A Little Advice

One of the first things you learn as a Fool is that the vast majority of mutual funds do not beat the market, so why buy one? Well, some people may still be tempted, when investing only a small sum, to let a money manager do their work for them. After all, how can you diversify with, say, only a couple thousand dollars? And even if you did, why bother putting $500 here, $700 there? Can you really get anywhere that way?

I found myself in this position a couple of years ago, after I changed jobs and had a modest 401(k) distribution to invest. I wanted to invest in high-tech, but unFoolishly decided to do it through a mutual fund: in this case, Seligman Communications and Information A. With all due respect to Seligman, it turns out I would have been better off just buying a couple of stocks.

In fact, had I been smart enough to buy two no-brainer high-tech stocks, such as Microsoft and Intel, I would be much better off. Of course, hindsight is 20-20, but these were hardly obscure companies. In fact, I was tempted to buy them at the time, but again, acted unFoolishly, and decided that since they had high P/E ratios, I wouldn’t. Had I read my 13 Steps, located in the Fool’s School, I would have known not to put such emphasis on the P/E, but I was too late.

So, the damage? Well, on June 28, 1995 I bought 91 shares of the Seligman Communications and Information A mutual fund, at $25.10 each, for a total investment of $2,284.10. By October 31, 1997, a little more than 2 1/4 years later, these shares were worth $30.11 each; my investment stood at $2,740.01, an increase of almost 20%. Not too bad, but spread over more than two years, my annual return was less than ten percent. This is certainly way behind the S&P 500, and therefore a side lesson is that I could have just bought an index fund and been in good shape as well.

But, had I put the $2,284 into Microsoft and Intel, (or even just one or the other), I would have done, let’s just say, a little bit better. On June 28, 1995, had I spent half my money on Microsoft shares, I could have purchased 27.19 shares at the split-adjusted bid price of $42. In addition, I could have bought 30.44 shares of Intel at the split-adjusted bid price of 30 1/2. By October 31 of this year, Microsoft had increased to $130 per share, and Intel to $77. My combined shares of Microsoft and Intel would now be worth $5,878.58, a growth of over 150 percent. (I didn’t want to calculate the exact number.)

This also illustrates a problem with mutual funds: one of the things I told myself was, well, Seligman owns Microsoft and Intel; therefore, I am buying them, in a way. Hello! McFly! Seligman also owns so many other stocks that of course they dilute the winners, as the returns described above demonstrate.

Of course, there are the usual disclaimers: these past couple of years have been pretty spectacular, especially for those two stocks (though Intel recently dropped quite a bit). And 2 1/2 years is a fairly short period, and perhaps over the longer term things will look different (though Seligmann has a lot of catching up to do). Nevertheless, the basic lesson is pretty clear: even when you only have a modest amount, and even if you don’t necessarily have a lot of time, you will probably be better off with an index fund or a couple of solid stocks than a managed mutual fund.