Investing 101 – Learning The Hard Way


I used to indulge myself by thinking I could pick stocks that would outperform the market. And sure, I did pick a few winners. Winners?? How quickly we forget the losers…. I then read Paul Samuelson and Burton Malkiel on the topic.[1] They both argued quite persuasively that most new information is discounted immediately in the stock market. So stock picking is a pretty random bet, unless you can get new information before anyone else. And as an individual, I cannot compete with the big investment houses paying millions of dollars to get new information a half a millionth of a second before anyone else. The lesson I draw: picking stocks is a money-losing indulgence/hobby for individuals. Risk considerations add weight to this view because in almost all situations, investing in more than one stock reduces risk.

This leads me to consider mutual funds and exchange-traded funds for investments. The thought that mutual funds have managers is comforting: someone there fulltime to make investment selections. It is less comforting to learn that most mutual funds underperform appropriate sector indices. ETFs are cheaper (less management required) and can be traded like stocks rather than having to buy or sell with no price limits at the end of the trading day (mutual funds). With those differences in mind, I choose between funds and ETFs by performance: if the sector performance of the ETF is significantly greater than comparable mutual funds, I buy the ETF and vice versa.

I start by looking for sectors that are doing well, or ones I think will do well in coming years. I then use the Morningstar data bases to screen for the best performing mutual and exchange traded funds for investments.


What is a sector? As I have noted, the most talked-about investment sectors include: global, international, emerging markets, international, domestic, large cap, mid-cap, small cap, fixed income, high yield, value, real estate, timber and other commodities, energy, finance, microfinance, health, industrial, information technology, telecom services, utilities, private equity, hedge funds, funds of funds, multisector, alternatives (primary buyout, venture capital, mezzanine, distressed debt), passive and actively managed. There are more. One wonders how soon before there are more investment categories than actual investment vehicles. However, we have to prioritize our investment choices somehow, so I choose the following four for further consideration.

1. Health/Biotech Research

In the last year, companies in bio-tech/health research outperformed all other sectors. It is not likely to do as well in future years. Nevertheless, the sector has momentum and will probably continue to outperform many sectors going forward.

In Tables 1-4, I present data on performance, price earnings ratios and expenses for the leading Mutual Funds and ETFs. I rank them on 3 year performance.

Table 1. – Best Performing Mutual and Exchange-Traded Funds in Health/Biotechnology Sectors

Source: Morningstar

The last 12 months have been very good for this sector. My favorite is Fidelity Select Biotechnology because of its 3 and 5 year performance and because of its relatively modest price/earnings ratio. It is notable that differences in expense ratios between ETFs and mutual funds are not large enough to be of significance in choosing between the two.

2. Other Technology

Health sciences are only one of a number of the industries where research is opening up new commercial possibilities. So my “Other Technology” sector is also are worth looking at closely.

Table 2. – Best Performing Mutual and Exchange-Traded Funds in Other Science/Technology Sectors

Source: Morningstar

The distinguishing feature in Table 2 is how well the two leading ETFs did last year. But they also had relatively high P/E ratios.

3. Value

Some argue that even though the US is on a steady recovery from the 2008 meltdown, the rest of the world faces a highly uncertain future. The “value” sector does not have the performance numbers of science, but in an uncertain world….

Table 3. – Best Performing Mutual and Exchange-Traded Funds in the “Value” Group

Source: Morningstar

To me, the Guggenheim ETF is most impressive, in part because of its low P/E ratio.

4. Global

With the shine off the “BRIC” countries, the ‘global” investment category has performed poorly in recent years. It is probably worth reconsidering with the inevitable growing demand coming from the expanding middle classes of emerging market countries.

Table 4. – Best Performing Mutual and Exchange-Traded Funds in the “Global” Group

Source: Morningstar

China was rediscovered last year by foreign investors. In addition, a growing number of Chinese citizens are replacing their property investments with equities. However, I don’t see last year’s performance being replicated this year. On top of that, the Oberweis International Opportunities Fund has outperformed the leading China-specific ETFs.

Concluding Note on Investing

Once every 12 months, I undertake a similar process to the one outlined above and make seemingly appropriate adjustments to my portfolio. And as a result of this process, I just purchased FBIOX, ISTIX, RPV and OBIOX.

And yes, I know past performance is hardly a guide to the future – just look at what happened in 2008. On the other hand, I prefer this approach to getting taken to lunch once every six months by a “wealth manager”.

[1] Paul A Samuelson, “Proof That Properly Anticipated Prices Fluctuate Randomly”, Industrial Management Review, 6:2, 1965 (Spring) and Burton G. Malkiel, A Random Walk Down Wall Street, W.W Norton & Co., Inc., 2007.

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