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Rooting Around

When you're looking to invest in a mutual fund, dig deeper than past performance.
June 1, 2004
URL: http://www.entrepreneur.com/article/70934

Mutual fund advertisements tell you, usually in the finest of print "Past performance is no guarantee of future results." While that statement has always been true, now's a particularly good time to take heed.

We've had a three-year bear market where virtually everything lost money, followed by a stupendous year where virtually everything made money, topped off by the biggest regulatory scandal in the $7 trillion fund industry's history. It's been an especially topsy-turvy time for fund managers and investors, which makes it that much harder to evaluate potential homes for your investment dollars.

Which is not to say you should ignore a fund's recent performance if you want to add it to your portfolio. Just take it with a big ol' grain of sodium chloride.

Once you have a particular fund in mind, check with Morningstar Inc. or another fund-rating agency to see how the fund compared with its peers over one-, three-, five- and 10-year periods. If its annual returns are not in the top half of all funds in its category over most, if not all, of those time periods, this investment is a nonstarter. Walk away. If it is in the top five deciles-top 50 percent-over all or most periods, look into it a little further.

Also check to see how a fund stacks up in terms of volatility. Some funds skyrocket during one quarter, only to plummet during another; while others are steady-as-she-goes. While volatility isn't always a terrible thing-some of that volatility is upward-the best-performing funds over time tend to be those that post consistently solid returns relative to their volatility rank.

Look, too, to see how long the fund manager has been on the job. After all, a 10-year track record isn't worth much if the manager has been making the investment decisions for only three of those years. The stock picker doesn't matter if you opt for an index fund, of course; and it matters less at big, process-oriented companies like Fidelity or American Funds. But a manager's tenure and performance are generally your best window into how a fund will behave in the future.

Finally, don't overpay. Why pick a high-expense fund if there's a low-expense alternative that's just as good? And don't pay a sales charge, or load, to a broker if you've done the investment homework yourself.

There are plenty of low-cost, no-load funds out there with above-average returns and managers with long-term track records. You just have to look closely enough to find them.


Scott Bernard Nelson is deputy business editor at The Oregonian and a freelance writer in Portland, Oregon.