If you decide to invest through mutual funds, you'll
have literally thousands of funds to choose among.
Hoping that your fund will do well in the future,
you'll likely look for a fund that has done well in
the past. You'll have to go over a great deal of data
in order to make an informed decision.
Set your sights
Your fund choice may partially depend on how long
you intend to keep it. Some investors buy mutual funds
in the hope of catching hot sectors.
Example 1:
Alicia Warren allocates 10% of her investment portfolio
to trend spotting. She knows that emerging markets
stock funds will have some high return time periods;
high yield bond funds also have their quarters or
even years of superior performance. Alicia aims to
catch such trends and ride them until she takes profits
and moves her money elsewhere.
Alicia may decide to focus on results from the past
few months. If a fund's share price starts to move
up rapidly, she might decide to investigate that fund
more closely. Alicia could, for example, look at previous
periods when that category of fund did well and see
if a particular fund outperformed the category average.
(Mutual fund data is available at the sponsoring company's
website as well as research sites such as www.morningstar.com.)
Other investors may view mutual funds as long-term
holdings. Indeed, investors who buy some funds for
short-term results also might hold others for years.
Example 2:
While Alicia Warren allocates 10% of her portfolio
to short-term mutual fund purchases, she invests the
other 90% in funds that she expects to hold for the
long term. For these selections, she pays less attention
to recent results. Instead, Alicia looks at fund performance
for the previous 5 years and 10 years. If a fund has
been around long enough, she will evaluate the results
of the past 20 years, which cover several bull and
bear markets in stocks and bonds.
Drilling down
If you take this long-term view, you might see that
fund ABC's average return was 9% per year for the
past 10 years, while Fund XYZ, which is in the same
category of stock funds, had an average return of
7%. Does that mean ABC had the better record? Not
necessarily.
Looking at the calendar year results for the past
10 years, you might see that ABC had greater gains
than XYZ in 2003-2007, when stocks enjoyed steady
gains, and also in the rebound year of 2009. XYZ had
lower returns in those years, but smaller losses in
2002 and 2008. In 2000 and 2001, XYZ had modest gains;
ABC had losses. Therefore, ABC's long-term superiority
stemmed from some outstanding years, but XYZ generally
gave investors less year-to-year volatility.
From such a pattern, you might infer that ABC is
likely to be more aggressive in its investment strategy
than XYZ. Depending on how long those funds have been
in existence, with the same management, you might
go back even further and try to detect similar patterns.
If returns patterns are indeed similar, you might
decide to invest in ABC for the long term because
you can live with volatility in pursuit of higher
returns. If you'd prefer a less nerve-racking mutual
fund, you may choose XYZ instead.
Source: January, 2010 CPA
Client Bulletin; a monthly publication of the AICPA)
