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Bill Freehling is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Bill Freehling.
This week’s (8/15) investing column
LOWER-COST mutual funds consistently outperform higher-priced ones, Morningstar found in a study published Monday.
Morningstar is best known for its mutual fund rating system that assigns between one and five stars to a fund.
A study published by Morningstar’s Russel Kinnel showed that star ratings are a useful way to pick top-performing mutual funds, but they’re not as good a predictor as how much a fund charges its investors every year. That cost is called an expense ratio, and Morningstar advises investors to find low ones.
“Investors should make expense ratios a primary test in fund selection,” Kinnel writes. “They are still the most dependable predictor of performance.”
The Morningstar study looked at star ratings and expense ratios from 2005 through 2008 and then examined performance through March 2010. In every asset category, including a variety of types of stocks and bonds, lower-cost funds had better total returns than high-cost ones.
“If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision,” Kinnel writes. “In every single time period and data point tested, low-cost funds beat high-cost funds.”
Lower-cost funds were also less likely to be closed due to poor performance, the study found.
The Morningstar study is hardly the first to show the virtues of low-cost mutual funds. Plenty of mutual funds have slick marketing tactics to convince you of their excellence, but the cold fact is that very few actively managed funds outperform indexes over time.
On average, actively managed mutual funds underperform the market by whatever they charge investors in the form of sales commissions, expense ratios and other fees. This suggests that most investors would be better off in low-cost index funds. Those who choose actively managed funds should select those with long track records of market-beating results and reasonable expenses.
Buffett’s strategy broken down in book
I just finished reading a new book by Georgetown University business professor Prem C. Jain called “Buffett Beyond Value.”
The book provides an excellent breakdown of Warren Buffett’s investing strategies. It shows that Buffett isn’t just a traditional value investor who looks for underpriced stocks, but instead a man who carefully evaluates a company’s growth prospects. Buffett puts it thus: “Growth is always a component in the calculation of value.”
Jain’s book offers a lot of useful advice for investors on how to keep their emotions in check, analyze corporate balance sheets, and in general make good decisions. He uses many of Buffett’s decisions as a framework to present his ideas.