I recently attended the Morningstar Investment Conference here in Chicago. As usual Morningstar did a great job hosting and staging this large conference.
During one of the breaks I was walking through the exhibit hall with another financial adviser, and I remarked to him that I was amazed at the sheer number of mutual fund providers with booths and the fact that I had never heard of many of these companies.
I’m a financial professional who does this for a living. If I was surprised at the sheer volume of fund company exhibitors, I have to wonder how individual “do it yourself” investors choose from among the available options for their portfolios. Picking the best fund is always tough, but picking a bad one can be even worse for your portfolio. Here are a few tips on how not to choose a mutual fund.
Always assume that a household name in the investment business translates into a good mutual fund. This fallacy has never been more evident than during the recent arbitration award against JP Morgan in connection with its brokers pushing their proprietary high-fee, low performing mutual funds over those of other fund companies.
Rely on the top fund lists that appear in many financial publications (including online here at U.S. News) to make your selections. There is nothing wrong with these lists per say. However, as a fund selection tool they are not very useful. The common disclaimer in the investment world is that “past performance is not an indication of future results.” Last year’s top fund might continue to deliver top performance, or it might not.
Stay away from funds that you’ve never heard of. The 2011 Morningstar Domestic Equity Managers of the Year are from Artisan, a smallish fund shop based in Milwaukee. These managers run the large-, mid-, and small-cap value funds offered by Artisan. While the award was for 2011, this team has done a solid job over the past ten years under difficult market conditions. Unfortunately for new investors (but not for existing shareholders), two of the three funds managed by this team are closed to new investors. Selecting a mutual fund is about research, not about fund ads you might see in the press or on television.
Assume all index funds are created equal. Nothing could be further from the truth. Different funds tracking the same index can vary greatly in their expenses and structure, which will impact their performance. Additionally there may be transaction costs for some funds at various custodians which can eat into your returns, especially for smaller transactions.
Believe the fund companies wouldn’t offer the fund if it wasn’t a solid investment. I’m not saying that any fund company is out to hurt investors, but on the other hand they are in business to make money. New funds are often the result of recent market trends, good or bad. For example, a number of lower risk “absolute return” funds came into being after the market declines of 2008-09 as a result of a general climate of fear among many investors. Time will tell if these funds have merit, or if they were just another asset gathering strategy for the fund companies. Not that a new fund or fund type is bad, but again don’t invest based on the hype fund companies might create around these new offerings. Rather, invest with your goals, risk tolerance, and your overall plan in mind.
Choosing the right mutual fund, individual stock, or ETF is difficult. Make sure you select investments based upon solid research and based upon their fit with your overall portfolio.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. Read more about Roger here.