23-Jun-2004
By Amy Buttell Crane
These days, investing isn’t a choice for most people – it’s a necessity. From 401(k) Plans to college savings plans, investing is a must if you want to reach critical financial goals. And in most cases, mutual funds are an integral part of the investing package.
Mutual funds aren’t particularly complicated investing products. When you invest in a fund, you pool your money with other investors and pay a professional money manager to invest for you. You can invest a little at a time through automatic purchase programs or you can invest a larger sum once. Mutual funds are convenient and flexible.
As simple as they are, funds are full of traps for the unwary investor. From paying too much in fees to collecting too many funds, these traps can cut your returns and blur your focus. Both the experienced and new investor can benefit from avoiding the following mutual fund investing pitfalls:
Ignoring costs is potentially the worst sin a fund investor can commit. Costs directly cut into your fund returns – the more you pay in funds, the less you earn on your investment. Because fund costs are virtually invisible, it’s easy to overlook them. Keep your focus on the cash that is draining out of your account every day by translating these percentage-based costs into actual dollars. Paying 1 percent a year in fees doesn’t sound too bad, until you figure out exactly how much you pay in fees each and every year. An investor who owned $20,000 in fund shares that charged 1 percent in fees pays $200 a year and will pay more if the shares increase in value.
Fixating on short-term returns is no way to evaluate funds. I disregard returns of one, three and six months as well as one-year returns. I place the most value on 10 year and five-year returns and give a bit of weight to three-year returns. Short-term returns don’t prove anything except that a manager may be in the right place at the right time when the particular area or sector that he or she focuses on is in favor with the market. Take a fund’s long-term returns and compare them with a market benchmark index that is correlated with the fund you’re studying. Look for a fund to outperform that benchmark in the long-term, which, again, is over five or 10 years.
Buying hot funds will get you a portfolio of dogs. Studies show that funds with spectacular performance are poised for a fall, yet this is the time when shareholders pile in. When the fund’s share price falls, you’re left holding the bag. Too many shareholders take their money out of one fallen fund and put it in the next hot fund, frittering away their capital time and time again. Check out any fund you hear about before investing. Look for a solid investment objective, experienced management and below-average costs.
Focusing on one sector or area leaves your portfolio overly vulnerable to market swings. You haven’t forgotten what happened to tech-happy investors in the brutal bear market of 2000-02, have you? Investors who invested in technology to the exclusion of other sectors got pounded, while those who were more diversified were hurt but not as badly. Build your portfolio around core funds that invest in a solid portfolio of domestic and international stocks and bonds. If you’re tempted to bet on a particular sector, do it with a small portion of your portfolio – 10 percent or less – so you won’t be hit too hard if it falls.
Collecting funds instead of building a coherent portfolio. Most investors own a number of separate accounts, each with several different funds. Unless you look at your portfolio as a whole and develop an investing strategy to meet your goals, you’re likely to be a collector of funds rather than a savvy investor. Think about what you’re trying to accomplish with your investing, whether it be a comfortable retirement or funding college for your kids, and tailor your portfolio to meet those needs. With goals that are farther out, be more aggressive and invest in diversified stock funds. For goals that are closer, a mix of short-term bond funds and conservative stocks funds will work or a balanced fund that invests in both stock and bond funds can work as well.
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Tip of the Month:
Visit Fund Alarm (www.fundalarm.com), Roy Weitz’s shareholder advocacy Web site. Roy doesn’t take advertising from fund companies, and his monthly commentary on the fund scandal and the latest fund news is savagely on-target.
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New Book
O’Reilly & Associates published Online Investing Hacks in mid-June. My 23 tips on fund investing, college savings, finding investing news and analyzing banks and REITS appear in this book. To order a copy, go to
http://www.oreilly.com/catalog/0596006772/
