The best funds for your core portfolio

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We all dream of finding the next Warren Buffett. But even Warren Buffett is having trouble finding the next Warren Buffett. And, he's not the only one. Out of the more than 11,000 mutual funds on the market, almost 70% have replaced their managers in the last five years. That's a pretty high turnover rate.

The scarcity of investment talent is perhaps the single biggest reason why there are so few mutual funds that I find worth recommending for the core of your portfolio.

There are a few, though. Among my favorites:

• American Century Strategic Allocation (TWSAX), which invests in both stocks and bonds to provide a smoother ride.

• GAMCO Westwood Mighty Mites (WMMAX), which invests in the smallest stocks, where the market is the least efficient at setting prices.

• DF Dent Premier Growth (DFDPX), a growth-stock fund that did well even when growth stocks were out of favor.

• Click here for my full list of 16 (.pdf file).

When I offered Strategy Lab readers this list of 16 top core funds last round, the response overwhelmed our e-mail server. A lot of readers asked the same questions. Why are there so few core funds? And a topic close to my heart, what makes Marketocracy's fund different from others? Here are my answers:

Core and explore

The portfolios I usually discuss here in Strategy Lab are designed to seek maximum returns -- what I call "explore" portfolios, after a strategy called "core and explore." The objective for your core is different: getting the rate of return required to achieve your financial goals while taking as few risks as possible.

Index funds are often used for a core portfolio because they are diversified with a variety of stocks, reducing risk and virtually guaranteeing that you'll get close to the return of the market. The problem is that there's no guarantee the market's return will get you to your financial goals.

For example: Let's say your retirement plan is built on the market advancing 10% a year. Since 2000, the S&P 500 ($INX) has actually risen that much only twice. If you're getting the market return, you're behind.

Since the core is the largest portion of many people's portfolios, the selection of a good core fund or funds can have a big impact on whether you achieve your financial plan.

After giving this some thought, I think the reason so few core funds exist is because no single investor has the expertise to do well in every industry. Consequently, in order to be a diversified fund and still have a chance to outperform the S&P 500, you need more than just one skilled investor. You need a team.

And since Morningstar's data shows that mutual funds change managers quite frequently, I infer from this that they have a hard time finding and holding on to even one skilled manager, much less the team they would need to manage a good core fund.

Market meritocracy

I can tell you how we do it at Marketocracy -- and part of it is our search for the next Warren Buffett.

At Marketocracy, investors can set up model portfolios, practice and compare themselves with other users. (To start now, click here.)

More than 100,000 people have done so; more than 30,000 have track records that are now more than five years old. Based on their results, we have signed research contracts with about 500 of the best. From this talent pool, we choose our m100 team.

By tapping the wisdom of so many skilled investors, rather than just hiring the single top investor, we are better able to run a core fund than almost any other company.

Now, if any fund could beat the S&P 500 every day, month, quarter and year, it would be easy to recommend it as a core holding. No one can promise that, but it is the goal all core fund managers should strive for. To measure our progress, we use a metric we call the success ratio -- the percentage of all of the days over a period of time when the m100 beat the S&P 500 after a specified holding period. For the last three years, here are the m100's success ratios for various holding periods.

Holding period	Success ratio
One month	59%
One quarter	67%
One year	73%
Two year	96%

Since 2005, the m100 had a 59% chance of beating the S&P 500 after a holding period of just one month. With a holding period of one quarter, there was a 67% chance of beating the S&P 500. The longer the holding period, the more likely it was that the m100 did better than an S&P 500 index fund.

Now, I would never recommend that anyone with a time horizon of one month, or even one quarter, invest in stocks. But for those with an investment horizon of at least two years, I think the m100 is a great team for a core portfolio.

Keep in mind that these statistics are for the m100, not the Masters 100 Fund (MOFQX). Even if the m100 does well, I am the fund's manager, and I could still screw it up. However, over the weekend Morningstar upgraded our fund to four stars overall and five stars for the past three years. So I haven't screwed things up too badly -- at least not in the last three years!

And mind you, there are other ways to succeed; this is just the fund I know best. On my list you'll find it and 15 others to consider for your core.