Spoiler Alert: It’s Not an “Either / Or” Choice”

Much like the debate between “passive” versus “active” mutual fund and ETF investors, there is a similar debate between those who favor investments in individual stocks versus mutual funds.  Yet, in both, it’s not simply an “either/or” choice.   

There are logical rationales for each and only by objectively examining those rationales can investors determine what is actually “best” for them.   

When we first started developing our patented decision-assistance technology for the scoring and ranking of mutual funds, ETFs and index funds, some of our affiliated investment advisors asked us how to present and discuss the technology with clients who avoided mutual funds and preferred to invest in individual stocks.  

That caused us to take a serious look at the arguments on both sides.  

There appear to be four principal rationales favoring investments in individual stocks rationales:  

“Cost.” 

First, and possibly foremost, are mutual fund management fees, which arguably represent a drag on investment performance - an unnecessary drag –  if that cost cannot more than offset by the value produced by the mutual fund’s investment management team.  

Such as a hoped-for increase in returns over and above the returns of passive benchmark index-funds / ETFs. 

“Poor investment performance.”   

Second, and closely related, is that the investment performance of too many actively managed mutual funds appear to be average at best and, many times, subpar in comparison with passive-index funds and ETFs.  

“There has been no practical way to comparatively evaluate and identify superior funds.” 

Third, with nearly 30,000 mutual funds, and so much information available about each, it’s been virtually impossible for individual investors to comparatively evaluate and identify which ones might best meet their investment needs, goals and preferences. For many individual investors, this has forced a dependence on brokerage and advisor recommendations. 

Yet, these groups not only face the same problem of having no practical way to comparatively evaluate all available choices, that reliance on them all too often introduces the possibility that their recommendations may have been influenced by conflicts of interest, to the potential detriment of the best interests of the individual investor. 

 “I can do as good or better than mutual fund managers.” 

Fourth, in view of the average or subpar investment performance of so many mutual funds, it has been easy for many investors to conclude that they can likely do as good a job, if not better, in picking stocks and timing decisions to purchase and sell decisions than mutual fund managers, and at much less cost. 

All of these are valid observations and concerns.  However, that’s simply one side of the story. 

The resulting belief sometimes summarily dismissively expressed as “mutual funds are for suckers,” 

has too often operated to prevent an objective review of equally valid considerations supporting the use of mutual funds. 

Here are ones that we believe are most often overlooked: 

First is the reality that individual investors are not really “in the game.” 

What we mean is that individual investors have comparatively little to no direct access to the information available to professional investment teams. For example, there is no way that I, as an individual investor, can call the CFO of Microsoft or Pfizer or any other publicly traded company and ask how things look for the coming quarter. 

But a Fidelity or other large mutual fund manager likely can get his or her call answered and be able to obtain information not otherwise readily available to me or other individual investors. The SEC is so concerned that nonpublic information might be provided in such a call that there is a rule that requires the company to publish any non-public information provided within 24 hours.

So, a private investor might think; “That's good – I’ll be able to get the information I need and act on it.” Of course, that’s assuming that the investor is vigilant and has a way that would alert him or her to such publications. 

But what was the Fidelity investment manager able to do in the initial 24 hours? 

He or she was able to act on that information ahead of me and every other individual investor. 

In that sense, neither I nor any other individual investor are really “in the game.” 

Second is that individual investors seldom fully realize that they are effectively functioning as “money managers.” 

They don’t see or refer to themselves in that way. They refer to themselves as “investors.” 

However, very similar to mutual fund investment managers, they are investing money in pursuit of one or more investment goals. 

Most individual investors must, however, do their research only in their “spare time,” while mutual fund money managers are typically doing their sector and company-specific research and due diligence full time. 

In contrast, most individual investors inevitably are both “part time” and “amateur” money managers. 

Much like the differences between professional and amateur sports, in a “competition” to see which might be expected to produce better results, which group might be reasonably be expected to “win.” 

 “Cost” is relative to what you get for it. 

No one wants to pay for something that they do not receive.  In the case of actively managed mutual funds, that “something” is typically the hoped-for prospect of better performance than that of passive index funds and ETFs, which often have very low “expense ratios” – i.e., costs. 

If you have no way to identify funds delivering superior investment performance then, avoiding such funds and investing in passive index funds, ETFs, or individual stocks would appear to be an obviously wiser bet. 

