Mutual Fund Investing: The Dangers of Chasing Performance
- Tuesday, November 02, 2004
Jesus made an interesting comment one day. He warned His followers that they should strive to be as wise as serpents but as innocent as doves. (My rough paraphrase of Matthew 10:16.) Interesting thought-one that has a universe of applications in the Christian walk. But, while Jesus was speaking on a spiritual level, I think this teaching crosses into the way we conduct all the affairs of life-including our investing. At No Debt, No Sweat! Christian Money Management Seminars, I spend a lot of time discussing the pitfalls of mutual funds.
One of the biggest traps investors fall into is the trap of chasing performance. Frequently people hop from one fund to another trying to get the best returns. While there are times when it makes sense to switch funds, it can easily become a sucker's game. There are at least three things to think about before you take the fund leap:
1) Past performance does not insure future results. Looking at how a mutual fund has done in a previous period has its place. But making fund decisions based solely on past performance is a little like driving your car by looking in the rear-view mirror. It may tell you something about the terrain around you, but it isn't going to do a thing to warn about that tree dead ahead!
Many an investor has jumped to "greener grass" on the other side of the investment fence just in time to ride the new fund down -- as his old fund comes back in favor and begins to gain ground again.
2) Big returns frequently equal big risks. Sometimes, the greatest return comes from taking the greatest risk. The same is often true with mutual fund investing. Frequently, the stellar fund that everyone is talking about is investing in highly volatile assets that can go down as fast as they go up.
I really get spooked when I see a mutual fund advertising incredible return rates that far exceed other funds in it's category. Sometimes this happens simply because the fund manager has been taking big investment risks -- which so far have paid off. But, remember, such a risky investment strategy can do a neck-breaking u-turn in a New York minute and leave investors in a world of hurt!
3) Lookout for the expenses. All other things being equal, high fund expenses
can have a big, negative drag on a mutual fund's performance. Don't let some fund salesman cock back in his chair and say, "Hey, what's the big deal? It's only another 1/2 percent!"
Here's the plan: If it's no big deal to him -- let him pay it! That 1/2 percent could cost you thousands of dollars over the years.
Understanding Mutual Fund Expenses
When you are looking at a mutual fund investment, there are at least three issues to consider: Return, risk, and expense. Often fund investors who pay close attention to return and risks tend to forget about the expenses. This over-site can cost thousands of dollars through the years. So, as boring as it may seem now, let's spend a few moments to look at how mutual fund expenses work. The Securities and Exchange Commission requires that expense information be disclosed in the prospectus that you should receive before buying shares in any fund. But to give you a quick overview, you may find the table below helpful.
Some Pointers From A Pro
One of my buddies in the financial trenches is Paul Winkler, President of The Investor Coach, Inc. in Goodletsville, Tennessee. I asked Paul to list what he thinks are some of the important considerations for a new investor.
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