Mutual Funds

The term “money market” can refer to two different products: [1] one is offered by the mutual fund industry and [2] the other is a type of bank account wherein the lender sets the interest rate. As of the beginning of 2012, ~ $2.7 trillion was in money market mutual funds while close to $6 trillion were in bank money market deposit accounts. The average money market yield was 0.06% while at banks it was 0.15% (Feb. 10, 2012, source: Crane Data).

Taxable investors may prefer ETFs over mutual funds due to a regulatory loophole that shields investors from capital gains distributions until final sale of the ETF. As shown in the table below, many popular foreign and global ETFs have not ever paid capital gains distributions (at least from their 2007-2008 inception to Dec. 2011). 

The following are excerpts from a February 2012 interview between Vanguard founder John Bogle and the Journal of Indexes.

There are two myths about equity funds: [1] management may be forced to sell some fund holdings because of increased redemptions during bear markets (thereby triggering unwanted capital gains) and [2] embedded capital gains for equity funds can eventually trigger unwanted gains (particularly to newer investors who did not enjoy the previous appreciation that is now called “embedded”).

Although it is difficult to predict the likelihood that actively managed mutual funds will outperform their benchmark index over any 12-36 month period, there is a high level of predictability that index investing will outperform actively managed funds when looking at any given 5-year period—as shown in the table below.

Risk-parity, also known as balanced-risk funds, is a new category of asset allocation funds. Advocates of risk-parity funds take the position that a typical asset allocation fund with a 60/40 (stock/bond) mix really has about 90% of its risk coming from the stock portion—meaning the overall risk level is higher than most investors would suspect. In a risk-parity fund, 50% of the portfolio is in bonds, 33% is in cash and the remaining 17% is split between stocks and alternative assets such as commodities.

At the beginning of 2001, there were over 540 index funds; of those, over 130 (25% of the index funds) outperformed their peer group 10 years later. Another 245 (45% of the index funds) underperformed and the balance (30%) were either liquidated or merged during the 10-year period.

According to The Wall Street Journal, as recently as 1989, the total number of share classes matched the 2,262 mutual funds in the U.S. (excluding money market funds). By 2010, there were 6,928 U.S. funds available in 20,188 share classes (meaning each fund offered ~ 3 different share classes). A 1% difference in annual fees can have a significant impact over time.

Many stocks that have done well for the first 50 weeks of the year frequently trade even higher during the final 1-2 weeks of the year (e.g., Video Display +38% and another 4% during the 51^st week of the year). Conversely, bad losers for year-to-date can take a final beating as the calendar year comes to a close (e.g., Salesforce.com -19% for the first 50 weeks and another 8% during the 51^st week).

According to The Wall Street Journal (December 2011), Over 10 years, an investor with $200,000 already invested in mutual funds and adding another $20,000 a year, could end up with an extra $48,000 if he could save one percentage point in yearly fees. A study done by IndexUniverse for the WSJ looked at returns of five well-known U.S. stock funds (Dodge & Cox Stock, Windsor, ICA, Fundamental Investors and GFA)) showed that their active management was explained entirely by three factors—beta, size and style (traits that can easily be duplicated by an ETF).