On Index Funds, Target Dates, and Fees

An author and money manager advises on choosing the best mutual funds.


Selecting a mutual fund may seem like a daunting task, with thousands on the market to choose from. Recently, I talked with Steven T. Goldberg, a former Kiplinger's Personal Finance writer (and a former colleague of mine), about how to pick funds. I figured he'd have some good tips, now that he's in the money management business. Goldberg also writes a weekly column for Kiplinger's—I particularly like this week's post on Five Great Green Funds—and he's the author of the book But Which Mutual Funds?: How to Pick the Right Ones to Achieve Your Financial Dreams. Here's what he had to say about choosing funds (tomorrow, I'll highlight a handful of his favorites):

Any new insights into the fund industry, now that you've crossed over into money management?

It's really satisfying to help people on an individual basis—I'm finding it a little more difficult than expected, mostly because of the psychology of it. Investors' portfolios are kind of like garages: places where they put all the stuff they don't know what to do with. There will be one fund someone's brother-in-law told them to buy, another stock they heard about at the water cooler, and a fund some broker sold them with horrible fees, none of which work together at all. Often, people just want to forget about it. It's also been made very, very complicated by fund-industry people telling you so many different things; it's easy not to do anything. Index funds or actively managed funds?

I think most individuals investing on their own ought to stick primarily to index funds, or index ETFs [exchange-traded funds]—but really broad-based ones. The easiest way to do that is put 70 percent of your stock money in Vanguard Total Stock Market, 30 percent in Vanguard Total International Stock, then put your bond money into Vanguard Intermediate-Term Tax-Exempt (those in a lower tax bracket can do Vanguard Total Bond Market). What about the world beyond index funds?

I think if you really work at it, if you become a hobbyist in spite of the odds (we know that roughly two thirds of actively managed stock funds don't beat their benchmarks), and if you take some time to research funds, you can do better than the index. Not by a lot. Index funds are boring intellectually, and it's temping to go active. If you're going to go active, you really have to make a commitment, because there are so many ways to get burned. The 2000 to 2002 bear market caused real scars for people. Imagine you had half a million dollars in retirement, and 80 percent of that gone would be $100,000. Target-date funds: Who has the best?

I love T. Rowe Price's target-date funds, and the reason is because T. Rowe, in my mind, is the best no-load, big fund shop around. They are very much growth at reasonable price. With target-date funds, you don't want two layers of expenses. Some will charge you for the target fund, and then they'll go invest in other people's funds. You just pay one fee at T. Rowe. Target-dates are good retirement funds for a lot of people, as a one-fund solution. Pretend you're five or 10 years younger to make the funds more aggressive; I think they do add a little too much in bonds too soon. How much should you pay in expenses?

Maybe I was naive, but one thing that really shocked me since I got into the business is how sleazy some of the major financial firms are. I see that, because I see the portfolios that come in from big brokerages. They have all these hidden fees—people are paying far more than they realize. The market, theoretically, should give you 10 percent a year based on history, and if you take away 3 percent for inflation, you're down to 7 percent. How much could you give up in fees? For a domestic stock fund, too much over 1 percent indicates concern. What other tips could you offer for beginning investors?

One of my sayings is, if you're looking for good mutual fund, go to a mutual-fund company. There are funds out there owned by Dutch insurance companies, Swiss banks, and big brokerages, and most don't do a good job. One thing people should look at is volatility or standard deviation. You can get this number from Morningstar. Volatility has proven to be such a great predictor of bear-market performance. That doesn't mean you shouldn't buy a volatile fund—just limit your dose.

index funds
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