Top Ten Mutual Funds | Putting Your IRA or 401(K) on Autopilot

 

I love all those top ten mutual fund rankings. What a myth! I’m going to take a bit of a diversion today to talk about IRA and 401(k) retirement account management. I hope you folks don’t mind taking the discussion in a different direction today but as you are well aware I am all about leverage – be it time, money, or effort. Putting the top ten mutual funds myth out of your mind and instead designing an efficient portfolio of diverse funds (see what an efficient portfolio expected risk/return chart looks like) will put your IRA or 401(k) on a steady, automated path that will require maintenance only once per year.

The Myth of the Top Ten Mutual Funds

At any given time one market or sector is going to be performing better than another, and wouldn’t you know it, all those ‘guru’ financial sites (after the fact, of course, because reporting is always after the fact) will show that the health sector (for example – don’t run out and buy health stocks right now… please!) is performing well at such and such a date and as a result the top ten mutual funds are dominated by what? You guessed it: health care specific mutual funds. What a shocker!

What happens next? Of course the stupid money that follows the ‘latest and greatest’ from those “top ten mutual fund” sites yanks their money out of their “tech” sector fund (again hypothetically here…) and dumps it all into the top ten funds currently dominated by health care.

Meanwhile at the Smart Money Farm

All the while the stupid money is pouring out of tech and into health care, the smart money is quietly taking advantage of the opportunity to divest or rebalance out of health care and into… tech… or whatever other sector has been divested from by the stupid money. Don’t believe it? It’s actually fairly simple to see why and how it happens.

Lord I Hope You Are Never This Bored

If you ever had the misfortune of having nothing better to do other than read mutual fund prospectuses (prospecti???) you would find an interesting financial chart describing the how the gross money flow of the fund (contributions, redemptions, gains, losses, dividends, and interest) contributed to the ending net asset value (price) of the fund.

Take a look at a hot sector fund, whatever fund is presently in the top 10 mutual funds at Morningstar or whatever other fund rating site you happen to read. Find the NAV table I talk about above. Look at how HUGE the contributions to the fund are relative to the actual gains, losses, and income. Talk about the moths flying into the light!

Now look at a poorly performing sector fund (a.k.a. the bottom ten mutual funds). Find the same chart in their prospectus. Look at how huge the redemptions are relative to the actual losses racked up by the fund. The babies went out with the bathwater!

The Herd Mentality Exacerbates Mutual Fund Performance

What is going on with these top ten mutual funds and bottom ten mutual funds is that investors inevitably choose funds based on ‘grades’ or ranks they see in the Wall St journal or Investor’s Business Daily and plow money in where the market has been hot. This adds a lot of liquidity into that sector and sure enough, that sector goes up a little more. Meanwhile the smart money is re-balancing out of those sectors (either via the funds themselves or by actually selling out of that market directly) and taking advantage of the current liquidity.

Next Thing You Know It – No More Money Is Coming In to The Top Ten Funds

So once the stupid money has exhausted its ability to move money into the prior month’s hot sector, all of a sudden what happens? NAVs in the hot sector aren’t being boosted by contributions anymore, and in fact redemptions start to be greater than contributions. The net result of this? Yep, declining NAVs, and a trip to the bottom ten mutual funds. Just in time for the stupid money to exit.

Why I Bothered to Write About This Topic Today

A few years ago I wrote a research paper and created an excel spreadsheet program designed to create efficient portfolios of mutual funds (or any other assets).  You would use the program once per year to help you redistribute/rebalance your mutual fund assets in your IRA or 401(k) so you didn’t have to actively manage them or monitor them.

I was thinking about offering the research paper to my subscribers here for $30 or so and the excel spreadsheet program for $200. It would take some effort to dress them up for sale and rather than sink a bunch of effort into that without having an audience for it so I wanted to make the offer first and see whether there was a market for it.  Again, there is an example chart of an IRA CD combined with an efficient portfolio at this link.

Post a comment or drop me an email at optiontradingbasics09{at}gmail.com

2 thoughts on “Top Ten Mutual Funds | Putting Your IRA or 401(K) on Autopilot

  1. Thank you very much for sharing. Your information always proves to be useful. I think your post is suitable for everyone, who is interested in valuable resources . I will keep following your posts.

  2. I agree with you that too many people mess up their 401K by trading and chasing performance. I do think that 2010 will be a stock pickers market.
    We shall see.
    Fund picks for 2010

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