If you look at investment magazines and the financial pages of the newspapers, you will doubtlessly see advertisements trumpeting mutual funds earning breathtaking returns. Usually, though, these returns are just for the past year. If you really want to get a sense of whether a fund is a good investment candidate, you might want to follow these suggestions:
• Don’t get hung up over recent performance – Many factors can explain a fund’s short-term performance – but some of these reasons are not really relevant to long-term investors. For example, a fund could consist of many stocks belonging to a “hot” industry; yet, this same industry could easily cool off next year.
• Look for consistency – Try to find funds that perform well year after year, even in difficult market environments. While no fund can guarantee strong returns – or even positive returns – all the time, some funds continually outperform the market averages.
• Study the fund’s managers – As you consider a mutual fund, find out as much as you can about its managers. How long have they been on the job? What sort of performance have they turned in? What’s their investment philosophy? It’s essential you know what to expect from a fund’s managers, and what their relation has been to the fund’s performance. In fact, if new managers have just come aboard, you might want to suspend judgment on the fund’s past performance.
• Watch out for volatility – All mutual funds will fluctuate in price. You’re better off looking for those funds with histories of relatively low volatility. Of course, some funds – such as growth funds – are, by nature, more volatile than other types of funds, such as bond funds.
• Look at “value” – not just price – Mutual funds come with different fee and expense structures. Generally speaking, of course, higher expenses will cut into a fund’s overall return, so you will want to pay attention to these costs. And yet, even the “cheapest” funds aren’t good values if they don’t meet your needs. So, look first for those funds that can help diversify your portfolio.
• Compare similar funds – If you are choosing between one or more funds, make sure you are comparing funds that are similar in investment philosophy and size. It makes little sense to compare an aggressive growth fund’s performance and outlook with that of a growth-and-income fund.
• Invest for the long term – When you buy mutual funds, choose those that you can envision holding for several years. If you sell funds that you’ve owned less than a year, you might incur short-term capital gains, which are typically taxed higher than long-term gains. But even more importantly, the more time you give a high-quality mutual fund, the greater the likelihood that it will overcome “down” periods and reward you with a strong performance.
By observing these basic guidelines, you may be able to avoid some unpleasant surprises – while you build a portfolio of mutual funds that can help you meet your long-term investment goals.
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