Understanding the differences in Investing

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amindu
Posts: 22
Joined: Thu Aug 04, 2016 11:59 am

Understanding the differences in Investing

Post by amindu » Tue Dec 05, 2017 2:56 pm

Hello All,

I have been reading this forum for the past year and have learned a lot, so thank you for that. I have slowly transferred some of my past and all future contributions to the 3-fund portfolio. However, I am struggling with converting my rollover IRA that signifies a major portion of my retirement account. I am just looking for some clarification based on some of the comparisons I have done. The following below are the various funds that I am invested in which have an average ER of 0.494%. I picked two funds, and ran a 10-year analysis to see how the results would flush out. Below is the charts to show the progression, I know I am being short sided by comparing past performance which is no indicator of future results. I am just trying to understand where I am missing the big picture. An estimate of the ER impact over the past 10 years may net an additional $1,500 in fees over the more efficient fund, this is a guess I do not know the exact amount. However the return based on an initial investment of $10K even after the additional ER would surpass the results of the S&P 500, or would it?


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Current Funds in Rollover IRA

FHLC FIDELITY MSCI HEALTH CARE INDEX 0.084%
FSMEX Fidelity® Select Medical Equipment and Systems Portfolio 0.760%
FSTVX Fidelity® Total Market Index Fund - Premium Class 0.035%
FBIDX Fidelity® U.S. Bond Index Fund - Investor Class 0.140%
FBIOX Fidelity® Select Biotechnology Portfolio 0.750%
FBMPX Fidelity® Select Multimedia Portfolio 0.820%
FPHAX Fidelity® Select Pharmaceuticals Portfolio 0.800%
FSCHX Fidelity® Select Chemicals Portfolio 0.800%
FSCSX Fidelity® Select Software and IT Services Portfolio 0.760%
FSPHX Fidelity® Select Health Care Portfolio 0.740%
FSRPX Fidelity® Select Retailing Portfolio 0.780%
FSTVX Fidelity® Total Market Index Fund - Premium Class 0.035%
FTRNX Fidelity® Trend Fund 0.740%
FUSVX Fidelity® 500 Index Fund - Premium Class 0.035%
FSTMX Fidelity® Total Market Index Fund - Investor Class 0.090%
PRJIX T. Rowe Price New Horizons 0.650%
RNPGX American Funds New Perspective R6 0.450%
VPCCX Vanguard PRIMECAP Core Inv 0.460%

Average ER 0.494%

alex_686
Posts: 2620
Joined: Mon Feb 09, 2015 2:39 pm

Re: Understanding the differences in Investing

Post by alex_686 » Tue Dec 05, 2017 3:27 pm

Let us try to unpack this a bit. You have gotten superior performance for a couple of reasons.

1. You have selected outstanding portfolio managers. This is a bit tricky. So as you have stated, past performance does not indicate future performance. Funds that charge higher fees tend to have better gross performance - that is before expenses are charged. There are 2 problems here. The first is that the portfolio managers have a better idea of the value that they bring to the table then you do so they tend to grab the extra performance via higher expenses. The second issue is identifying the superior portfolio mangers ahead of time.

2. You have selected a outstanding asset allocation. You have picked sectors that have done better than average. Hooray for you!. What is the chance of this repeating itself over the next 10 years?

3. You have taken on more risk than average. This happens to many people during a long bear market. They load up on risk and are rewarded by higher returns. Adjust for risk and you may get a better story. What happens if there is a crash?

4. How you rebalance can have an effect. I suspect the 3 portfolio return is a hypothetical and your return is actual.

5. Luck. Don't discount this.

6. Calculation error. I am not seeing a huge difference between the numbers you are showing me. Over 10 years it is .5% a year? I have seen lots of calculations over 10 years go much future off because of calculation errors. Sometimes it can be as trivial as somebody entering the EOY NAV verse the 12/31 NAV for a fund. Funds with a calendar year end will always post a 12/31 NAV even if the market is closed because of a weekend.

deikel
Posts: 430
Joined: Sat Jan 25, 2014 7:13 pm

Re: Understanding the differences in Investing

Post by deikel » Tue Dec 05, 2017 5:06 pm

You picked some software fund and a bio fund, both being above the (average) S+P500 in return.

That in itself is not surprising, if you pick the right sector fund (the last decades for example healthcare, biotech or technology) you could have beaten the S+P500 handily. In that case a slightly higher fee just does not have a negative impact since your gain above the S+P500 is so much better.

But when having the choice between two different S+P500 index funds with one having a fee of 0.05 and the other of 0.7, than its obvious that one does take your money for no real reason.

