If you were forced to invest in just one mutual fund now and hold it for an entire year, which fund would you choose?
This scenario may not be a realistic one but it is useful for framing investment decisions.
Let’s assume further that you may choose to hold the fund longer than just the one year, if it continues to suit your investment objectives, and that your primary performance criterion is to balance risk and reward. By doing so, you give yourself the best chance of obtaining reasonable returns without taking on unreasonable amounts of market risk.
What makes this scenario useful is that it forces an investor to find a way to narrow the thousands of choices down to one outstanding mutual fund. I suggest using a kind of inverse pyramid approach, where you begin with broad categorization, then continue to narrow down until you have just a few funds remaining.
Stocks: Best Asset Type in 2015
With interest rates hovering around historic lows but expected to begin rising at some point in 2015, a reasonable assumption to make about asset types is that stocks will likely have a better year than bonds and cash. Low rates, low unemployment, and low gas prices translate to more dollars in the pockets of consumers, which represent more than two-thirds of the U.S. economy. Higher 401(k) balances and better home values can also lead to the “wealth effect” that makes consumers feel better about their finances and in more of a spending mood. And while stock prices on average are a bit higher than some might call fair value, a price-to-earnings ratio of around 20 for the S&P 500 is not exactly screaming overbought just yet.
Large-Cap Stocks: A Better Bet than Mid Caps and Small Caps
As stocks get closer to the end of a bull market, risk appetite is starting to dwindle. Investors have inevitably begun shifting into low gear and away from the perceived risk of smaller capitalization stocks, fleeing to the safety of larger, better-known companies. Small caps, as measured by the Russell 2000, lost out to the large-cap S&P 500 in 2014, while mid caps, as measured by the S&P Midcap 400, also fell short. Look for that trend to continue in 2015.
Ruling Out Sectors and Alternative Investments
Investors willing to take risks in 2015 can do well to invest in a solid sector, such as technology or consumer discretionary, with good prospects for outsized growth in the late phase of the business cycle. Or, if you wanted to make a more defensive move, you might choose utilities, consumer staples, or healthcare. But if our one mutual fund choice is to have a chance at solid returns without the added risk, something more diversified in 2015 is a better idea. Following the same reasoning, an investor would also rule out using funds that don’t really invest in anything and track commodities indexes or use options that bet against the market.
Active Investing vs. Passive Investing
There are always active traders and fund managers that beat the broad market averages every year. Recently, however, more and more of them have been on the losing side. In fact, the S&P 500 index has beaten the majority of large-cap funds for five years running. If 2015 is a transitional year marked by volatility, an actively managed fund can be a good choice. But uncertain times can also be a killer for even the best active managers. The active versus passive choice may be the toughest of all in this short exercise. To me, passive investing may be the safer choice given the likelihood of volatility in the next 12 months.
If I Had to Choose One Mutual Fund for 2015…
After narrowing the asset type to stocks, then to large-cap stocks, then to avoid sectors, and then to choose passive over active, I would then choose what I believe to be the best large-cap index fund in the universe of mutual funds – Vanguard 500 Index (VFINX) – an outstanding mutual fund with a proven record of tight index tracking and extremely low expenses.
Which mutual fund would you choose?
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