Buying Funds Now -Learn to Earn_ A Beginner’s Guide to the Basics of Investing and Business.
It would take a whole book in itself to describe the different kinds of stock funds that are out there: the all-purpose funds, single-industry funds, multi-industry, small-company, large-company, pure, hybrid, foreign, domestic, socially conscious, socially unconscious, growth, value, income, and growth-and-income funds. It’s gotten so complicated that there are funds of funds that specialize in buying shares in other funds.
You could stay up day and night studying how to choose the right fund, and you wouldn’t get through half the information that’s been printed on the subject. If all these how-to books, pamphlets, and articles fell on top of you, it would take a rescue squad several hours to pull you out. In fact, so much attention is devoted to picking the right fund in any given year, it could begin to drive people crazy. They’d be happier, more relaxed, and nicer to dogs and children, plus they’d save on psychiatry bills if only they would abandon the search for the absolutely perfect mutual fund.
At the risk of contributing further to the unhealthy fixation on this quest, we present the following bits of advice:
- You can buy mutual funds directly from the companies that manage them, such as Dreyfus, Fidelity, and Scudder. You can also buy them through a stockbroker, although a broker may not be able to sell you the fund you want.
- Brokers have to make a living, and they sometimes get a bigger commission for selling the firm’s own products. Convincing you to buy one of the in-house mutual funds may be in their best interest, but not necessarily in yours. Whenever a broker recommends anything, always find out what’s in it for the broker. Ask him or her to provide information on the full range of what’s available. There might be a fund that’s similar to the one the broker is recommending but that has a better record overall.
- If you’re a long-term investor, ignore all the bond funds and hybrid funds (those invest in a mixture of stocks and bonds) and go for the pure stock funds. Stocks have outperformed bonds in eight of the nine decades in this century (bonds ran a close second in the 1980s, but stocks still did slightly better). In the first half of the 1990s, stocks once again are way ahead of bonds. If you’re not 100 percent invested in stocks, you’re shortchanging yourself in the long run.
- Picking the right fund isn’t any easier than picking the right auto mechanic, but with a fund, at least you’ve got the record of past performance to guide you. Unless you interview dozens of customers, there’s no simple way of telling whether an auto mechanic is good, bad, or indifferent, but you can find out easily which of these ratings applies to a fund. It all boils down to the annual return. A fund that returned 18 percent a year over the past decade has done better than a similar fund with similar objectives that returned 14 percent. But before you invest in a fund on the strength of its record, make sure the manager who compiled the great record is still in charge.
- Over time, it’s been more profitable to invest in small companies than in large companies. The successful small companies of today will become the WalMarts, Home Depots, and Microsofts of tomorrow. It’s no wonder then that funds that invest in small companies (the so-called small caps) have beaten out the “large cap” funds by a substantial margin. (“Cap” is short for “market capitalization”—the total number of shares issued by a company multiplied by the current share price.) A couple of Wal-Marts is all they need to outperform the competition. That one stock is up more than two-hundred-and-fifty-fold in twenty years.
Since smallcap stocks are generally more volatile than large-cap stocks, a smallcap fund will give you more extreme ups and downs than other types of funds. But if you have a strong stomach and can take the bumps and stay on the ride, you’ll likely do better in small caps.
- Why take a chance on a rookie fund, when you can invest in a veteran fund that’s been around through several seasons and has turned in an all-star performance? A list of funds that have stayed on top over many years can be found in financial magazines such as Barron’s and Forbes. Twice a year, Barron’s publishes a complete roundup of funds, with the details provided by Lipper Analytical, a high-quality research company run by a prominent fund watcher, Michael Lipper. The Wall Street Journal publishes a similar roundup four times a year.
If you want more information about a particular fund, you can get it from Morningstar, a company that tracks thousands of funds and issues a monthly report. Morningstar ranks all these funds for safety, rates their performance, and tells who the manager is and what stocks are in the portfolio. It’s the best onestop source in existence today.
- It doesn’t pay to be a fund jumper. Some investors make a hobby of switching from one fund to another, hopping to the bandwagon of the latest hot performer. This is more trouble than it’s worth. Studies have shown that topranked funds from one year rarely repeat their performance the next. Trying to catch the winner is a fool’s errand in which you are likely to end up with a loser. You’re better off picking a fund with an excellent long-term record and sticking with it.
- In addition to taking the annual expenses out of the shareholders’ assets, some funds charge an entry fee, called a load. These days, the average load is 3 to 4 percent. That means whenever you invest in a fund with a load, you lose 3 to 4 percent of your money right off the bat.
For all the funds that charge an entry fee, there are just as many that don’t. These are the no-loads. As it turns out, the no-loads perform just as well, on average, as the funds with loads. This is one case where paying a cover charge doesn’t necessarily get you into a classier joint.
The longer you stay in a fund, the less important the load becomes. After ten or fifteen years, if the fund does well, you’ll forget you ever paid the 3 or 4 percent load to get into it.
The annual expenses deserve closer attention than the load, because those are taken out of the fund every year. Funds that keep their expenses to a minimum (less than 1 percent) have a built-in advantage over funds that run a bigger tab (2 percent or more). The manager of a high-cost fund is working at a disadvantage. Every year, he or she has to outperform the manager of a low-cost fund by 0.5 to 1.5 percent to produce the same results.
- The vast majority of funds employ managers whose goal it is to beat the socalled market averages. That’s why you’re paying these managers—to pick stocks that do better than the average stock. But fund managers often fail to beat the averages—in some years more than half the funds do worse. One of the reasons they do worse is that fees and expenses are subtracted from a fund’s performance.
Some investors have given up trying to pick a fund that beats the averages, which has proven to be a difficult task. Instead, they choose a fund that is guaranteed to match the average, no matter what. This kind of fund is called an index fund. It doesn’t need a manager. It runs on automatic pilot. It simply buys all the stocks in a particular index and holds on to them.
There is no fuss, no experts to pay, no management fees to speak of, no commissions for getting into and out of different stocks, and no decisions to make. For instance, an S&P 500 Index fund buys all five hundred stocks in the Standard & Poor’s 500 stock index. This S&P 500 Index is a well-known market average, so when you invest in such a fund, you’ll always get an average result, which based on recent performance will be a better result than you’d get in many of the managed funds.
Or, if you decide to invest in a “small cap” fund to take advantage of the big potential payoffs from small companies, you can buy a fund that tracks a smallstock index, such as the Russell 2,000. That way, your money will be spread out among the two thousand stocks in the Russell Index.
Another possibility is to put some of your money into an S&P 500 Index fund to get the gains from the larger companies, and the rest in a small-stock index fund to get the gains from the smaller companies. That way, you’ll never have to read another article about how to pick a winning mutual fund, and you’ll end up doing better than some of the people who study the situation very carefully, and then put themselves into funds that fail to beat the averages.