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.
Content Continues Below
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.
Originally published in the June 2004 issue of Entrepreneur Magazine