Choices, Choices (Part 1)

How do you choose?

Many people have a hard time figuring out how to pick stocks and bonds, so they use mutual funds where they pay an expert. But how do you pick which mutual fund? There are about 8000 mutual funds, and they all say that past performance does not predict future results.

Do you go with the hot fund of the moment? Lots of folks do that, and it almost never works. Hot funds often stand out because they invest in a small niche area. Their fund does well and they get written up as the new, new thing.

Being featured in the press attracts billions, which they almost never refuse–it increases their fees. But it’s impossible to put all that money to work in their sector without raising prices and impacting future performance. Buying stocks or bonds at higher prices means future results can’t be as good and performance suffers. After seeing performance lag the investors that committed the new money lose patience and pull out, forcing the fund to sell. That causes prices in the sector to collapse, and the fund darling becomes a dog.

So chasing performance is self-defeating. Do you just buy losers? That seems stupid—they may be losers because they’re incompetent. How about “winning funds in a losing sector?” Nice idea, but increasingly complex strategies have their own pitfalls.

It’s no wonder many people throw up their hands an just buy CDs. But giving up is a bad approach, too. The truth is out there; investors just need to find it.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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