Saturday, February 14, 2009

The power of hindsight

In order to drive home my previous message about not buying actively managed mutual funds for your retirement portfolio, I've run a little experiment.

I picked up the most recent edition of MoneySense, the greatest magazine on the planet. In it were this year's Honor Roll mutual funds. The author, Suzane Abboud, picks what she thinks are the best mutual funds in each category to guide readers in choosing quality funds for their portfolio. So I thought, surely if this woman who spends her time doing nothing but researching and recommending mutual funds recommends these funds, they must be able to beat a passively constructed index portfolio. Let the battle ensue!

My currently planned portfolio is called the Modified TD e-Series Simple Recipe Portfolio. I will be using all TD e-Series funds, because you can purchase them online through TD EasyWeb for no commission charge and no annual account fees. Plus, they are index funds so they merely track the index with super low management costs. The portfolio asset allocation will be as follows:

TD Canadian Bond Index-e: 40%
TD Canadian Index-e: 30%
TD International Index-e: 20%
TD Dow Jones Average Index-e: 10%

If I had invested $900 a month in this portfolio starting on March 1, 2002, my cumulative return today would be 1.4%. Although that seems paltry, it relatively kicks ass to the -25% I've seen with some actively managed portfolios I tested.

How do the Honor Roll mutual funds stack up? Well, I originally back tested the performance of this year's Honor Roll funds. They did very well, returning 7.2%, clobbering my return. Problem is, I would not have had the foresight to pick these funds in 2002. In fact, neither did Ms. Abboud. (Her 2002 recommendations were strikingly different to those in 2009.) The current crop of Honor Roll funds is largely based on past performance. But what good is past performance unless you can invest in the past?

What advice would a reader in 2002 have received from Ms. Abboud? I went back to the MoneySense archives and took a look at her column in the 2002 February issue. None of the best funds listed in the 2009 issue appeared. So I put together a portfolio of the best funds she listed that the average joe could actually afford (I excluded funds with minimum initial investments of more than $5000, except in one case) and back tested how one would have done investing $900 a month since March 1 of 2002, shortly after the February issue was released. The competitor portfolio would be as follows:

40% TD Real Return Bond Fund
30% Bissett Canadian Equity-A
20% Mackenzie Cundill Value-A
10% Mawer U.S. Equity

(Note: Mawer US Equity has a $10 000 minimum but it was much cheaper than the other US honor roll funds. One had a minimum of $150000. What?)

So had you shunned index funds in 2002 and took the advice of a professional mutual fund analyst and put your money in this portfolio your return from March 1, 2002 until now would be............dunh dunh dunh.....-5.7%

That is a negative sign in front of that number folks. So all that work meeting minimum investments, all those trailer fees paid to your broker or advisor, and all those potential sales charges paid for investing in the funds, just to get -5.7%.

So stick with what works. The main driver of fund performance is expense and index funds are the cheapest, so by mathematical reasoning, they are destined to do better in the long run then actively managed mutual funds. Besides, who wants to spend their time picking winners out of a crowd of 3000 mutual funds when you can do something simple like the MoneySense Couch Potato Portfolio using TD e-series funds and get better results?

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