"Of Mutual Interest," -Predicting Performers
Tuesday, February 20, 2007SUSIE GHARIB: With over 7,000 mutual funds in the U.S., picking the right one can be a daunting task. Many people base their decisions on a fund's past performance. But as Erika Miller explains in tonight's "Of Mutual Interest," last year's triple crown winner can often be this year's laggard.
ERIKA MILLER, NIGHTLY BUSINESS REPORT CORRESPONDENT: Selecting a mutual fund can be a lot like betting on horses. At the track, people often pick horses based on past wins. Similarly, many investors choose mutual funds based on past performance. But Christine Benz, director of mutual fund analysis at Morningstar, says that's usually a bad strategy.
CHRISTINE BENZ, DIRECTOR OF MUTUAL FUND ANALYSIS, MORNINGSTAR: I would be on high alert if you've seen a fund and you're attracted to it because its returns have been far higher than any other fund like it. Lots of times, what you have there is a fund that is taking outsized risks and those risks have helped it generate very strong past returns. But returns might not be so strong in the future.
MILLER: She says the mutual fund performance figures touted in magazines are frequently misleading. They are time-weighted returns, representing what a person would have made with a single investment over a particular time frame -- like one, three, or five years. Instead, Morningstar developed a new measure of fund performance called investor return. It measures the gains or losses actual investors made in a fund over a particular time frame by tracking money flows.
BENZ: We found that in many, many categories, investor returns were far lower than the funds' published total returns. We also found a very strong correlation with high-volatility categories, high-risk categories and poor investor returns.
MILLER: For example, over the past 10 years, Fidelity select technology fund has had a total return of almost 8 percent a year. But, according to Morningstar, the average investor in that fund lost 4 percent a year. Mutual fund experts say it's better to put your energy into picking the right fund category rather than the perfect fund. To do that, Phil Edwards of Standard & Poor's says it's important to have a defined investment goal: will the money be used for retirement, a house, education or something else?
PHILIP EDWARDS, DIR. OF MUTUAL FUND RESEARCH, STANDARD & POOR'S: Most savings goals are typically fairly long-term and when I say long-term, I mean more than 10 years. In that case, the thing that has proven to work more often than not is diversification.
MILLER: He says your risk tolerance and time frame should determine how aggressively you invest your money. The longer the time frame, the more risk you can afford to take with your portfolio. Nearly everyone agrees you should also know the track record of the fund's manager.
EDWARDS: You should look for overall investment management experience and secondly, that investment management experience with this product. What's typical is that they'll say that John Smith or Jane Doe has 15 years of investment management experience, of which three months has been on this product. The 15 years sounds good, but the three months is not good.
MILLER: Financial planners also say one of the best things you can do to boost your returns is find funds with low fees. Standard & Poor's recommends focusing on funds with a less than 1 percent expense ratio. Erika Miller, NIGHTLY BUSINESS REPORT, New York.
