Posted on 01 September 2013.
Beating the stock market averages when investing in mutual funds is not as difficult as many investors believe. The reality of mutual fund investing is that a majority of mutual funds in any given year do not beat their tracking indexes. In fact, during an average year, 70 to 80 percent of all mutual funds that are available to invest in fail to beat their tracking indexes. For mutual fund investors, it means that to beat the stock market averages while investing in mutual funds, an investor needs to find, evaluate, and invest in the 20 to 30 percent of mutual funds that have track records of beating their tracking indexes.
This startling bit of mutual fund investing information is something that the mutual fund industry would rather keep quiet and ignore. After all, investors pay professional mutual fund managers annual fees ranging from under 0.5% to over 2.00% to manage their mutual fund investments, with the expectation that in return for those fees, the fund managers will use their expertise to beat the stock market averages and provide better returns than can be had by simply investing in low-expense unmanaged stock market index funds or just investing in stocks directly. But such thinking is wishful thinking, and is not based on factual mutual fund annual return data.
Most investors are invested in the stock market and subsequently stocks via mutual funds that they hold in their retirement accounts, such as 401-Ks and Individual Retirement Accounts (IRAs). While all boats tend to rise during a rising bull market, the reality is that annual mutual fund returns vary greatly, even during bull markets, with certain mutual funds consistently beating their tracking indexes and other mutual funds in their category.
A tracking index is a representative basket of stocks in a category that can be used to compare the performance of a mutual fund. For example, the performance of a mutual fund that is designed to invest in transportation related stocks could be compared to a stock market index that tracks the investment category, such as the Dow Jones Transportation Average. If a mutual fund does not have a consistent track record of beating the tracking index, what is the point of investing in it? Better investment returns could be earned by buying the stocks in the tracking index and avoiding mutual fund management fees altogether.
While losing a few percentage points in gains per year, due to being invested in underperforming mutual funds may not seem to be a great concern, for a long term investor, a few percentage points difference in returns can add up to a significant missed opportunities for gains over a long period of time. That is because long-term mutual fund investors make money over time by building upon and reinvesting previous year’s gains. Just a few percentage point difference per year can add up to a significant difference in total returns over a period of thirty or forty years, which is the investment time horizon of many investors that are invested in mutual funds through retirement accounts.
For example, if a mutual fund returns an average of ten percent annually over a period of forty years, versus one that returns only six percent annually over the same time period, the four percentage point difference in annualized returns works out to an astounding $968,412 difference at the end of the forty year investment period, based an annual retirement investment of $3,000 per year and reinvestment of dividends. The mutual fund with an average six percent annual return will be worth $492,143 after forty years, while the mutual fund with an average ten percent annual return will be worth $1,460,555 after forty years.
The four percentage point difference in returns changes the investment returns dramatically over a long period of time. This clearly demonstrates why it is so important to find mutual funds that beat the stock market averages when engaged in long term investing. A broad investment in the stock market returns approximately nine percent per year over long periods of time, when dividends are factor in. As a result, an investment in blue chip stocks or a low cost broadly-based stock market index tracking funds will perform better and provide a much better return than underperforming mutual funds.
Finding mutual funds that beat the stock market averages is not complicated. A 401-K retirement plan often has either printed materials or online resources that can be used to review the annual investment returns of the various mutual funds that are available to invest in through the plan. If comparisons of annual investment returns of various mutual funds to relevant tracking indexes are not offered via retirement plan resources, then comparisons can be made using online financial websites, such as YahooFinance or GoogleFinance. The important thing to remember when trying to beat the stock market averages while investing in mutual funds is to identify the handful of mutual funds offered in a retirement plan that consistently beat the stock market averages and invest in them.
If a long-term investor invests in mutual funds via an Individual Retirement Account, then a large variety of mutual funds offered by the brokerage firm that hosts the Individual Retirement Account can be considered to find ones that consistently beat the stock market averages.
Besides the annual investment returns of various mutual funds under consideration, there are other things to consider to increase an investor’s chances of beating the stock market averages while investing in mutual funds. Consider future positive economic trends that are either underway or will likely develop in the future that could result in above average returns for certain stock market sectors and find mutual funds within those sectors that have track records of beating their tracking indexes. For example, with tens of millions of Baby Boomers set to retire in coming decades, healthcare related stocks may see a significant increase in revenue and earnings, as the large influx senior citizens increase the amount of money spent on expensive medical treatments and pharmaceuticals. This increased medical and pharmaceutical spending could translate into above average returns for mutual funds that invest in healthcare related stocks.
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