Investing in Investment Funds
This is the ninth discussion of the ModernGraham Book Club’s reading of The Intelligent Investor by Benjamin Graham (affiliate link).  In last week’s discussion, we discussed the eighth chapter, which reviewed how investors should view the inevitable fluctuations in the market.  This week we will discuss the ninth chapter, which is titled “Investing in Investment Funds.”  I encourage you to purchase the book (preferably by clicking the link to Amazon, because a purchase through that link will help support the club) and join in with us as we read through a chapter each week; however, even if you don’t have the book I think you will find our discussions to be very useful in your own understanding of value investing, and you can still bring a lot to the discussion from your own experiences as an investor.  Whether this is the first day you’ve ever been interested in investing, or you have decades of experience with the stock market, we’d love to hear your thoughts in the comments below!
Please feel free to leave a comment on this post with your own responses to the questions, along with any other thoughts you have, and return throughout the next couple of days to see what others have said. If you find something that has been said by another commentator interesting, feel free to respond to them with another comment.  We’ve had some great discussions the last few weeks, so keep it up!
ModernGraham’s Comments
Ben
Graham goes into some detail about opportunities to invest in Investment Funds in this chapter, but there are a couple of important points to make before we think about what he had to say.  First, in the opening sentence he says “one course open to the defensive investor. . . ” indicating that a Defensive Investor may choose to take this path, but it does not really fit into the Enterprising Investor’s approach.  Remember that the Enterprising Investor is willing to take the time to do substantial research into each investment.  If that’s the case, then it makes sense that the Enterprising Investor will not be all that interested in investment funds.  Second, the advent of computers has changed a bit of the opportunities available to the investor in terms of investment funds.  Mutual funds and index-based funds were around when Graham wrote this book, but they certainly were not as prevalent as they are today and the exchange-traded fund (“ETF”) did not exist.  An ETF is a fund that typically has very low fees and allows the investor to purchase a share of a fund without going through the commission-based experience one sees when investing in mutual funds through a broker.  I believe that any defensive investor looking at investment funds as a possibility should strongly consider utilizing ETFs rather than traditional mutual funds.
Later in the chapter, Graham presents some trends found in the investment fund industry that remain fairly true today. Â As a fund increases in size, it becomes significantly more difficult for the fund to attain the same level of performance. Â This is true for both investment funds and individual investors. Â When starting an individual portfolio, the investor may have a small amount of money and as a result the individual trades will not move the market. Â However, if a fund is attempting to invest, say, $10 million in a company, the purchase alone will create a change in price because of the potential to flood the market with demand for additional shares. Â It is easy to see that it may be preferable to invest in smaller funds, and even more preferable (in my opinion) to invest in stocks directly rather than utilizing the investment fund at all.
HeatherÂ
In this chapter on investing in investment funds, Graham applies the basic principles of research and awareness to funds as he has applied to individual stocks in previous chapters. One important aspect to note, however, is that unlike investing in individual stocks, funds are managed by the company rather than per your directive. A positive of this arrangement is that you can review a fund for soundness and then allow them to make the decisions about how to invest your money. However, as Zweig notes in his commentary key management employees do not often stick around long because as soon as they find success as one firm, others are quick to lure them away. Therefore, when purchasing shares in an investment fund, you can’t be sure who is really going to be investing your money. Therefore, this aspect of investments funds means you can’t ensure that those investing your money are necessarily going to be making the right choices. While the same can be said for any CEO at an individual company whose stocks you own, the difference is those companies have much more standing behind them giving them value. Beyond that, the incredibly large sums of money they are investing makes it harder for them to easily balance their investments and not sway the price of what they are purchasing.
At the same time, many companies offer employees opportunities to invest in mutual funds and at times it could make sense to utilize this opportunity. If your company does this as part of a retirement program or optional investment plan, make sure you know what options you have. I was surprised recently at work to learn that there are dozens of mutual companies that I can invest in through my employer and after brief research it is clear that some are absolutely better deals than others.
Discussion Questions
Please leave a comment below and feel free to answer any of these questions, or just give your general thoughts.
- What quote from this chapter do you think best summarizes the point Graham is making?
- Do you invest in any funds?
- What is your general sentiment about the value of funds?
- What did you think of the chapter overall?
Next Week’s Discussion: Chapter Nine
Chapter Title – The Investor and His Advisers
When reading the next chapter, try to think about how the concepts Graham presents in the chapter could apply to your own investments, whether you consider yourself a Defensive Investor or an Enterprising Investor.
What are some other ways to participate?
If you are a blogger, you can give your thoughts in a post on your own site, link to the discussion here on ModernGraham, and I will be sure to let our readers know that the conversation is going on over at your site as well.
In addition, you can use the hashtag #MGBookClub in social media to talk about the book on Twitter or Facebook!
1. What quote from this chapter do you think best summarizes the point Graham is making?
“All financial experience up to now indicates that large funds, soundly managed, can produce at best only slightly better than average results over the years” In today’s world, most funds do not do as well as their averages from year to year. To me it makes sense to buy an ETF that tracks the index average. By doing so management expenses are less and you will do no worse than the market index you are imitating. To buy an actively traded fund you are paying higher management fees in the hopes of beating the market, but chances are you won’t and it is even likely you will do worse than the market. Common sense tells the defensive investor to take the safe bet and be happy with the market index.
2. Do you invest in any funds? Yes, about 50% of my portfolio is in funds which is a holdover from my working stiff days. I have a REIT fund, emerging market bond fund, index fund, and a value fund. I am drawing down the REIT fund and the emerging market bond fund to fund my purchase of individual stocks as opportunity arises. The index fund QQQ and the value fund Longleaf Partners are IRA accounts and have paid me handsomely over the years so they are keepers.
