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September 24, 2000
Many investors make the mistake of jumping from mutual fund to mutual fund -- searching for the next hottest fund. Every time their mutual fund has a bad year or their friends rave about another "hot mutual fund tip", these so called long-term investors abandon ship and move on to the next fund -- many times missing out on significant gains. The key to successful mutual fund investing is to buy a top-performing diversified growth fund and stick with it! When you invest in a solid mutual fund for ten to fifteen years and roll your dividends and gains back into your account you'll benefit from the tremendous power of compounding -- allowing larger sums of money to work for you. As with all things in life, your mutual fund will have some "down" years, but a well-managed, well-diversified growth fund will recover over time. Take for example S & P 500 Index funds. This year they are barely breaking even (through September 2000), but the five-year and ten-year annualized return for most Index funds is 25% and 18%, respectively. So if you jump out now while the fund is down, you'll miss out on future returns. However, if you sit tight through the inevitable "ups" and "downs" of the stock market, you'll be handsomely rewarded for your long-term commitment.
If you are invested in any specialized funds such as a small-cap or biotech mutual fund, there are certain situations where switching funds is a smart move.
1. The Fund Manager Changes - A mutual fund is a professionally managed portfolio of investments where the decision to buy or sell an investment is made by the fund manager. Therefore, whether you make or lose money is in the hands of the fund manager. A top-performing mutual fund may lose its "magic" if the fund manager leaves. Always read your quarterly and annual mutual fund reports for any changes in management. Although a new fund manager does not always lead to decreased performance, you should carefully watch the results for any signs of weakness.
2. The Mutual Fund Philosophy Changes - Although a rare occurrence, some mutual funds may decide to change their investing strategy. For example a conservative mutual fund looking for higher returns may decide to invest in high-risk derivatives. This approach may not fit into your risk profile. If you are not comfortable with the added volatility you may want to switch to a more conservative fund. Changes in investing strategies are always mentioned in the quarterly or annual mutual fund reports.
3. The Specialized Fund is Either Under Performing the Market or Does Not Fit Your Risk Profile - Investing in a specialized mutual fund is riskier than investing in a well-diversified fund such as an Index fund and requires much more research and upkeep. You may find that the sector you selected, such as the Internet, maybe too volatile for you because your heart pounds every time you check the price. This may not be the fund for you. You may also be in a sector that consistently under performs the S & P 500 Index. Surprisingly, only 20% of all funds outperform the S & P 500 Index. So why go through the brain damage just invest in an Index fund.
4. Reduced Diversity - If you are also investing in individual stocks, you may discover that the mutual fund you selected is also heavily invested in the same stocks. Investing in a mutual fund where the top ten holdings looks like your own stock account may increase your risk. I believe a good strategy is to use mutual funds as a way to diversify your investments outside of your individual stocks. Although we all hope to pick winning stocks every time, the reality is you'll pick some good ones and you'll pick some bad ones. A well-diversified, well-managed mutual fund can help balance out your risk and can help increase your overall returns if by chance you made any bad individual stock choices. Review the mutual fund's top ten holdings periodically to evaluate the risk of any duplicate investments.
If you take the time in the beginning to carefully select the right mutual fund for you (see related article - Selecting the Right Mutual Fund for You) then all you need to do is sit tight, relax, enjoy life and let the magic of compounding work for you.
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