So how do you pick a mutual fund?
The mutual fund industry has made a business out of selling this diversification and manager expertise. There are now almost 90 million investors in funds worth over $10 trillion in the market. What are some of the most common pitfalls of using mutual funds?
We saw last week why picking a hot fund is self-defeating: hot funds attract hot money that overheats their sectors and leads to a boom/bust cycle. But investing in an un-hot sector has its problems as well. Often those turn out to be specialized niches of the investment landscape—such as emerging market funds, junk bond funds, or mico-cap stocks. Prudent investors are wise to limit how much they put into any one of these areas.
Eventually, however, by putting a little money into lots of different funds, you end up owning the whole market. That’s okay, but active managers are going to charge active management fees, so after fees you’re probably not going to do as well as the market. You’d be better off in a total market index fund.
So hot funds and the grab bag approach are out. But what does work? An old Russian proverb: trust, but verify.
Douglas R. Tengdin, CFA
Chief Investment Officer
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