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Taking the Snake Oil Out of Mutual Fund Evaluation

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Superior mutual fund and ETF performance charts are the sales tools of modern financial snake oil salesmen

Historical performance charts allow investment fund promoters to market selectively their supposedly superior funds and to allege that their excessively high fees are worth it. Lured in by superior past performance, most often individual investors will get mediocre future performance before costs and even worse performance after costs. Unreasonably high investment expenses, industry sales and marketing fees, and excessive yet hidden, performance killing portfolio trading costs are the real economic factors that investors should pay attention to — not the snake oil of historical performance charts. See this article: How to lie with statistics: Investment performance charts.

The Fund Authority Score system zeros in on your expected costs, because lower investment fund expenses and lower portfolio transactions costs repeatedly have been proven to increase mutual fund returns over the long term. Fund Authority Scores focus on the very heavy long term burden of unreasonably high investment expenses, excessive industry sales and marketing fees, and performance killing portfolio transactions costs. (See this article: Pay less to get more)

Fund Authority Scores are a better ETF and mutual fund performance rating system

Fund Authority Scores intentionally do not emphasize past performance measures, because market volatility, randomness, and plain old dumb luck in portfolio securities selection greatly influence historical fund performance. Study after study has shown that most mutual funds tend to demonstrate a “reversion toward the average” over longer periods of time. Investment funds simply tend to have lucky and unlucky streaks that are not sustained.

Furthermore, there seems to be no reliable way to tell which fund might sustain a superior past performance record. Superior past performance simply is not a reliable indicator of better future performance. In contrast, lower management, marketing, and trading costs are a far better indicator of which funds will tend to do better in the future. This is what counts to every individual investor — what ends up in your portfolio when you need it later.

The level of competence is very high across most mutual funds and ETFs and global real-time auction securities markets have a leveling effect. Modern securities markets make almost everyone average in the long term, before costs are considered, and costs remain as that most influential long term differentiating factor. After visible and hidden costs are taken into consideration, funds with lower costs and lower turnover tend to the big winners. (To learn more about mutual fund and ETF selection, you could read this investment book review on no load index mutual funds. This investing and personal finance book provides both the research rationale for low cost investing, as well as, easy to use lists of the lowest cost no load mutual funds and index ETFs that you can invest in directly. Also see this article: The illusion of superior professional investment manager performance)

Therefore, the Fund Authority Score rating system avoids giving a big reward to past investment fund returns that most likely were just the luck of the draw. The Fund Authority Score does include a past performance factor, but the focus of this measure is to penalize substantially inferior past performance. Substantially inferior fund performance has been shown to be correlated with somewhat inferior performance in the future. Substantially inferior past performance also has been correlated with excessive costs.

Fund Authority Scores give modest credit to average past performance and a little more credit to superior past performance. This is appropriate given the huge element of luck in superior historical performance. (See these articles: Scientific mutual fund and ETF screening criteria – a summary, Investment Astrology, and What the instability of mutual fund Morningstar Ratings means for long-term investors – a commentary)

Fund Authority Scores rate mutual funds and ETFs on the most important economic factors that influence individual investors’ net long term diversified investment fund performance

The Skilled Investor developed the Fund Authority Score system to provide individual investors with concise and objective comparative summaries of mutual funds and exchange-traded funds (ETFs) within investment style categories.

Fund Authority Scores measure investment fund cost, maturity, efficiency, and performance factors. Fund Authority Scores use only those objective measures that have been demonstrated in the financial research literature to be correlated with improved investment results over long time horizons, when using a buy-and-hold personal investment strategy. You can find a directory of Fund Authority Scores for mutual funds and ETFs here.

Using a “worst to best” integer scale ranging from minus 10 to plus 10, Fund Authority Scores weigh most heavily the investment expenses and costs that investors pay repeatedly. Additional scoring weight is given to historical performance, investment fund maturity, and fund operating efficiency. (See this article for an explanation of how Fund Authority Scores are determined: The Mechanics of the Fund Authority Score System for ETFs and Mutual Funds)

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