S. Large-Cap Core Fund, expense ratio = .91%

As Nutria mentions, this fund has only been around 7 years and according to T. Rowe Price's website, it's performance over that time has exactly matched the S&P 500.

PRGFX = T. Rowe Price Growth Stock Fund ER= .67%

This fund has been around since 1950 and according to T. Rowe Price's website, it's performance over that time has been slightly less than the S&P 500.

In both cases, you could have just purchased VFINX Vanguard S&P 500 Index Fund and came out ahead and the ER is .16%.

My IRA only gives me access to T Rowe Price's mutual funds unless I open a brokerage window (which I have considered).

I think we have deviated from the central argument of this thread and for whatever reason this has turned into two people ganging up on another.

I was merely showing an example as to when it could be advantageous to pick a mutual fund over an index fund. I was also showing that a blanket statement of "index funds always outperform mutual funds" does not always hold water.

In my situation and what investment options I have available, I have chosen mutual funds and have explained (satisfactorily) why. I never once claimed that my mutual funds outperformed all other index funds and have not made any outlandish claim that mutual funds are always better than index funds. All that I have said is that in some cases, one may be better than the other, but we cannot apply a blanket statement.

If at some point in the future index funds outperform mutual funds, then I will absolutely buy index funds and take advantage of the lower costs. But right now, I am just not seeing it in my situation. It could certainly be different for other people.

With that being said, let's try to stick with the theme of this thread.

[corn18]

Apologies if you feel like you are being ganged up on. In your case, I would recommend switching from your current mutual funds to the equivalent TRowePrice index fund (PREIX) and save on fees.

I like disneysteve's recommendation: build a foundation with index funds. Then add mutual funds to "tilt" in a direction you desire. Some tilt small cap, some tilt value. You could also tilt towards a sector (medical, high tech, region of world). Just don't put a large portion of your portfolio into the tilt. I just switched to all index funds late last year, so I haven't added a tilt yet. Maybe I never will.

And more importantly, make sure you select an asset allocation that fits your risk tolerance. Selling on a dip is the worst possible move. Make sure you pick an AA that keeps you from doing that.

Tom

[dczech09]

Apologies if you feel like you are being ganged up on. In your case, I would recommend switching from your current mutual funds to the equivalent TRowePrice index fund (PREIX) and save on fees.

It's all good. I just want to make sure that we are sticking to the purpose of this thread.

I will definitely consider the index funds when it comes time for my annual rebalancing, but that will not be until January. For now, I will stick with the mix that I have.

I like disneysteve's recommendation: build a foundation with index funds. Then add mutual funds to "tilt" in a direction you desire. Some tilt small cap, some tilt value. You could also tilt towards a sector (medical, high tech, region of world). Just don't put a large portion of your portfolio into the tilt. I just switched to all index funds late last year, so I haven't added a tilt yet. Maybe I never will.

Very interesting ideas. I have seen some industry-specific fund options, but have typically shyed away because I have been worried about putting too many eggs into one basket. Still might not be bad if it is just a small amount.

And more importantly, make sure you select an asset allocation that fits your risk tolerance. Selling on a dip is the worst possible move. Make sure you pick an AA that keeps you from doing that.

I completely agree. If you pick too risky of investments, you run the risk of selling on market dips, which as you mentioned is the worst possible move. It is important to set an allocation that you will hold steady.

[Petunia 100]

A lot of people say "historical performance is not indicative of future results." This is very true. Future results are never guaranteed and it would be foolish to believe that historical performance alone is a good judge of what will happen going forward.

It's not just that a lot of people say it. Every mutual fund in every advertisement discloses it, as the disclosure is required by law. That law exists for a reason.

With that being said, no one can predict the future with certainty or accuracy. At least not consistently. Nobody knows for sure what tomorrow will bring, especially when it comes to investments. Not even mutual fund managers.

However, if I am looking at a mutual fund that has a 50 year track record of 15% annual returns, I can be pretty confident that that track record may continue going forward. I am much more confident with that mutual fund than a mutual fund with a 10 year track record of 3% annual returns.

Think of it this way. Let's say that you go to a doctor's office and have the choice between two doctors: one who is right 95% of the time, and one who is right 75% of the time. Which would you choose? Probably the 95% doc. There is no certainty that you will have no issues with the doctor, but historical performance is a great indicator (and may be the only one that you have).

Perhaps that is a bad analogy. The point is that experience breeds confidence. And historical performance is experience.

Have you ever read the Morningstar study which concluded the best predictor of future returns is costs? You have to be logged in on MorningStar to read it there, but here is a link from CBS MoneyWatch:

http://www.cbsnews.com/news/the-best-predictor-of-future-fund-performance/

[dczech09]

It's not just that a lot of people say it. Every mutual fund in every advertisement discloses it, as the disclosure is required by law. That law exists for a reason. [/URL]

The disclosure exists in order to protect the financial industry from people who look at historical performance as a sole means of predicting an investment's future performance.

I have never said one should use historical performance as a single criteria. It is a pretty good indicator (especially one's with long-term track records). You still need to use other analysis to judge whether or not a certain investment is worthwhile.

Have you ever read the Morningstar study which concluded the best predictor of future returns is costs? You have to be logged in on MorningStar to read it there, but here is a link from CBS MoneyWatch:

http://www.cbsnews.com/news/the-best...d-performance/

That is definitely interesting, and definitely a valid piece of information. In fact many experts, including John Bogle himself say that cost is one of the best indicators.

Why can't this be just one criteria you can use? Why can't historical performance be used as why? Why not use a beta analysis, or a correlation of returns and standard deviations? Oh wait a minute. These are all used in fundamental analysis!

All that I have been getting at is that historical performance is part of fundamental analysis and it can be used in our investment choosing processes. Perhaps it was my bad for saying that historical performance is the BEST indicator that we have available (and I do apologize for that). It can provide valuable information to us as investors, but it should not be a sole method of judging an investment.

At the end of the day, there is no one best indicator of an investment's future returns. There are several indicators that we can use collectively.

Also, please note that when I say "historical performance," I do not mean looking at a chart and watching for candlesticks and what not. I do not mean technical analysis. I mean looking at what the fund has returned over certain periods of time.