But what if you could identify superior performing funds – funds that might be producing 5%, 6%, or more better returns annually and with less volatility than an index fund or ETF for that asset class? 

Would you be willing to pay 0.5% more for the prospect of that better than index return?  If so, then it’s not a question of cost alone, it’s really a question of whether or not you are getting sufficient value for the cost you’ll be paying.   

There’s now a better way to ensure that you are.  

Overcoming the problem of too many choices and too much information… 

Until now, there has been no way to comparatively evaluate the 30,000+ mutual funds – i.e., no way to answer this key question: 

“Of all the available choices, which ones are best for me?”  

Our efforts to answer that question led to the development of a decision-assistance technology for which we received U.S. and foreign patents. 

Using it, investors can now pick any number of performance factors, prioritize and weight them, in a way that best matches their needs, goals, and preferences.  And with that, they can now score and rank literally hundreds of mutual funds and can identify those that have been best at producing the composite investment effect they are seeking over time. 

Importantly, this also filters out all conflicts of interest, both known and unknowable . . . there is simply no way to “game” it.   

Why did we decide to focus on mutual funds and not individual company stocks?  

We could easily score and rank the performance of the stock of individual companies. 

Our technology could, for instance, tell us which telecommunications stocks had best met our investment goals and preferences over time.  However, our technology could not tell us when to buy or sell those stocks.  

The advisors for whom we originally developed this tool were CPAs and attorneys who simply could not afford to be wrong. 

With this new tool, they were not “recommending”, or “selling”, a particular mutual fund. 

They were performing a comparative analysis of all available similar funds (management teams) and empowering their clients, with their assistance, to select the ones their clients felt best matched their needs, goals, and preferences.   

The comparative evaluation of the performance of mutual funds provided a solution.  You see, mutual fund managers “add value” in three ways: 

1. They overweight or underweight “sectors” within the asset classes in which they are investing (e.g., investing proportionally more in tech stocks than financial services stocks); 

2. They overweight or underweight individual stocks within those sectors – ones they think will perform better than others; and, 

3. They decide when to buy and sell the stocks. 

 Those that perform one or more of these functions better than others will score and rank higher than others. 

Importantly, all three are also what individual investors must do.  So, during development of our technology, we posed this “thought experiment”/challenge to individual investors:   

 “If we were to take your brokerage statements for the last 5 years and, from them, we were able to calculate the characteristics of your investment performance, including average multi-period returns, volatility, and other factors relevant to you, how do you think you would score and rank in comparison with mutual fund management teams investing for those same investment goals? 

In other words, if we assume that your investment goal is “growth,” and that there are 600+ mutual funds with “growth” as their investment goal, here’s the key question that could and probably should be asked:  

If, in comparison to over 600 “growth”-focused mutual fund investment management teams that you might have picked, you ranked 275, would you consider “firing” yourself and “hiring” #1?”   

So, if the choice is not really “either / or”, what did we do? 

What’s our position regarding whether to invest in individual stocks or mutual funds? 

Well, it may sound flippant, but our answer actually falls in line with one of our ‘mottos:’ “When offered a choice, take both.” 

We completely understood and still understand that many individual investors truly enjoy investing in individual stocks and all of the learning, research, risk, and excitement that comes along with it.  Yet, acknowledging the sound logic of the factors that favor the use of professional investment management teams, especially since there is now a way to identify and select those teams that have proven best at producing the investment results that the individual investor is seeking, we advised those investors who had avoided mutual funds to now consider doing both.

Now, with a decision-assistance technology that could give investors a much better chance to identify and invest in mutual funds that have proven “best,” especially in relation to their individual needs, goals and preferences, a number the otherwise legitimate objections to and concerns about investing in mutual funds, may no longer logically apply. 

For example, investors could take some portion of their investment assets – for instance 30% – and use that portion to invest in individual company stocks.  The remaining 70% could then be placed in mutual funds, the historic performance profiles of which best matched the needs, goals, and preferences of the investor.   

This approach offered individual investors two things they had not had before.  It gave them a professional team to compete against, and the possibility of the thrill of beating them.  But, if he or she didn’t beat them, that management team would have provided the investor with better investment results than they would have individually produced.   

As we had hoped and anticipated, this approach met with wide-spread investor acceptance and enthusiasm. 

Because this newly available decision-assistance technology enables investors to identify those mutual funds that are “best for them” (and not simply for those recommending or selling them) it proved to be a true “win / win.”