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Friday, November 08, 2013

How NOT to pick a mutual fund

The Wall Street Journal had an excellent article recently about how NOT to pick a mutual fund:

1. Focusing too much on past returns.  Separating luck from skill is extremely difficult, so you don't know whether the fund with excellent past returns is going to do well going forward or blow up.

2. Not understanding how the money is invested.  The process of investing generates results, so you need to focus on the cause, not the effect.  If you don't understand the process, there's no proof it works, or it's too narrowly focused on what has worked well recently, stay away.

3. Diversification in name only.  Diversification is only worthwhile is if it's truly diversified and if it's very low cost.  If diversified means 5 different mutual funds focused on gold, you're toast.  If it means you buy 5 full cost (1% annual fees) mutual funds that cover large, small, value, growth, bonds, etc., then you're throwing your money away.

4. Chasing headlines.  If you buy something because it's in the headlines of the news, then you'll almost certainly get crushed over time. The smart money has already bought and sold before it's in the headlines.

5. Buying on ratings alone.  If you focus on the ratings/stars that most mutual funds advertise (there's a reason why they are advertising that fund now, and not at other times), then you'll likely get bad results.  Most returns aren't persistent (they don't continue in the future), so if you buy what has done well recently, you'll probably lose money.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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