Thank You, John Rekenthaler, For The Uncomfortable Truths About Investing

John Rekenthaler, longtime Director of Research at Morningstar, recently announced his retirement from a 35+ year career with the article Farewell, For Now. As a regular reader of his “Rekenthaler Reports”, I have respected his clear writings that were often about the uncomfortable truths of investing.

I am old enough to remember when the “5-Star Rating” from Morningstar was the ultimate goal of every mutual fund, as that meant they could place a huge ad inside Kiplinger’s Personal Finance and Money magazines (along with the inevitable other mentions) and wait for the money to roll in. Morningstar still has fund ratings and offers stock picks, but they’ve also evolved their business and to their credit, acknowledged these “uncomfortable truths”:

5-star Morningstar ratings weren’t very useful. Even way back in 2000, the research showed that high past performance did not result in high future performance. The only thing that showed “persistence” were the worst-performing funds. Bad funds stayed bad. From a 2000 article by Jane Bryant Quinn:

John Rekenthaler, Morningstar’s research director, says there’s actually not much difference between mid-ranked funds and top-rated ones. Three-star, four-star and five-star funds have been found to perform pretty much alike, he says.

Still, those funds do better, on average, than two-star or one-star funds. If that’s the case, you shouldn’t worry if your fund moves from level to level, as long as it rates three stars and up.

Low expense ratios matter the most in fund selection. Russell Kinnel was the author of the 2010 Morningstar article How Expense Ratios & Star Ratings Predict Success, but Rekenthaler was also part of that research team and the admission was really big news for that time:

Perhaps the most compelling argument for expenses is that they worked every time–because costs always are deducted from returns regardless of the market environment. The star rating, as a reflection of past risk-adjusted performance, is more time-period dependent. When the market swings dramatically, the star rating is going to be less effective.

Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance. Start by focusing on funds in the cheapest or two cheapest quintiles, and you’ll be on the path to success.

Doing nothing is often the best investing advice. Could it be that the “Do Nothing Portfolio” could compete and often beat the average mutual fund and even index funds (which still add and remove stocks within their index)? There is a lot of interesting stuff here: More Lessons From the Do Nothing Portfolio.

There is something to be said about minimizing your trading to the absolute minimum. The reason behind making extra trades is often either performance-chasing or panic-selling. Less is often more.

Edges don’t last. From William Bernstein:

Rekenthaler’s Rule: “If the bozos know about it, it doesn’t work anymore.” In other words, as soon as an anomaly is uncovered, it is arbitraged out of existence.

Time IN the game, not timing the game. Rekenthaler even included some uncomfortable truths inside his last article. If he had listened to Jack Bogle and picked the low-cost Vanguard S&P 500 index fund from early on instead of his actual picks (as an employee at Morningstar!), he’d likely be much richer today. But because he still kept investing consistently and mostly in US stocks, he still did just fine. Thus, we should not expect investing perfection from ourselves, either.

Another tribute article: What I Learned From John Rekenthaler