Morningstar is a research company that ranks mutual funds. Want to know what they say about finding the best performing mutual funds? Their research shows that funds with the lowest fees are the best performers.
Research Shows Low Fees Indicate Best Performing Funds
In the Wall Street Journal article Low Fees Outshine Fund Star System Morningtar’s director of fund research says fees "have proven to be the strongest predictor out there." "The stars system, as a measure of past risk-adjusted performance, is going to be a little more limited."
Learn more: Should You Use Morningstar’s New Analyst Ratings.
Another article Best Predictor of Mutual Fund Performance states that “expense ratios are the strongest predictors of performance. In every single time period and data point tested, low-cost funds beat high-cost funds.”
Why Low Fees Result in Better Performing Mutual Funds
As one famed economist professor is known to say, “there aren’t hundred dollar bills lying around for the taking.” What he means is financial data is available at the click of a mouse, instantaneously, to millions – make that billions – of super smart people across the globe. They don't leave money on the table.
Actively managed funds employ analysts to scour the data, and interview management teams to find a way to pick the best stocks or bonds. It costs money to pay all of these people, so to deliver higher returns this approach has to overcome its higher costs.
Passively managed funds simply pick a set of defined criteria and own the stocks or bonds that meet that criteria. They don’t need to pay a lot of people to do this. Costs stay low. And the data shows this lower cost approach wins.
I expand upon why low cost approaches work in What is an Index Fund and Why Would I Use One.
Where to Find the Best Performing Mutual Funds
So how do you find these low cost best-performing mutual funds? The answer is simple. Buy index funds, or passively managed funds.
Not sure what the difference between a passively managed fund and an index fund is? You’re not alone. One reader asked this question, and I posted her questions and my responses in What is the Difference Between Passive and Index Funds.
If you already know the difference between passive and index funds and you’re ready to get started then check out this List of Best Index Funds.
If you’re near retirement you might also want to browse through this list of Low Fee Retirement Income Funds.
What to Watch Out For When Seeking Best Performing Funds
I have frequently seen ill-informed financial sales people who are employed as a captive representative (meaning they can only promote the products of the company they work for), tell people the exact opposite of what is stated in this article above. I would like to believe that they are not intentionally lying. The higher performance of mutual funds with lower fees has been documented for years. If anyone tries to tell you differently, they are grievously misinformed.
You should also be cautious of the latest “hot fund” list. When you look back a few years later on the subsequent performance of funds listed on some publication's “best funds to own” list, most of the time you had better performance by owning a simple portfolio of index or passively managed funds.