Nearly one year ago, I asked readers to come up with a list of the best mutual funds they could. 

And they didn’t fail me—coming up with a list of 10 beauties.

Then I asked readers to give me names of the worst stocks they knew:  stocks destined to fall through the Earth.

Keep in mind that one person’s dream fund or stock could always be another person’s pariah.

That said, once I collected the names of the dream mutual funds and the terrible stocks, I hypothesized that over a long period of time, the loser stocks would likely beat the aggregate results of the top-rated mutual funds.

Why would I do that? 

Don’t I know that some of the smartest minds in the business are running these funds?  Yes, I do know that.  But I also know that the stock market is tough to predict, and it’s highly efficient.  If a stock has poor prospects, it’s likely going to be priced cheaply.  And if its reputation reverses, we could see some serious gains.

First of all, it’s no surprise that Vanguard’s total stock market index fund has beaten 8/10 of these mutual funds over the past 10 months.  That’s mathematically inevitable over the long haul.  And over the short term, you’ll still very likely see that trend (as we see here, since April 14, 2010)  With the index up 11.3%, we see that only “Fidelity Select Energy” and “American Heritage Century A” have beaten the market over the past 10 months.  Eighty percent of these fund managers would have lost to monkeys throwing darts at a newspaper stock market page.

Selected Super Funds
Wednesday February 16, 2011 02:45 AM EST

But that’s never going to be considered news to the well-read investor.

What’s interesting, and a prologue of what’s to come (I believe) is that 4/10 of these mutual funds are losing to the terrible stocks my readers compiled. 

Let’s be clear about the purpose here. 

My readers were trying to pick the worst stocks they could think of—stocks they felt would tank badly. 

And these mutual fund managers were doing their best to beat the market.  In many cases, they are paid millions of dollars to do so.  In a taxable account, 5/10 of these funds would be losing to the “loser stocks” because the portfolio turnover in the T. Rowe Price Equity Fund would create a drag that wouldn’t be offset by its 0.91% advantage over the loser stocks—ensuring that it joined the other 4 underperforming funds.

So half of these fund managers are doing their best in race where the competitors (the loser stocks) are actually trying to run in the opposite direction. 

Hmmmm…it does make you think, doesn’t it?

I’m standing by my hypothesis that over many years, without changing these portfolios, the loser stocks will pull far ahead of the aggregate returns of these super mutual funds.  Time is the enemy of the fees they will generate internally.  And fees are forever.

23 loser stocks
Wednesday February 16, 2011 02:46 AM EST