Why Ryan Does Not Invest in Mutual Funds

Posted on March 14th, 2008

Out of 19,000+ mutual funds, the average return this year is -7.53%. This was according to Morningstar as of this morning (3-7-08).

Out of 19,000+ mutual funds, there are a whopping 40 funds that have a return greater than 15% this year. The highest performing fund is a fund that is primarily biased to the downside in the Nasdaq. It is up 58% this year. However, after last year’s 36% loss, a $10,000 account would be up a whopping $112 in the last 14-months.

In fact, the majority of the funds that are higher by at least 15% this year are involved in either energies, precious metals, or shorting stock indexes. Take for example Evergreen Precious Metals B. This fund is up 23% so far this year and holds the 11th best fund ranking so far. However, over the past 5-years, the fund is up a total of 35%. In short, the past 2 months or so has made 65% of the total return over the past 5-years!

Bond funds, the “safe stuff” are down an average of 1/2% for the year out of 6,000 funds.

U.S. Stock funds are down over 10% on average across almost 11,000 funds.

Intl Stock funds have a whopping 10 funds that are up for the year, the highest return being at 4%! The average across the almost 3,000 funds is down almost 10%.

There are over 6,000 “balanced funds“, the average return being down approximately 6.5% and the highest yielding fund at just over 8%.

Over the past 5-years, the best of the best only average about 10% per year.

And for what. That is the big question. If you happen to choose the best of the best across thousands of funds over the next 5-years, what are you risking to achieve the expected return of about 10% annually?

At any given time, most funds are at risk to drop between 10% and 30%. A select few could be down as much as 50% depending on how aggressive the fund is.

So to answer the question, personally, if I am going to be risking 30% of my money in something, it is going to be in something that has the potential to do far, far greater than an average of 10% per year.

There was a young man at a university who had bought into the philosophy that one can never really know what is real and what is not real. So, he stood up and thinking he was profound, asked the question, “how can I really know I am real“. The professor stood there for a few seconds and replied “And whom may I say is asking“.

Reality can be hard to discern sometimes, but it doesn’t mean it doesn’t exist. That is equally true in the investment world. What is reality?

Last week, I discussed why I do not invest in mutual funds. Reality is that mutual funds can be a positive experience, especially over a long period of time. Reality is also that returns are highly limited in most mutual funds. A third reality is that risks are still substantial. My conclusion was that if I am going to risk 30% of my mo- ney, I am going to risk it in something that has a greater potential return.

However, that doesn’t mean that I should risk money on anything that carries a higher potential return.

I can throw a few thousand on a few horse races and have the potential to make millions…but I don’t. I can fly to Vegas and throw a few thousand on a roulette number and gain many times over my risk…but I don’t.

In an attempt to make the right investment decisions, I have to look at what I call the three P’s of investing:

1. Potential risk (first and foremost)
2. Potential return (and as a ratio to the potential risk)
3. Probability of success

A horse race has very small probabilities if you want to win big. The roulette table has very small probabilities of success to gain a large payoff. This disqualifies them from consideration.

Ultimately, I am looking for something that has a low probability of realizing the maximum risk, with a potential payoff that is much larger than that risk. But, this is key…my probability has to be first and foremost on realizing the risk…not necessarily on realizing the maximum potential. You see, if my probability of hitting the maximum risk is small, then even if I don’t realize the maximum potential, there is a greater probability that I will at least partially succeed. Part of this is due to the fact that the longer you can stay in the game without hitting the maximum risk, the longer you give the opportunity to work out.

This is 100% OPPOSITE of how so many traders view trading. If they do not succeed immediately, they are off trying to find that next quick fix. In trying to succeed now, they propel themselves toward ultimate failure.

- R.y.a.n J.o.n.e.s

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