In the world of equities -style investing, growth funds offer investors access to the companies believed to have the best prospects for strong sales and earnings performance. They are often not cheap—growth stocks will tend to have higher price-earnings (PE) ratios than the overall market. Investors buy these stocks—and the funds that hold portfolios of them—because they believe the high PE ratio is justified by the companies’ strong growth prospects. Within the universe of growth funds, large cap growth funds typically concentrate on names in the large to midcap space, as opposed to newer companies that may be riskier with business models that rely on unproven technologies.
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Investors in growth funds tend to have long time horizons, relatively low income needs (as these stocks on average pay lower than average dividends) and the capacity and willingness to take on risk in pursuit of stronger gains. They may also be attracted to the brand value of growth stocks, which tend to include the “media darlings” that receive extensive, often positive coverage by the financial press. But not all growth funds are the same; nor is the best growth fund for one investor the best fund for another. Every investor is different with unique needs, circumstances and preferences. But, how do you know what funds are best for you? In the following case study, we illustrate the fund selection process for an example investor, showcasing the measures every investor should take into account when selecting funds, and describing the three growth funds that are a good fit for this example investor and three which the investor should avoid.
Case Study: Tom Adams
Tom Adams is 35 years old, married with two young children and has a relatively good income from a software development company. His primary financial goal is to build wealth over the long term for expected lifestyle events like his children’s education, a vacation house in the mountains and a comfortable retirement.
Tom knows that over long periods of time, equities have proven to be better investments than bonds, and he believes that pattern will continue into the future. He is comfortable with taking on short-term investment risk in order to be better positioned for higher long-term returns. As someone who works in the technology field, Tom finds technology-driven business models interesting and believes these companies to be the likely future growth engines for the economy. Large cap growth funds are a natural investment for him.
Tom wants funds that will perform strongly over the long term and that will emphasize capital appreciation rather than dividend payouts. He cares about fees—he does not want to pay more than he has to for a good fund. Risk measures like standard deviation are important only insofar as the risk level for any given fund is reasonable in the context of its asset class peers.
Here are the funds we found that best suite Tom’s needs and preferences:
Tom Adams’s Top Three Large Cap Growth Funds
These are from a pool of 791 funds with a track record of at least five years.
These funds all demonstrate higher than average returns over multiple time periods with risk slightly higher than the overall market (we use the Vanguard S&P 500 index fund as a proxy for the broad equity market). In particular, the top fund’s earning nearly double the S&P 500 over a ten year period, which is attractive for an investor with a long term perspective like Tom.
Actively- managed style funds will tend to have higher expense ratios than index funds. Interestingly, the top fund in this list, NASDX, is actually an index fund whose strategy is to track the largest non-financial companies as measured by the Nasdaq 100 index. This approach enables the fund to charge a significantly lower fee than its two closest competitors, which is important to Tom.
What funds should Tom Adams stay away from? There are plenty of poor performers in the large cap growth space. Here are the three at the bottom of Jemstep’s ranking engine for the category. In addition to showing below average performance relative to the broad market (in time periods where growth stocks generally have been stronger than other styles), these funds all charge very high fees—yet more evidence that high fees are not a good predictor of fund performance.
Three Worst Large Cap Growth Funds for Tom Adams
When choosing funds for long-term investment goals, it is always a good idea to pay close attention to performance in the areas that matter most to you—whether that be long or short-term total returns, risk, management team tenure or fees. Keep in mind that generic rankings are not going to give you insights into how fund performance relates to your own unique investment needs. And watch out for brokers trying to sell you whatever funds their firm happens to be pushing that week—they may include those funds at the bottom of the pile that you want to stay away from.
Jemstep Inc. is a free online investment guidance and management service that helps individual investors make better investment decisions and achieve their financial goals faster. Jemstep’s investment evaluations, based on patented technology and objective market data, are unbiased and transparent. Jemstep does not accept paid listings or sponsorships that influence its fund rankings in any way, nor does it factor subjective user reviews into the guidance it provides. A privately owned company with headquarters in the heart of Silicon Valley, Jemstep is a registered investment advisor under the rules and regulations of the U.S. Securities and Exchange Commission. To learn more, please visit www.jemstep.com.