As those who have been out to the Yard know, one of the popular, albeit goofy, side entertainments is the Esskay Hotdog Race where three cartoon hotdogs race on the jumbo screen. The crowd jumps up and down and yells for their favorite.
Anyways, it struck me that picking a favorite hotdog in the race is probably similar to how many 401 (k) participants pick their investments.
This particular problem was on my mind because, in the morning, I had met with a young lady who works for the county and sought my help "getting started and learning about investing." She told me she was the first one in her family to invest and is excited to learn the process.
An important part of the process that sometimes confuses people is choosing which funds to invest in.
As I watched the hotdog race, I reflected that probably 20% or more of the baseball crowd had likely faced this issue, via the exact same investment vehicle The Maryland Teachers and State Employees Supplemental Retirement Plans.
So how do you choose which funds to invest in? Some plans have a ridiculous number of choices, and this is one area where research has shown that too many choices can be detrimental. Thankfully, the Maryland Plan has a reasonable number of choices.
Some participants throw up their hands and go with target date funds. These funds set an allocation based on your expected retirement and make rebalancing moves over time. This is OK and is a lot better than not participating. But choosing funds directly is a less costly method that can more accurately reflect risk tolerance.
By the time you've come to pick funds, you've already picked an asset allocation model. The young lady and I agreed to start with the "Moderate Model" which is basically 60% stocks and 40% bonds. Even though she is young and can stand some volatility, we thought it best to start a bit conservatively. I explained, since she will be contributing on a regular basis, that the best thing for her would be for the market to drop 50%! What is important to her is where the market is 30 years from now - not what happens over the next few years.
The "Moderate Model" specifies 30% allocated to "Large-Cap Stock Funds." The choices offered are shown in the following table along with 1-year, 3-year and 5-year performance numbers:
|FUND||Ticker||Exp Ratio||1 Yr.||3 Yr.||5 Yr.|
|Neuberger Berman Partners Fund Inst.||NBPIX||0.69%||-7.81%||23.60%||-1.43%|
|Vanguard Instl. Index Fund Plus||VIIIX||0.02%||8.54%||23.47%||2.07%|
|Parnassus Equity Income Fund Inst.||PRILX||0.75%||5.73%||20.67%||5.97%|
There are actually 3 additional choices, but they are not "Large Blend." "Large Blend" means that the funds blend value stocks (i.e., those with low P/Es) and growth stocks (i.e., those with higher than average earnings growth).
So how do we choose? Is this like picking in the cartoon hotdog race? Should we throw darts? Actually there are well-defined principles supported by academic research and recommendations from leading market analysts. Those who support this approach include Warren Buffett, Burton Malkiel (author: A Random Walk Down Wall Street), Charles Ellis (author: Winning the Loser's Game), Andrew Hallam (author: Millionaire Teacher), and, of course, John Bogle, founder of the Vanguard Funds.
The process is straightforward: pick funds that have low expense ratios and closely track the overall market. This leads us to choose the Vanguard Fund with its .02% expense ratio and close tracking of the S&P 500 stock index.
As you go through this exercise, you notice that the low-cost index fund is not the best performer over some periods. That's fine and to be expected. It may not even be the best performer in the future. What you get when you pick a low expense ratio fund that tracks the market is a fund that will beat 8 out of 10 competitors in a long-term race.
One point that gets a bit tricky is style. Are the funds really "Large Cap Blend?" To check this, go to Morningstar and put in the ticker symbol. Do this for PRILX, the Parnassus fund listed above, and scroll down a bit. You come to what is called the "Style Box":
We find that, rather than a Blend, it appears the manager has tilted towards Growth. A sausage has snuck into the race!
Scrolling down on the same page will show you as well that the fund has a brand new manager!
Disclosure: The information here is intended for education purposes. Individuals should do their own research or consult with a professional before making investment decisions.