The Sunday Wall Street Journal has an article with the title “Bad Ways to Pick a Mutual Fund.” We think it’s worth while examining this list and making a few comments.
1. Focusing on past returns –
This may well be the biggest problem for people who pick their own mutual funds. There is a good reason that funds mention that “past performance is no indicator of future results.” There are all sorts of reasons that past performance may not predict how well a fund will do in the future. Among them are management changes, style drift, and sector rotation.
2. Not looking under the hood
I am always amazed by the number of people who buy a fund without knowing what they do or how their money is being invested. Going by an advertisement or an article in a financial magazine is no substitute for research.
3. False diversification
Buying multiple funds that all do the same thing is not diversification, its duplication.
4. Chasing headlines
I recall that dot.com stock funds were incredibly hot in 1999 and people losing their shirts when the tech bubble burst the next year. The retail investor is never going to be ahead of the information curve.
5. Buying on ratings alone
Focusing on stars alone is as bad as buying based on what some magazine has deemed, say, the top five funds. In both cases, past performance plays too big a role.
The focus for serious investors is to look for a well diversified portfolio of funds that focuses on generating superior risk-adjusted returns. To do that, serious investors get professional guidance.