Best funds for Me may not be best funds for Thee

At year end, articles about market predictions, or what funds to buy, tend to appear more frequently. I am always skeptical of predictions concerning which funds or sectors (or individual stocks) will be “best for the coming year.”  I wish I had kept a running log of how these predictions tend to turn out.  Generally, predictions are no better than flipping a coin.  But they are fun to read and think about.

One such “best funds” prediction recently appeared at Kiplinger, by a storied regular contributor. (https://www.kiplinger.com/slideshow/investing/T041-S001-the-10-best-vanguard-funds-for-2020/index.html)

The article discusses the situation at the start of 2020 and how that influences what are likely to be the best funds to own. Several of the funds recommended are actively managed. While I am a big fan of Vanguard, I generally prefer their passive funds.

The question about whether passive or active funds are “better” will go on indefinitely.  One fund they mention, VDIGX (V. Dividend Growth Investor) has a five-year return cited of 12.1%, “a hair below the S&P500” but less volatile. True enough, but they mention it only has 42 stocks.  If one of them had been an Enron or a Lehman, that might have turned out worse.  I’d still rather hold 500 companies than 42, because diversification reduces individual-company risk.

We could rightly ask, what is the guarantee that dividends will continue to grow, for these 42 stocks, in 2020? Or, will the portfolio managers change the positions in response to a change in fortunes of one of the companies? What hidden trading costs will be incurred if this happens?  On the other hand, with a passive fund like the S&P 500 (VFIAX), trading costs for the portfolio are bound to be lower and dividends will be a lower percentage of NAV.  This means a lower tax bill, on a percentage basis.

The point in mentioning the foregoing illustrates the warning on all fund advertisements: “Past performance is no guarantee of future results.”  It has been shown repeatedly that lower cost funds tend to outperform higher cost funds. Also, current dividends, while smoothing the volatility, create additional current income that can increase income taxes – and decrease after-tax returns.

Several of the article’s funds are bond funds – and we could conduct a similar analysis of them that would involve credit quality, duration and tax treatment.

All the funds mentioned are well-managed, low-cost funds from a highly respected provider. Subtle differences between funds may well become inconsequential in light of overall market conditions.  For example, 2008 was a terrible year to hold any equity fund. It was harder to envision that at the start of that year.  Those who sold after these terrible results, and stayed out of the market, suffered losses they never recovered from.

Other factors to be taken into consideration in portfolio design and investment selection are the context created by unrealized gains, taxes, estate plans, and personal goals, and to what degree taking risks in the equity market will be compensated by higher expected returns within each family’s investing horizon.

While interesting reading, take these types of predictions with a grain of salt. What may be the best funds for Me, may not be the best funds for Thee.

 

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