The question is: do you want to bet that Healthcare will continue to be a good sector to invest in ? Possibly reaping good results at the risk of high volatility (I am not political here) AND a guaranteed higher fee structure or just ride the average performance of the market with the low fee S+P500 index

Rather than playing single companies, I think sector funds are an interesting alternative, but there is still risk that you pick the wrong sector at the wrong time although one can argue that tech, bio and health are fairly reasonable sectors to expect more than average growth.
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immidiatly and destroy any copy or remembrance of it.

amindu
Posts: 22
Joined: Thu Aug 04, 2016 11:59 am

Re: Understanding the differences in Investing

Post by amindu » Tue Dec 05, 2017 8:56 pm

alex_686 wrote:
Tue Dec 05, 2017 3:27 pm
Let us try to unpack this a bit. You have gotten superior performance for a couple of reasons.

1. You have selected outstanding portfolio managers. This is a bit tricky. So as you have stated, past performance does not indicate future performance. Funds that charge higher fees tend to have better gross performance - that is before expenses are charged. There are 2 problems here. The first is that the portfolio managers have a better idea of the value that they bring to the table then you do so they tend to grab the extra performance via higher expenses. The second issue is identifying the superior portfolio mangers ahead of time.

2. You have selected a outstanding asset allocation. You have picked sectors that have done better than average. Hooray for you!. What is the chance of this repeating itself over the next 10 years?

3. You have taken on more risk than average. This happens to many people during a long bear market. They load up on risk and are rewarded by higher returns. Adjust for risk and you may get a better story. What happens if there is a crash?

4. How you rebalance can have an effect. I suspect the 3 portfolio return is a hypothetical and your return is actual.

5. Luck. Don't discount this.

6. Calculation error. I am not seeing a huge difference between the numbers you are showing me. Over 10 years it is .5% a year? I have seen lots of calculations over 10 years go much future off because of calculation errors. Sometimes it can be as trivial as somebody entering the EOY NAV verse the 12/31 NAV for a fund. Funds with a calendar year end will always post a 12/31 NAV even if the market is closed because of a weekend.
Thanks for the comments. On point 6 I am a little confused as the diffence in performance is $18k and $16k respectively over a 10 year period.

alex_686
Posts: 2620
Joined: Mon Feb 09, 2015 2:39 pm

Re: Understanding the differences in Investing

Post by alex_686 » Tue Dec 05, 2017 9:53 pm

amindu wrote:
Tue Dec 05, 2017 8:56 pm
Thanks for the comments. On point 6 I am a little confused as the diffence in performance is $18k and $16k respectively over a 10 year period.
I am looking specifically at your second chart. IIf there were any type of calculation errors - initial inputs off, reinvested dividends not calculated just right - one could get different results from identical portfolios. I have done this professionally and there are so many little gotchas which can throw off the calculations over 10 years.

Or maybe the first few months were good and different but the next 9 years were average and identical.

In short, using my naked eye, it does not look like thhe 2 portfolios are that different. It is some small difference that got magnified

Nate79
Posts: 1455
Joined: Thu Aug 11, 2016 6:24 pm
Location: Portland, OR

Re: Understanding the differences in Investing

Post by Nate79 » Tue Dec 05, 2017 11:34 pm

Yes, it is not hard to find funds, sectors, asset classes that outperform in the short term. Put a chart of bitcoin up against your funds and see what real outperformace looks like. Doesn't mean it will happen in the future.

amindu
Posts: 22
Joined: Thu Aug 04, 2016 11:59 am

Re: Understanding the differences in Investing

Post by amindu » Wed Dec 06, 2017 11:12 am

I understand the point that i had selected two of the strongest sectors, however i did the same analysis for all of the Fidelity Funds, and 8 out of 10 seem to have exceeded the returns of the S&P anywhere from $4-10K.

alex_686
Posts: 2620
Joined: Mon Feb 09, 2015 2:39 pm

Re: Understanding the differences in Investing

Post by alex_686 » Wed Dec 06, 2017 11:48 am

amindu wrote:
Wed Dec 06, 2017 11:12 am
I understand the point that i had selected two of the strongest sectors, however i did the same analysis for all of the Fidelity Funds, and 8 out of 10 seem to have exceeded the returns of the S&P anywhere from $4-10K.
FYI, I prefer annualized percentage returns, not dollar returns. Easier to compare, easier to calculate risk adjusted returns.

Momentum has done well over the past 10 years. Growth, Value, small cap, etc. all have had their turn. That explains the Trend fund. Any reason why you think the Momentum / Trend factor will continue to outperform? No saying it won't - it is a healthy area of debate. Just know that the underlying economics factors can change. No magic reason why the future will be the same as the past.

Fidelity offers 30 odds sector returns. You have 8. Maybe you were lucky in picking the hot ones. Or maybe not. How did the other sector funds do compare to yours? Or maybe Fidelity just offers sector funds for sexy stocks and the past 10 years have been outstanding for sexy stocks. This ties back to the momentum factor. Look back over 50 years and sexy stocks tend to underpreform boring stocks.

