Max's Investment World Stock Market Challenge
How to Pick a Mutual Fund
Every other month, it seems, personal finance magazines holds
their mutual fund beauty pageant. Each magazine has its own favorites,
which often differ markedly with their competitors.
Virtually all of the magazines rate their funds on the basis
of past performance. Unfortunately, as the tiny type at the
bottom of all mutual fund prospectuses states, past returns aren't
necessarily an indicator of future returns. Indeed study after
study shows that stock mutual funds, just like stock prices,
are mean reverting, meaning that the underperforming funds of
today become the overperforming funds of tomorrow.
Still, it probably makes sense to eliminate funds that have done
poorly over the last three-, five- and 10-year periods. After
five years, mean reversion should start to work, evening out
the funds with bad records. Funds that don't bounce back after
that time should be overlooked.
Here's another rule: be cheap like us at Max's Investment World Stock Market Challenge.
We believe that you should only pay higher prices for higher
performance. So far, studies have shown that funds with loads,
or sales commissions, don't perform any better than no-load funds.
And funds with high annual expenses aren't, in general, better
performers than funds with low expenses. High expenses can reduce
the performance of a fund's annual return by a half of a percentage
point or more.
There are 700 no-load funds with low expenses to choose from,
cutting the field of choices considerably.
You can also safely ignore funds and fund managers with less
than a three-year track record. Why? How do you know how they
perform in up and down markets? You don't, so be safe rather
than sorry.
Pick a couple of funds with different objectives, such as funds
that invest in blue chips, small stocks and international stocks.
That way, you further diversify risk and most likely will increase
returns.
Bottom line: You can be just as good if not better a judge of
mutual funds than the personal finance magazines. Any decent
library will have the Morningstar and Lipper ratings of mutual
funds, which should help you come up with at least a couple of
winners.
Go to $Idea Central for more
investment ideas!
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