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. Comedy Central star 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 prior 15 months, Americans suffered $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 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.

But 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. 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 Fidelity Dividend Growth (FDGFX) as an illustration. The vital stats:

Source: Morningstar.

Fidelity Dividend Growth has low fees and no loads, but earns only two stars from Morningstar and has a poor track record of performance. At least, its former manager did. See, the manager has been on the job just six months (since September 2008).

Which is to say: The lousy track record isn't his fault, just as stellar performance figures wouldn't be to his credit. That's no knock on Lawrence Rakers; he's a longtime Fidelity veteran who has impressive records running other Fido funds.

While he's had success elsewhere, until he's been on the job at Fidelity Dividend Growth a little longer -- and the performance numbers over one, three, and possibly even five years fully reflect his picks and not his predecessor's -- my money's staying on the sidelines.

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.

This article was first published Nov. 11, 2008. It has been updated.

Brian Richards is frightened by the look in Mr. Donut-Head-Man's eyes. Brian doesn't own shares of any security mentioned. National Oilwell is a Motley Fool Stock Advisor recommendation. The Motley Fool is investors writing for investors.