Now's a Great Time to Invest -- So Don't Blow It

These past months have been as painful for my psyche as they have been for my portfolio. Stephen Colbert summed up my feelings about the recent market movements quite well: He said watching the Dow "is like a roller coaster, only you vomit your money."

Despite my queasiness, I believe today's prices present an opportunity for investors focused on the long term -- and I'm not alone. Investing legends Warren Buffett, Marty Whitman, and Chuck Royce have all gone on record to say something similar.

So while it's been painful to be a current investor -- The Wall Street Journal reported in October that over the past 15 months, Americans lost $2 trillion in paper losses in their workplace retirement plans -- it's a great time to be a prospective investor.

But don't do this
Through 401(k)s, IRAs, or taxable accounts, nearly 90 million Americans own mutual funds. But if you're thinking about adding even a penny to a new fund, hold that thought ... for now.

Why? Data suggests that the majority of mutual fund investors may be going about choosing funds in a way that could undermine their long-term wealth.

Author and professor Louis Lowenstein, writing in his superb new book The Investor's Dilemma, outlines the sad state of affairs: "[W]hen one considers the fierce attention that consumers devote to the cost, and to the quality, of their weekly groceries or, say, to the purchase of a new washer and dryer, their nonchalance when it comes to mutual fund cost and quality is remarkable."

Nonchalance, you say? OK, readers of this website are undoubtedly better informed than the hordes of fund investors in our country. But even those in the know may be hitching their life savings to funds that -- apologies to Wayne and Garth -- aren't worthy.

First, the good news
According to the Investment Company Institute, investors look at two main characteristics when they're researching a mutual fund -- fees and performance: "Investors usually review a wide range of information before purchasing fund shares outside these plans. Most often, investors want to know about a fund's fees and expenses, its historical performance, and its associated risks prior to purchasing shares."

That's the good news, because focusing on those data points (which takes maybe 10 minutes per fund) will get you pretty far.

But when my colleague Tim Hanson and I looked back at the 10 best-performing mutual funds of the past decade, we found two factors that mattered most: low expenses/fees and long-tenured managers.

And according to the Investment Company Institute report cited above, investors aren't that interested in the fund manager. That's a big mistake.

And now the bad news
Incredibly, the ICI found that of the 19 characteristics fund investors looked for while researching prospective investments, "information about the fund's portfolio manager" ranked 17th on the list. Just one in four investors researched the person actually managing the money.

What's striking is that nearly one in two (45%) investors wanted information about the fund company, which is a little bit like assuming that because MI6 sent them, 006 and 008 are just as good as 007.

In The Investor's Dilemma, Lowenstein explains why this tendency plays to the desires of the fund companies: "The chief economist of the Investment Company Institute ... recently explained that team management is popular because fund complexes have been creating marketing and brand identification more around the fund and the fund complex than around the manager."

The fund companies have very good reasons for this. The fewer star managers they have, the less they're tied to the whimsy, ego, and demands of said star managers. They want to establish a brand, not a personality. It's a sound business strategy for them -- but it's much less useful for us consumers.

Take Fidelity Magellan (FMAGX), for example. What's probably the most famous actively managed mutual fund in the world became so because of Peter Lynch's supreme talent in picking stocks. The fund gained 30% per year during Lynch's 13-year tenure from 1977 to 1990.

But in 1991, after Lynch had left Magellan, what would you rather have known: Whether Peter Lynch was still in charge or whether Magellan was still a Fidelity fund?

Let's look under the hood
OK, enough with the hypotheticals. Let's look at the Janus Orion (JORNX) as an illustration. The vital stats are great:

Janus Orion

Vital Stats

Expense Ratio

0.92%

Load Fees?

None

12b-1 Fees?

None

Turnover

24%

5-Year Annualized Return

3.1% (5th in category)

Major Holdings

CVS Caremark (NYSE: CVS  )

Celgene (Nasdaq: CELG  )

Goldman Sachs (NYSE: GS  )

PotashCorp (NYSE: POT  )

Research In Motion (Nasdaq: RIMM  )

American Express (NYSE: AXP  )

United Parcel Service (NYSE: UPS  )

Source: Morningstar.

Janus Orion has low fees and no loads. The low turnover means that the manager sticks to his strategic guns, which has a nice side effect of keeping a lid on your tax bill. Toss in a four-star (out of five) Morningstar rating and Orion is sitting pretty.

There's just one thing: The manager has been on the job less than 12 months (since January 2008). That's no knock on John Eisinger; he appears to be a quite capable skipper. But until he's been on the job a little longer -- and the performance numbers reflect his picks and not his predecessor's -- my money's staying out.

What you can do about this right now
More than anything, when you invest in a fund, you're investing with a fund manager. Never lose sight of that as you entrust (via retirement accounts) ever-growing sums of money to mutual funds.

The takeaways, then, are as follows:

  1. Alongside fees and expenses, research and study the fund manager.
  2. The most important data point about the manager is his or her tenure at the fund. Motley Fool Champion Funds advisor Amanda Kish likes to see seven years at the same fund; although not a firm rule, that's a good starting point.
  3. Look at the fund's performance across the manager's tenure to get a sense of how he or she performed in both good markets and bad. Consistency of style is important.
  4. Read the fund's Statement of Additional Information (SAI) to see how much of the manager's own money is invested in the fund. If the manager eats his or her own cooking, then the manager's savings are on the line alongside yours -- and that's a good sign.

Here at The Motley Fool, long-term management is one of the key things we look for in a good mutual fund. Of course, if you want to see the hand-picked funds that have received the Fool stamp of approval, click here to check out our entire lineup of Champion Funds recommendations. We offer a free trial without obligation to subscribe.

Brian Richards is frightened by the look in Mr. Donut-Head-Man's eyes. Brian does not own shares of any security mentioned; the Fool owns shares of American Express. American Express is a Motley Fool Inside Value recommendation. United Parcel Service is an Income Investor selection. Morningstar is a Stock Advisor recommendation, and the Fool owns shares of it. The Motley Fool is investors writing for investors.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 11, 2008, at 4:44 PM, vernmama wrote:

    Great article. However, as one who has a sizable portion of those "$2 trillion paper losses", are you suggesting realizing some of those losses in order to capitalize on some of the bargains available?

  • Report this Comment On November 14, 2008, at 11:37 PM, MasterIoda wrote:

    The funny thing about this article is that it fits perfectly Berkshire-Hathaway, like a well tailored shirt ! While not a mutual fund per se, it is a holding of top notch companies that have been carefully researched and studied by probably the best and most senior manager of all who invests his own money into the venture. As for his track record over the past 10 years or so, how many fund managers worldwide have outpaced him constantly over the same period ? Not many I guess...

  • Report this Comment On November 15, 2008, at 11:30 AM, cruiser9806 wrote:

    Yes, jump with all your hard earned cash into the market. Especially buy financials. Prepare for hyperinflation with all gears roaring. Can anyone of you imagine three or four trillion dollars hitting the market at once? That's whats going to happen eventually!!! And i got a bridge in Brooklyn for sale...dirt cheap :)

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