I think you have stumbled onto out-performance. You picked a period which starts with a long steady bull market. A investor which loaded up on risk would have been rewarded. This is actually fairly common. The real test will be a down market.

amindu
Posts: 22
Joined: Thu Aug 04, 2016 11:59 am

Re: Understanding the differences in Investing

Post by amindu » Wed Dec 06, 2017 11:57 am

alex_686 wrote:
Wed Dec 06, 2017 11:48 am
amindu wrote:
Wed Dec 06, 2017 11:12 am
I understand the point that i had selected two of the strongest sectors, however i did the same analysis for all of the Fidelity Funds, and 8 out of 10 seem to have exceeded the returns of the S&P anywhere from $4-10K.
FYI, I prefer annualized percentage returns, not dollar returns. Easier to compare, easier to calculate risk adjusted returns.

Momentum has done well over the past 10 years. Growth, Value, small cap, etc. all have had their turn. That explains the Trend fund. Any reason why you think the Momentum / Trend factor will continue to outperform? No saying it won't - it is a healthy area of debate. Just know that the underlying economics factors can change. No magic reason why the future will be the same as the past.

Fidelity offers 30 odds sector returns. You have 8. Maybe you were lucky in picking the hot ones. Or maybe not. How did the other sector funds do compare to yours? Or maybe Fidelity just offers sector funds for sexy stocks and the past 10 years have been outstanding for sexy stocks. This ties back to the momentum factor. Look back over 50 years and sexy stocks tend to underpreform boring stocks.

I think you have stumbled onto out-performance. You picked a period which starts with a long steady bull market. A investor which loaded up on risk would have been rewarded. This is actually fairly common. The real test will be a down market.
Ahh thank you. I knew i was missing something. You are absolutely correct, the real test would be a down market although most of these did go through the 2008 recession, however that was 1 year and then we had 9 solid years of positive returns. Assuming if the downtrend was over a longer period these sector funds may have lost a lot more than the overall S&P 500 fund would have. Is this the correct thought process here? Thanks

alex_686
Posts: 2620
Joined: Mon Feb 09, 2015 2:39 pm

Re: Understanding the differences in Investing

Post by alex_686 » Wed Dec 06, 2017 12:15 pm

amindu wrote:
Wed Dec 06, 2017 11:57 am
Ahh thank you. I knew i was missing something. You are absolutely correct, the real test would be a down market although most of these did go through the 2008 recession, however that was 1 year and then we had 9 solid years of positive returns. Assuming if the downtrend was over a longer period these sector funds may have lost a lot more than the overall S&P 500 fund would have. Is this the correct thought process here? Thanks
3 more thoughts on this.

When working with a sequence of returns, having the down year either at the beginning or at the end tends to blunt the impact of that down year.

We have had a very gentle bull market, with a nice upwards trend line. One could have very different results if the market had oscillated like a roll-coaster, depending on how one rebalances their portfolio.

The last point is on data mining. Often people will data mine historical data to find trends that outperform. For example the small & value factors have a good historical run. Then these factors stop working. Or they work differently. Is it a temporary reversal, which most factors have? Or have the economic fundamentals shifted into something else?

Doing what you are doing is a good first step. The next step is to ask why what happened. My guess is that you loaded up on risk at a particularly good time and got lucky, but you might come up with something else. The next step is to ask what you will think will happen in the future. For example, I doubt that biotech will continue to outperform, or even outperform or a risk adjusted basis. You could come up with a different opinion which is just fine. Just figure out what risks you are taking and why.

amindu
Posts: 22
Joined: Thu Aug 04, 2016 11:59 am

Re: Understanding the differences in Investing

Post by amindu » Wed Dec 06, 2017 12:23 pm

alex_686 wrote:
Wed Dec 06, 2017 12:15 pm
amindu wrote:
Wed Dec 06, 2017 11:57 am
Ahh thank you. I knew i was missing something. You are absolutely correct, the real test would be a down market although most of these did go through the 2008 recession, however that was 1 year and then we had 9 solid years of positive returns. Assuming if the downtrend was over a longer period these sector funds may have lost a lot more than the overall S&P 500 fund would have. Is this the correct thought process here? Thanks
3 more thoughts on this.

When working with a sequence of returns, having the down year either at the beginning or at the end tends to blunt the impact of that down year.

We have had a very gentle bull market, with a nice upwards trend line. One could have very different results if the market had oscillated like a roll-coaster, depending on how one rebalances their portfolio.

The last point is on data mining. Often people will data mine historical data to find trends that outperform. For example the small & value factors have a good historical run. Then these factors stop working. Or they work differently. Is it a temporary reversal, which most factors have? Or have the economic fundamentals shifted into something else?

Doing what you are doing is a good first step. The next step is to ask why what happened. My guess is that you loaded up on risk at a particularly good time and got lucky, but you might come up with something else. The next step is to ask what you will think will happen in the future. For example, I doubt that biotech will continue to outperform, or even outperform or a risk adjusted basis. You could come up with a different opinion which is just fine. Just figure out what risks you are taking and why.
Makes sense, thank you for putting it into perspective, appreciate it.

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