Mistake to Avoid: Basing Mutual Fund Choices on Short-Term Results

Thursday, December 19 at 09:45 AM
Category: Personal Finance

The emphasis placed on the short-term performance of mutual funds can be misleading. The financial press and personal finance magazines are full of stories about the "best" funds of the last quarter or last year. Mutual fund companies often promote the short-term results in their advertising. But mutual funds are meant to be long-term investments. 

All too often, a mutual fund will have a spectacular quarter or year only to perform poorly over the next several years. Sometimes, that excellent quarter or year is due to one stock or one sector in which the portfolio manager had invested heavily. Sometimes, it's even luck. Past performance can never be taken as an indication of future results. 

What to look for

  • When evaluating a mutual fund, look at its long-term performance as a way to determine how well the portfolio manager has done over several market cycles. 
  • To make performance comparisons, first make sure you are using the right benchmark for the type of fund you are examining. If you are looking at a "long-term growth fund," then compare its results to those of its peers and the S&P 500 index. If you are considering an "aggressive growth fund" use the performances of its peers and an index of small growth companies. 
  • Make sure the current portfolio manager is the one responsible for the results you are reviewing. The portfolio manager makes the investment decisions that generate the results. Information on the portfolio manager is available in many publications, such as Value Line or Morningstar, or from the fund itself. 
  • Also, look at the age and size of the fund. Newer funds that have strong short-term performance are often small. As the fund grows, it can be difficult for the fund to match its early results. 
Take a long-term view 

When choosing a mutual fund, start by selecting the type of fund that matches your objectives. Then look at the level of fund expenses (they can erode gains) and its long-term performance.

Looking at the three, five and 10 year performance of a mutual fund is a better way of evaluating the quality of the fund. One quarter or one year results can be important, but only when viewed as part of the long-term performance of the fund. 
Tags: Financial Education
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