The Best Funds for Your Family
Introducing the MONEY 5O, an elite group of proven funds you can use to build a rock-solid portfolio--whatever kind of family you have
(MONEY Magazine) – Market-beating one-year returns. Five-star ratings. Celebrity managers. When it comes to fund investing, there are so many distractions. The fact is that hot short-term performance streaks are very often followed by blowups, and even managers with great long-term records can disappoint you. The trick is to focus less on performance and more on the things you really can control. That means keeping your costs down, dealing only with money managers who have a record of putting their shareholders first, and making sure you have a well-diversified portfolio suited to the level of risk you can live with.
That's the thinking behind the new MONEY 50, our elite list of recommended mutual funds. Only funds with low expenses and a consistent investment approach, plus a history of integrity on the part of management, made the cut. Among these choices, listed on page 91, you'll find everything you need to build a successful long-term investment plan. In the profiles that accompany this story, you'll also see how these funds can fit together into portfolios tailored to a variety of families.
How to pick funds from the 50
The most important decision you make when choosing a fund is what kind. The MONEY 50 includes stock funds that invest in large, mid-size and small companies. In general, the funds that buy large-capitalization stocks will be less volatile than those that buy smaller ones, so most investors should make large-caps the core of their stock portfolio. Each of these groups is further divided into growth, value and blended picks, according to how they are categorized by the fund-tracking group Morningstar. Growth funds are generally more aggressive than value funds. (The fund performance tables beginning on page 98 use the more fine-grained groupings favored by data provider Lipper, so in a few cases the categories you see here differ.)
For the most part, you want funds that diversify over many industries, rather than specializing in just one. Technology funds, for example, are useful if you have a strong opinion about that industry, but the rest of us get plenty of exposure to tech just by owning a typical blue-chip stock fund. Two real estate funds and the T. Rowe Price New Era natural-resources fund do find a place among the 50, however, as a way to tamp down the risk of a typical portfolio. Real estate values may move in the opposite direction of the broader stock market, and natural-resources stocks can provide a hedge against inflation.
The MONEY 50 also includes funds that invest in the major overseas stock markets—divided, again, by style and average stock size—as well as picks for each important bond category. What about hybrid or "life cycle" funds that mix stocks and bonds? Some of these funds are great, but they only make sense if you want to leave key asset-allocation decisions to a fund manager.
Making the cut
When you focus on what really counts in fund investing, the class acts stand out quickly. First, skip all the funds with assets of less than $100 million—for technical reasons, it's relatively easy for a fund manager to put up good numbers when he has a small asset base, and that advantage disappears when new investors pour in. For the same reason, ignore big funds that have grown so fast in recent years that they've had to alter their investment style. You can also disregard most new funds or those that haven't been run by the same person or team for several years. (A few exceptions: The MONEY 50 includes Dodge & Cox International, a young foreign-stock fund managed by a team with a great record picking foreign stocks for Dodge & Cox Stock, and Vanguard Inflation-Protected Securities, which invests in inflation-protected Treasuries, or TIPS, a relatively new kind of bond.) And naturally there's no point in looking at funds that are closed to new investors or restricted to institutional buyers.
After all that, a fund should pass three basic tests:
• Low costs—of all kinds. Nobel prizewinning economist William Sharpe has pointed out that the best predictors of strong future fund performance are low costs and low trading inside the portfolio. It's not hard to guess why. Based on historical returns, Wharton economist Jeremy Siegel expects stocks to beat bonds by an average of three percentage points a year over the long run. (And lots of market observers think Siegel is too bullish.) Buy a stock fund in which operating expenses consume the average of 1.5% of assets every year and you've already given up half that margin. Meanwhile, brokerage fees and other costs from the fund's trades can be as high as or higher than the fund's published expenses, according to estimates by the Plexus Group, a consulting firm that tracks trading costs. Fast-trading funds potentially add to your tax bill too. In other words, if you pick a high-cost, high-turnover fund, you're already deep in the hole. So every fund in the MONEY 50 has below-average operating expenses for its category—in many cases, far below average—as well as a low turnover rate. No exceptions.
• Putting shareholders first. The fund industry scandals of recent years have clearly shown that some investment firms are better than others at safeguarding their investors' interests—and when it comes to your family's money, there's no reason to accept anything less than high fiduciary standards. In 2004, Morningstar launched a new kind of fund rating called fiduciary grades. These rankings, from A to F, are based on five factors: the fund company's status with regulators, such as the SEC and the New York State attorney general's office; quality of the board of directors; manager incentives; fees; and corporate culture. In the end, for the MONEY 50, we ruled out any fund that received a fiduciary grade of less than B. In the few instances when funds didn't have a grade—Morningstar is still building its list—we made our own judgment.
• Solid performance—the knockouts are a bonus. Since fund returns are so unpredictable, the best way to use performance records is as a tool to weed out the obvious losers and one-hit wonders. Instead of insisting on category-crushing performance for the funds on the list, we simply focused on those that beat 60% of similar funds over the past five years. (We made some exceptions with specialty funds.)
The last detail
Are the 50 funds listed here the only ones that pass all these tests? No, but we wanted this list to be the best of the best. To make our final selection, we used a combination of quantitative and qualitative criteria. Where there were several funds that ranked similarly on fiduciary ratings, for example, we gave the nod to those with the lowest expenses and the most consistent investment approach. And since lots of 401(k) plans use just one or two fund groups, we tried to include picks from as many companies as possible.
If you already own funds that don't make this list—or have a 401(k) that doesn't include them—don't worry. Sharp-eyed readers of money will note that this list used to be called the MONEY 100, so there are plenty more worthy funds out there. The goal is to make sure the funds in your portfolio get the big things right—low costs, management integrity and consistency over razzle-dazzle. If your funds don't pass those tests, and the tax consequences aren't too great, consider switching. You can also use these funds for any new money you put in the market, and for any investments you make after you have fully contributed to your company's 401(k) plan. Although there's no way to predict whether all of these funds will come out winners, we're confident that a portfolio built around the MONEY 50 has a head start in the race.
The MONEY 5O
We sifted. We sorted. And we were merciless. Only those funds with the lowest costs and solid reputations for management integrity had a shot at making our list of recommended funds.
NOTES: Performance data as of Dec. 16. A dash indicates not available or not applicable.  Annualized.
SOURCES: Lipper (expense and performance data), Morningstar (style and screening tools).