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Mutual Fund Tips
Avoiding the Most Common Mistakes in Mutual Fund Investing
by Tom Wade (Write for us!)
(Click on the links within the article to get definition of that word)
Buying last year's best fund
It is very common to purchase a mutual fund based on its past track record. This is only natural. However, the conditions that cause a fund to be last year's big winner may not be in place today. As a result, it is very rare for a top fund to be on top more than one year in a row. In fact, because of huge inflows based on performance, often a fund manager is swamped with cash and can't possibly achieve the same results. The better strategy is to aim for consistency
in performance and management, rather than trying to hit the home run.
Impulse buying or selling
There is significant emotion involved in financialmatters. This often results in making investment decisions for the wrong reasons. Investment hype on television or the Internet is often enough to sway a person into buying or selling impulsively. "The best course is a methodical, well-planned strategy, designed to weather the storms, while taking advantage of market advances" Wade points out.
"Portfolio construction, starting with a solid foundation can be accomplished using stable, large company funds or index funds." Wade said. "The aggressive stuff should be limited to 10% or less, and for most people avoided altogether."
"Collecting" funds
Instead of adhering to a disciplined strategy, it is common for people to buy fund after fund, ending up with a "collection" of mutual funds. "Five to seven funds is generally enough to get the diversification needed, after that the Law of Diminishing Returns comes into play" Wade adds. This over-diversification is dilutive, having a negative effect on the results.
Under-diversifying
Another problem arises when an individualbuys a number of the same type of fund. People buy what they like, and if they like large-capgrowth funds, it is not uncommon to see several large-cap growth funds in the same account. The result is excessive overlap. Remember that mutual funds chargefees, and
you are paying an average of 1.5% per year for each fund.
Forgetting to watch the management
It is not easy for the average investor to know what each separate mutual fund is investing in, and therefore it is hard to know when the management is straying from its charter. Annual and semi-annual reports can help an investor review the largest positions a fund holds, to get a sense if the fund is still accomplishing its mission.
Management changes, significant portfoliomodifications and feealterations should be watched carefully. These are signals that the fund is different than when it was purchased, and it should be determined if it still fits into your overall portfolio strategy.
How to avoid common mistakes
Professional money managersrealize that the single most important determinant to portfolio return is being in the rightasset class at the right time. For example, owning bonds as interest rates are declining, or investing internationally as the US dollar is falling against other currencies. However, no one knows which sector or category will be the next big winner. Therefore, maintaining a diverse mix of assetclasses and rebalancing periodically will help investorsstay the course without taking excessive risk.
I recommend a variety
of index funds for lowcost, tax-efficiency and market-level returns, while avoiding bond mutual funds which could decline significantly in the event of future interestrate increases. "Investors should first outline their long-termneeds, quantify their risk tolerance, and not react emotionally to the constant stream of negative news" Wade said. "Maintaining a healthy dose of objectivity, rather than emotion, will guide you in the right direction."
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