How to Be a Better Fund Investor
How to Buy
Get the Right Fund for Your Goals
Funds come in a number of broad categories—stocks, bonds, money markets, hybrids and alternative investments, such as commodities. Each category is subdivided into more-specific groups—for example, stock funds may focus on small U.S. companies or large foreign firms. In general, the more a fund is oriented toward stocks, the riskier it is and the greater the potential for reward.
Check the Record
Look at long-term results—at least five years’ worth, preferably ten. Compare the record with a benchmark and the category average. Be wary of an advertising claim that a fund beat this index or that peer group over the past one, three, five and ten years. One recent blockbuster year can skew that kind of analysis. And check to see that the same manager was in place over the entire period.
Keep Costs Down
Fees eat away at your returns. Put $10,000 in a fund that grosses 10% yearly and charges 1.5% in fees and you’ll have $49,725 after 20 years. But if the fund charges 0.5% a year, you’ll have $60,858. Compare a fund’s fees with those of other funds in the same category. The average annual fee for diversified U.S. stock funds is 1.32%, for example. Avoid sales charges, too.
Make Sure You Can Live with a Fund’s Risk
Generally, the greater a fund’s volatility, the greater its potential reward. Be sure a fund’s returns have been commensurate with its risks and that you can sit through the inevitable downdrafts without flinching. A big problem with high-risk funds is that they attract many investors after they soar. Those investors then sell after the fund craters.
When to Sell
Your Manager Splits
If you own an actively managed fund, the person or group of people in charge is key. This is especially true at smaller firms that are intimately tied to one manager, such as Yacktman Fund and Don Yacktman. It’s less important at large companies with deep benches, such as Fidelity and T. Rowe Price. A manager’s departure shouldn’t be an automatic trigger to dump a fund, but it should raise a red flag.
Performance Turns Stinko
Selling for performance reasons is tricky. Even the best managers periodically hit a dry patch for a year or two. But if a fund persistently lags its benchmark and peer group—three years in a row, say—it may be time to put your money elsewhere.
The Fund Changes Its Stripes
Those small-capitalization stocks a fund bought years ago may have graduated to mid-cap or even large-cap status. Or a manager may have made a conscious decision to shift the fund’s focus. For example, Fairholme Fund morphed over the past year into something akin to a financial-sector fund. So check out a fund’s current investment style at Morningstar.com, with an eye toward how it fits in with your portfolio. If a fund is no longer a good fit, consider selling.
The bigger a fund, the less nimble. This is especially problematic for small-cap stock funds—as the fund trades shares, it may move the stock price in a way that hurts results. But asset bloat can hinder large-cap funds, too. Fidelity Magellan posted stunning gains in the early ’80s, but performance started to peter out as assets surged.