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At the end of the day, everyone wants to be holding mutual funds (or other investments) that are going to be top performers. People pick funds based on word of mouth, adviser recommendations, advertising, low fees (e.g., index funds), Morningstar ratings, and sometimes plain old intuition.
At Informed Investing, we believe that a disciplined, historically tested, repeatable fund selection strategy is superior to other alternatives over the long run. After all, most of the other products we buy go through testing and close scrutiny - shouldn't your investment strategy? If you're relying on an investment professional, have they shown you their historical results and fully explained the strategies they use?
 While some people try to keep the logic behind their strategies a hidden secret, we've decided to take the opposite approach. We believe that you should fully understand the logic behind your investments so that you can make the most informed decisions possible. Your money is too important to simply turn over to someone else, and at the end of they day, you care more about it than anyone else as well. Does this mean that you're never going to lose money and always beat the market by following this strategy or your own ideas? Unfortunately that's not the case - anyone making those claims should be immediately questioned. However, when evidence indicates that, on the whole, certain ideas seem to hold up over long periods of time, then we believe careful investigation is required.
So, what's the basis for our fund selection? This is typically the question people ask first. Instinct tells us that we should try to "buy low and sell high". Of course, this assumes that you know when low is truly low and high is truly high. As it turns out, this is more difficult that it sounds. Another principle that is sometimes stated is to "buy high and sell higher". As it turns out, our testing has shown that's there's something to this...
| Fund Selection Basics |
- The first basic step is to take each fund universe (Fidelity and Schwab), and to assign funds into their respective asset classes - U.S. sector, international, and bond funds.
- Within each asset class, we use historical data and our own custom software to determine the relative strength of each fund as it compares to other funds in the same asset class. Relative strength is computed by looking back over various time frames (6-12 months), and also factors in volatility of the fund.
- Within a given asset class, we then look for the top 3-4 funds that are not highly correlated to each other. This gives us added diversification, and helps avoid what some investors run into - holding multiple funds, but finding out that they all perform about equally (i.e., just because you hold multiple funds does not mean that you're necessarily diversified).
- The strategy calls for placing funds in all 3 asset classes - U.S. sector funds (one class), International funds (second class), and bond funds (the third class). In the ideal situation, you can put enough dollars into the strategy to purchase the funds recommended in each class: 4 U.S. Sector funds, 4 International funds, and 3 bond funds. We suggest a percentage of funds to allocate to each asset class depending on how aggressive/conservative you want to be.
Believe it or not, after correctly calculating relative strength (one must include dividends, etc.) and factoring in correlation and volatility, back-testing shows that the strongest performing funds have a great shot at out-performing the average performance of the funds within that same asset class. We also use some tie-breaker logic that helps us boost returns a bit further.
It should be noted that this isn't a "perfect" set of rules. That is, sometimes the leading funds we pick will end up under-performing over the coming quarter. However, our testing clearly shows that, on the average, this out-performance can provide a true boost to investment returns. We believe this is a much more logical and disciplined approach as compared to simply guessing at what funds might be best, or relying on someone else to make that guess.
Of course you shouldn't just take this at face value. By studying the back-test results and performance, you should judge the effectiveness of this for yourself.
We've only scratched the surface here, since it doesn't really make sense for us to re-write all the information we already have in our free strategy report. Take a minute, sign up for our free registration, and check out further details for yourself.
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Fund selection is of course critical to the strategy, but it doesn't stand alone. asset allocation is also very important, and the Cornerstone Fund Investing strategy calls for allocating funds over U.S., international, and bond funds. Asset allocation is widely used by all investors, but like the rules above, if careful thought isn't put into what those allocations should look like, it's easy to end up with an un-balanced portfolio.
| Asset Allocation Basics |
- For our testing, we modeled 3 different asset allocation approaches - aggressive, moderate, and conservative. It's up to you to decide how aggressive that you'd like to be.
- Our testing for the aggressive investor uses the following rules:
- U.S. Sector Fund Allocation (target 4 funds): 45%
- International Fund Allocation (target 4 funds): 40%
- Bond Fund Fund Allocation: (target: 3 funds) 15%
- Our testing for the moderate investor uses the following rules:
- U.S. Sector Fund Allocation (target 4 funds): 35%
- International Fund Allocation (target 4 funds): 30%
- Bond Fund Fund Allocation (target 3 funds): 35%
- Our testing for the conservative investor uses the following rules:
- U.S. Sector Fund Allocation (target 4 funds): 25%
- International Fund Allocation (target 4 funds): 20%
- Bond Fund Fund Allocation (target 3 funds): 55%
When you take a look at the performance results, you'll see that allocation does indeed impact performance, just as expected. Of course, the more conservative portfolios also don't have the same level of volatility (and portfolio draw-down), so there's trade-off's to be made between performance and risk.
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 The final part of using the strategy is understanding the timing of exactly when you make mutual funds purchases/exchanges. Fortunately this is very simple - you don't have to continually monitor your positions or the market for making updates to your portfolio.
| Exchange (Buy / Sell) Timing |
- Once you've decided to give the strategy a shot, pick a starting day. It can be any day that you choose. Look up the fund picks here at informed investing and make your initial purchases.
- Then, every 93 days, take a look at the current fund picks here at informed investing. Make any necessary fund exchanges, and repeat this every 3 months. Compared to other strategies, you'll only have to look at your investments 4 times a year!
- Why 93 days? There's nothing magic about 93 days, other than the fact that we want to ensure that we don't run into short-term trading fees if a fund is held for less than 90 days (a number of funds will charge short-term trading fees if something is held less than 90 days). Our back-tests are run with a 93-day holding period, and we want to conform to the back-tests that we trust as closely as possible. If you don't trade on exactly day 93, that's certainly OK. Our full research manual lays out in detail exactly how sensitive the returns are to the length of the holding period.
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Cornerstone Fund Investing