Follow The Rules

If you're seeking a few good mutual funds and have set your sights on a few of last year's hottest properties, look before you leap. In many cases, last year's top performers will be funds of similar style and market sector, which means they'll probably all move in the same direction--not bad if that direction continues to be up, but no fun if things go the other way. That old saying, "Past performance is not an indication of future returns," is especially meaningful here, as the performance of investments over time shows a regression toward the mean. In other words, investments that show far superior performance will tend to cool off while less-than-stellar funds may pick up the pace over time. Worse yet, a hot fund could cool off just as you're getting into it.

Consider looking for fund managers with good long-term track records whose funds are out of favor (and therefore aren't winning any popularity contests). By selecting funds that are out of sync with the current best and brightest, you'll have the chance to get in early.

This article was originally published in the January 2000 print edition of Entrepreneur with the headline: Follow The Rules.