Money 70: Best funds through thick and thin



(Money Magazine) -- For the Money 70, 2009 was a year of vindication. After the vast majority of the funds on our recommended list suffered steep losses in 2008's credit crisis, almost all rebounded strongly last year -- with many posting double-digit gains. But short-term returns aren't the point. It's far more important for you to focus on long-term results.

And over lengthy periods of time, Money 70 funds have proved worthwhile -- provided you stuck with them in good times and bad. Take the case of Royce Pennsylvania Mutual. In a decade where gains were hard to come by in the U.S. stock market, this small-cap fund earned 9.5% a year vs. 3.9% for small stocks in general. Yet by moving money into and out of the fund at the worst possible times, Pennsylvania Mutual investors earned just 3.9% annually, according to Morningstar.

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The good news: Many Money 70 investors are more patient than average. For example, while Vanguard Windsor II returned 3.8% annually over the past decade, investors in the blue-chip stock fund earned nearly all of that: 3.4% a year.

It just goes to show that you don't need to try to outguess or outperform the market to be a successful investor. Just choose a sensible, long-term strategy and have the patience to hold on during inevitable bad times. This group of funds was designed to help you do just that.

What we look for

Why don't we pay much attention to short-term performance when assembling the Money 70? Academic studies have shown that funds that zoom to the top of the charts during one cycle frequently lag in the next. And trying to choose the next winners is simply a waste of time.

What's more, this list was never intended to be a collection of hot funds. Instead, the point of the Money 70 is to give you a menu of high-quality funds and ETFs that you can use to construct a well-diversified portfolio, which in turn will help you achieve your long-term financial goals.

The criteria: When deciding which funds qualify, we focus on attributes with real predictive value. For starters, we insist that all of our recommended funds charge expenses that are much lower than their category average. In addition, we seek out only trustworthy funds -- those with proven records for putting shareholders first, as measured by Morningstar's stewardship grades. Those ratings are based on such factors as a fund's corporate culture, regulatory history, and board independence. On a scale of A to F, we consider only funds with grades of B or better. (If a fund isn't given a grade, we use our own judgment.)

Other qualities we look for: a consistent investment strategy and experienced managers. In fact, the average tenure for an actively managed stock fund in the list is more than twice the industry average.

Finally, we do consider performance -- but only over the long term. To initially qualify for consideration, a fund must have beaten more than half its peers during the prior five years. But once on the list, funds that start to underperform aren't automatically tossed out, especially if they have strong track records over longer stretches.

Why don't we quickly kick the laggards to the curb? Sometimes a fund underperforms simply because its investing style is temporarily out of favor. But there are also instances where good funds just make some bad bets.

That was the case with several funds on our list recently. Among them: Bridgeway Aggressive Investors 2, Muhlenkamp, and Weitz Hickory, all of which rank poorly over five years. Bridgeway's computer-driven strategy failed to pick up on the danger signals flashing in the subprime bubble. And contrarians Ron Muhlenkamp and Wally Weitz loaded up on financial and real estate stocks that imploded.

Still, there's a danger in bailing out of funds with good long-term track records too soon. For instance, Bridgeway's 10-year record at its older sister fund, Aggressive Investor 1, gives us confidence that the fund can bounce back. Muhlenkamp and Weitz, meanwhile, have a long history of wild performance swings, with top-notch years followed by dismal returns and vice versa.

Overall, the majority of our funds did well last year -- some 69% of the actively managed funds ranked in the top half of their peer groups. More important, over the past five years 78% outpaced their category averages.

This year's changes

Because we believe in patience, we try not to tinker with the list too often. But from time to time, as funds change and managers come and go, we have to make adjustments. This year there were an unusual number of moves. Among actively managed funds: We removed T. Rowe Price New Horizons, which invests in small, fast-growing companies, because longtime manager Jack Laporte will retire in March. If you own the fund, we aren't recommending that you sell. But we prefer actively managed funds that have five-year records under the same manager.

We replaced New Horizons with Wasatch Small Cap Growth, managed by Jeff Cardon, who's been at the helm since 1986. Cardon favors small stocks whose earnings are growing fast -- typically 15% or more a year. But to reduce the overall risk of the fund, he also mixes in slower-growing Steady Eddie shares. This cautious growth approach helped the fund finish in the top 30% of its peers over the past five years; over the past 10 years it ranks in the top 6%.

Wasatch frequently closes its funds when assets grow to unmanageable levels. In other words, if too much money comes pouring in, the company often turns away business to better serve existing shareholders. That's another reason we like this fund.

T. Rowe Price New Era's manager is also due to retire later this year, but we are keeping this fund on our list. We made an exception because this natural-resources fund offers more diversification than most of its peers. T. Rowe Price also has a strong record for hiring good managers.

At FPA New Income, Bob Rodriguez is stepping away for a year's sabbatical and will return as an adviser, not as the manager. Here again, though, we are making an exception because we expect New Income to follow the same cautious strategy under longtime co-manager Tom Atteberry.

We did reluctantly drop three offerings from Third Avenue -- Small Cap Value, Real Estate Value, and International Value -- because the fund group is raising expenses sharply. International Value, which now charges annual expenses of 1.48%, will see its costs go as high as 1.65%. And expense ratios for Small-Cap Value and Real Estate Value will rise from 1.15% to as much as 1.4% (If you already own them, hang on; you'll be grandfathered into a cheaper institutional share class). These funds are still solid options (see "Picking the Sweet Spot in Real Estate" on page 174), but because their fees are no longer significantly lower than average, they no longer qualify for the Money 70.

To replace Third Avenue's small-cap fund, we brought in T. Rowe Price Small Cap Value. This top-notch small-stock fund is run by 18-year veteran Preston Athey, who favors beaten-down or overlooked shares. Over the past five years the fund has trounced 75% of its peers, and over 10 years, Small Cap Value ranks in the top 10% of its category.

To replace International Value, we added Vanguard FTSE All-World ex-U.S. Small Cap Index. This fund is relatively new -- it launched last April -- but we have confidence in Vanguard's skill in managing index portfolios. We also chose SPDR Dow Jones International Real Estate, an ETF that invests in real estate securities abroad, to replace Real Estate Value.

Among index funds: There are two additional changes in our roster. We are taking out Fidelity Spartan 500 and Fidelity Spartan Total Market to make room for Schwab S&P 500 and Schwab Total Stock Market. We still like Fidelity's index offerings and if you already own them, there is no need to sell. But if you don't have a position in a broad-market index fund, the Schwab portfolios have a key advantage: Minimum investments have been lowered to just $100.

That makes them a terrific option for new investors, since most fund groups typically require you to ante up $2,500 or more ($10,000 in the case of Fidelity's Spartan funds). And for diehard cost cutters, fees on these funds have come down. Annual expenses for Total Stock Market, for instance, fell from as much as 0.53% to just 0.09%.

That's not the sexiest reason to buy a fund. But sticking with low-cost funds that have disciplined management will make it easier for you to stay the course. And in the end there's no better way to achieve your long-term goals. To top of page

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