An index mutual fund is a sensible option for building a diversified stock portfolio while keeping investment costs under control. The approach is simple: The fund holds the same stocks as the segment of the market it tracks. Expenses are low because there's no professional manager picking the investments.
But you also give up something with an index approach. You're guaranteeing that you'll never beat the market. In fact, you'll come up a bit short, because the modest fees that index funds charge are shaved off investment returns.
If that proposition isn't appealing, consider funds run by pros who try to outperform the market. With a little research, an investor can find managed funds charging fees that aren't far above those assessed by some higher-cost index funds. And several among that select group have beaten the market over periods spanning several years.
That's not to say these funds necessarily will maintain their standout performance. In most years, a majority of managed funds fail to beat the market. What's more, a wealth of research has shown that a fund's expenses are almost always a more significant factor in long-term returns than any edge a manager can achieve.
But it's hard to argue with the results the four funds below have delivered, or with the fees charged. Each invests primarily in large U.S. companies, the types of stocks that typically anchor a well-diversified portfolio. Each has outperformed a large-cap stock index, the Russell 1000, over the latest five- and 10-year periods. The funds have accomplished that while charging fees that are below 0.74 percent. That's the average expense ratio that investors paid last year to invest in U.S. stock funds of all types, managed and index, according to Morningstar.
Each of the four requires a minimum initial investment of $3,000 or less, so the funds are accessible to most individual investors. None charges an upfront sales fee, known as a load.
The four, listed in order of their 10-year returns:
MAIRS & POWER GROWTH (MPGFX)
This fund barely made the cut because its expense ratio of 0.71 percent is only slightly below average. But it's a standout in several other respects. Its 10-year return places the fund within the top 10 percent among its large-cap blend peers, which invest in a mix of value- and growth-oriented stocks. It's also in the top 10 percent over the past five-year period and 12 months.
The fund's managers, William Frels and Mark Henneman, typically invest a substantial portion of the portfolio in companies with headquarters in Minnesota or neighboring states. That's the region that the St. Paul-based managers know best. At latest count, the fund held 47 stocks, with Minnesota-based Valspar, 3M, Target, Ecolab and U.S. Bancorp making up the top five holdings. The fund tends to hold stocks for years before trading them. Three of those top five holdings have been in the portfolio since 1993.
VANGUARD DIVIDEND GROWTH (VDIGX)
This is one of the standout managed funds at Vanguard, best known for index funds. With an expense ratio of just 0.31 percent, it's among the lowest-cost managed funds. The emphasis in the portfolio of around 50 stocks is dividend-payers. Recent top holdings include PepsiCo, Johnson & Johnson, Occidental Petroleum, Target and Exxon Mobil.
Morningstar analysts currently give the fund a top-rung gold medal ranking, based on their assessment of its future prospects. Among other things, Morningstar cites the fund's stable management. Don Kilbride has run the fund the past six years, and has more than $1 million personally invested in the fund.
T. ROWE PRICE GROWTH STOCK (PRGFX)
With expenses of 0.70 percent, this fund also just made the cut. The emphasis is on growth stocks, which typically generate revenue and earnings at an above-average rate. Examples include Apple and Google, the fund's recent top two holdings, making up 11 percent and 3.8 percent of the portfolio, respectively. Apple's recent strong performance has been a big contributor to the fund's 17 percent year-to-date return, which ranks in the top 10 percent among peers. Over 10 years, the fund ranks in the top 20 percent.
Morningstar analysts are cautious about the fund, currently maintaining a "Neutral" rating. One reason is the fund's inability to offer much protection in sharp market declines. In 2008, for example, the fund lost 42 percent, worse than nearly two-thirds of its peers.
VANGUARD EQUITY-INCOME (VEIPX)
This fund takes a similar approach to Vanguard Dividend Growth, focusing on dividend-paying stocks while also charging expenses of just 0.31 percent. But this fund is more diversified than the other, with a portfolio of around 150 stocks. The four-person management team also puts a sharper focus on value-oriented stocks, which tend to generate steady earnings and are considered inexpensive based on their price-to-earnings ratios.
That emphasis can hold the fund back when the market rallies. For example, Equity-Income's 17 percent return in 2009 lagged the Standard & Poor's 500 by 9 percentage points, and trailed nearly nine of 10 peers. But last year, the fund beat that index by 8 percentage points, returning nearly 11 percent. In the large-value category, the fund's five- and 10-year average annualized returns rank within the top 10 percent among its peers.
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