Mutual Funds Fun Facts: One Factor Will Have an Outsize Impact on Your Profits

It’s not precisely which funds you choose that controls your portfolio’s destiny as much as the types of funds you choose.

Motley Fool Staff
Motley Fool Staff
Oct 29, 2016 at 8:02PM
Investment Planning
In this week's Motley Fool Answers, Alison Southwick and Robert Brokamp reveal some lesser-known facts about these pooled investment vehicles. In this segment, they talk about why your general asset allocation strategy is going to matter more than which specific funds you hold.
A full transcript follows the video.

This podcast was recorded on Oct. 4, 2016.

Southwick: And the fifth and final thing you maybe didn't, but probably should, know about mutual funds is that the types of funds you choose will have the biggest impact on your future wealth.

Brokamp: Right, and you may have read this or seen this somewhere. Basically the biggest determinant of how much money you're going to have in the future isn't which individual stock fund you buy, or even individual stock. It doesn't matter whether you get this Vanguard fund, or this Fidelity fund, as much as how much you have in stocks. How much you have in bonds. How much you have in international stocks versus U.S. stocks.

Your asset allocation is ultimately the biggest determinant of how your portfolio is going to perform. So if you have a limited amount of time -- you've got one hour on Saturday morning to figure out a way to improve your portfolio -- don't spend it choosing the absolute best U.S. large-cap value fund. Instead learn a little bit more about asset allocation and determine what the right mix is for you between stocks, bonds, and cash.

Southwick: Take us home here. What's your Foolish bottom line about mutual funds?

Brokamp: First of all, I love mutual funds...

Southwick: Put that on a T-shirt!

Brokamp: I love...

Southwick: Some of my best friends are mutual funds.

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Brokamp: They don't have "fun" in the word for nothing! The Motley Fool is known mostly for picking individual stocks, but most of my money is in mutual funds because I appreciate getting the diversification that comes from it, and I appreciate that in some cases I have the professional management of an active manager.

But there are certainly many criteria that you should be looking for to increase your chances of success. The low costs. The tax efficiency if it's outside of your IRA or 401(k). There's something that's becoming more popular now called active share, and it has nothing to do with Sonny and Cher. It has to do with how much of an intimate...

Southwick: The duo was not making that mistake, but thank you.

Brokamp: It is how much of an individual fund's holdings differentiate or are different from the index. A lot of so-called actively managed funds are pretty much 95% of the index, and they'll never outperform. They're just like an index fund with higher costs, so they have this thing called active share. There's some research that indicates the more a fund is different from its benchmark, the higher chance it will have of outperforming. That research is being debated. There are other studies that have said maybe not. But it still makes sense, and if you were going to go with an actively managed fund, you want to look for something that is different from the index fund.

Southwick: Give you an edge, because otherwise why are you paying?

Brokamp: Exactly.

Southwick: So everybody go forth, do your research, find some good mutual funds. Maybe we'll have an episode coming up where you actually call out some of your favorite funds that you love so much.

Brokamp: I think that would be great. I look forward to it so much.

Southwick: I think that would be fun.

Brokamp: I'll get a T-shirt for each one.

Southwick: Yay!