How to build your own Mutual Fund

by Jacky Pandion

Mutual funds provide several benefits:

• Diversification at reasonable cost due to economy of scale as money from several investors are pooled together,
  
• You don't need to agonize over the stock selection,
  
• Convenience: it is easy to add money regularly, even small amounts (Fractional Shares Investing and Dollar Cost Averaging).
  
  
  
  
  

On the other hand, Mutual Funds often failed to beat the Stock Market. The reasons include high Expense Ratios and fund manager's reluctance to deviate too much from Indexes.

Index Funds and Exchange Traded Funds (ETFs) are good alternatives. However, with such investment vehicles, you settle to track Indexes and not beat them.

Building your own Mutual Fund

The good news is that it is both:

• Easy to buy a large number of stocks at low cost and
  
• Select a portfolio of stocks that have a good chance of outperforming the stock market.
  

This is possible thanks to Stock Baskets and mechanical stock picking. These 2 tools allow you to build your own Enhanced Mutual Fund.

Stock Baskets

Stock Baskets allows you to buy/sell a large number of stocks for a low annual fee. For less than 200$ per year, you can have a portfolio of 50 or more stocks with almost unlimited transactions to buy/sell them. For portfolios greater than 20,000$, this is less than 1% per annum. For a 100,000$ portfolio, this is a mere 0.2% per annum.

Such low trading fees are possible thanks to window trades. With window trades, orders from investors are pooled together and executed at fixed times called windows. Discount stock brokers typically provide 2-3 trading windows per day. Unless you're a day trader, window trades are an economical way to buy/sell many stocks.

Another benefit of Stock Baskets is that you can trade all the stocks in your portfolio at the same time with just a few clicks. In addition, Fractional Shares and Dollar Cost Averaging are possible.

Stock Baskets are therefore as convenient as Mutual Funds Investing.

Now, you still have to select stocks by yourself and make sure that your strategy has a good chance of beating the market - otherwise Index Funds or ETFs would be more attractive - This is what mechanical stock picking can do for you.

Mechanical Stock Picking

Indexes often provide better returns because there are no emotional mistakes associated with the selection of stocks. Indexes are built mechanically whereas fund managers and individual investors are often affected by psychological biases that adversely affect their investing decisions - and ultimately returns -

With mechanical stock picking, you select stocks unemotionally as you spend little time in the selection process. A large number of stocks are automatically selected thanks to a Stock Screener giving you instant diversification.

Many mechanical stock picking strategies have been studied and several have proven to beat the market on a regular basis. It is also possible to tweak your strategy towards Large Caps or Small Caps and towards Value or Growth stocks.

Portfolios built through Mechanical Stock Picking can therefore be seen as Enhanced Indexes. Some simple strategies include:

• The Dogs of the Dow by Michael O'Higgins,
  
• Magic Formula Investing by Joel Greenblatt,
  
• Reasonable Runaways by James O'Shaughnessy,
  

Conclusion

You can build your own low cost Mutual Fund with a good chance of beating the market by using time tested stock selection strategies and then manage your portfolio with a Stock Basket.

Screen for mechanical stock picking strategies at the free Stock Screener. Check how much you can save with a Stock Basket thanks to the Broker Fees calculator that allows you to compare several Discount Stock Brokers.


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About the author:
Jacky Pandion is webmaster at www.mechanical-investing.com

Published at Feb, 14 '07 ; read 531 times;

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