3. What is your general sentiment about the value of funds? Mutual funds are an easy way to diversify a portfolio and not have to invest much time in monitoring it. A relatively easy way for a hard working person (or a person not ready to analyze company’s financial statements) to practice wealth accumulation. Again the safest bet is index funds or index ETF’s.
4. What did you think of the chapter overall? The chapter was good commentary but a bit outdated because of the absence of index funds and ETF’s. Graham also did not really touch on the subject of how to find a quality mutual fund suitable for one’s investment goals and temperament. There are books written on this subject but the best advise, echoed by Warren Buffet is buy an index fund or ETF.
1. What quote from this chapter do you think best summarizes the point Graham is making?
“We have presented this picture in order to point a moral, which perhaps can best be expressed by the old French proverb: Plus ça change, plus c’est la même chose. Bright, energetic people—usually quite young—have promised to perform miracles with “other people’s money†since time immemorial. They have usually been able to do it for a while—or at least to appear to have done it—and they have inevitably brought losses to their public in the end.â€
“We have presented this picture in order to point a moral, which perhaps can best be expressed by the old French proverb: Plus ça change, plus c’est la même chose. Bright, energetic people—usually quite young—have promised to perform miracles with “other people’s money†since time immemorial. They have usually been able to do it for a while—or at least to appear to have done it—and they have inevitably brought losses to their public in the end.â€
2. Do you invest in any funds?
Not in addition to some money from work that is currently invested in pension funds.
3. What is your general sentiment about the value of funds?
Since most funds perform worse than index at the same time as they take out high fees, I think that most people would do best in investing regularly in a low-cost index fond. By doing this you won’t do any better than the market, but you won’t do worse either. But compared to the probability of investing in funds that mostly perform below average, this seems pretty acceptable I guess.
The following words from Graham about the actual performance still holds up pretty good even today. “…the actual performance of the funds seems to have been no better than that of common stocks as a whole, and even though the cost of investing in mutual funds may have been greater than that of direct purchases.â€
In his most recent shareholder letter Warren Buffett provided some guidelines for how he prefers his capital to be managed by his trustee in the future.
“My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.â€
4. What did you think of the chapter overall?
Okeydokey.
This post has also been published at http://hurricanecapital.wordpress.com.
You have the perfect Buffet quote that I was going to use exactly.
1) What quote from this chapter do you think best summarizes the point Graham is making?
“…There have been instances of funds that have consistently outperformed the market averages for, say, ten years or more. But these have been scarce exceptions…â€
“ The average fund does not pick stocks well enough to overcome its costs of researching and trading them; the higher a fund’s expenses, the lower its returns; the more frequently a fund trades its stocks, the less it tends to earn; funds with high past returns are unlikely to remain winners for long.â€
The point of investing in funds is to make it easier for the defensive investor. This chapter shows that it is costly in time to try to pick the best fund. You are far better off choosing an ETF, and ETF are aligned with the key issue of the defensive investor – they do not have the time or desire to research.
2) Do you invest in any funds?
I have invested in mutual funds in the past only because I had no other options in my company 401k’s. I have since moved out of my old 401ks. I have one mutual fund that I have dollar cost averaged in for 15 years (now I get A shares), and I keep that easy way to systematically invest a set amount; I rebalance out of it at the start of the year. They did serve a good purpose for me. I was able to systematically invest over time and dollar cost average. Some of my previous employers matched my investment, and that is an obvious no brain decision to go with. If I have my preference, I will use an EFT.
3) What is your general sentiment about the value of funds?
I have no desire to invest in mutual funds in general. They charge high fees, and they rarely beat the market. One is much better off using an S&P ETF that has low fees. I have worked closely with various investments salesmen over my years in banks, and in 11 years I found only one that I would trust to any real extent (he charges a set fee and no commission). Bank investment advisers are the worst place to get investment advice because they have sales goals, they are general commission based jobs, and they often lose their job. They are concerned for their short run financial well-being and not you. I can remember the investment adviser that lasted 2 years at one bank. He pitched Franklin Income Fund and annuities – To Everyone. People stopped coming to him after a while, and eventually he started to draw from his savings/retirement accounts until he left. He had little to no finance knowledge – he was a salesmen, and he happen to be selling investments. He might as well have been pushing cars, or mattresses, or cooking ware. He only had credibility because he was working at the largest financial institution in the world at that time.
4) What did you think of the chapter overall?
This chapter highlights the many problems with professional investment advisors. They do not do better than the market on average. They might do better in the short run, but they rarely do it for any consistent period, so there is no need to pay their fees. Use ETF’s can call it a day – just like Buffet has in his will for his wife when he passes away – 90% S&P ETF and 10% in bonds. I think there are some other holding companies that might be worth investing in if they are attractively priced like Birkshire.
No quote particularly grabed me although I do have some money invested in ETF’s. However, I will offer the following thoughts or ideas from the chapter.
-The investment behavior of fund managers, advisors, and bank trusts determines the changes in the stock market averages.
-In choosing funds, compare the performances of similiar type funds over several years.But bewareof the fund which does tremendously better than its peersin a bull market. It may just be taking on excessive risk to obtain better relative performance.
-A closed end fund selling at a 10% discount may be a good buy.
-Avoid balanced funds. Instead, for your bond commitment, pick from U.S. Savings Bonds, corporate bonds with at least an A rating, and tax free bonds.