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

The past 16 months have been as painful for my psyche as they have been for my portfolio. Last fall, Stephen Colbert summed up my feelings about the recent market movements quite well. He said watching the Dow was "like a roller coaster, only you vomit your money."

Last fall and winter were brutal, plain and simple. And even though the market has rallied since March, I still believe it's a good time to be a prospective investor ...

Just 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 suggest 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, in his superb book The Investor's Dilemma, outlined 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. Just one in four investors researched the person actually managing the money.

What's striking is that nearly one in two investors (45%) 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, 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 nearly 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 Growth & Income (FGRIX) as an illustration. The vital stats:

Fidelity Growth & Income

Vital Stats

Expense Ratio

0.78%

Load Fees

None

12b-1 Fees

None

Annual Turnover

122%

5-Year Annualized Return

(7.1%) (near the bottom of its category)

Major Holdings

ExxonMobil (NYSE: XOM  )
Applied Materials (Nasdaq: AMAT  )
Pfizer (NYSE: PFE  )
Wal-Mart (NYSE: WMT  )
Microsoft (Nasdaq: MSFT  )
Halliburton (NYSE: HAL  )
Goldman Sachs (NYSE: GS  )

Source: Morningstar.

Fidelity Growth & Income has low fees and no loads, but has only one star from Morningstar and a poor track record of performance. At least, its former manager did. See, the current manager has been on the job for less than a year.

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 James Catudal; he's a Fidelity veteran who has capably run other Fido funds.

But until he's been on the job at Fidelity Growth & Income 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 two things you'll want to look for are a manager's tenure and his or her track record during that tenure. Motley Fool Rule Your Retirement advisor Robert Brokamp likes to see at least five 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 that 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 recommended funds and model portfolio picks at Rule Your Retirement. We offer a free trial without obligation to subscribe.

Already a member of Rule Your Retirement? Log in at the top of this page.

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 owns shares of Microsoft, which along with Pfizer and Wal-Mart is a Motley Fool Inside Value choice. Motley Fool Options has recommended diagonal calls on Microsoft. 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 January 04, 2010, at 2:31 PM, Ironbob wrote:

    Oy vey. Look, the one thing a mutual fund can do better than anyone or anything out there is lose your money. They've proven it to whoever is reading this time and time again. If you have a 401K, you can use some of the cash to manage your own stock portfolio.

    I manage 25% of the cash in my 401K. My return for 2009 was 32%. Does anyone really believe that the majority of mutual funds received that kind of return? Doubtful. I paid a commission for my purchases and plan on holding them for years.

    I've made sure that my mix was 85% middle to high yield dividend with the remaining 15% going into medium to high risk. In order for this to work though, you must have a program that will reinvest your dividends at little or no cost. Be sure to check prior to setting it up.

    At the present time, it will be next to impossible to get 32% return for 2010 but you can still set yourself up for dividend payouts that are meaningful if you play your cards right.

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Brian Richards
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Now: I work on global strategy for The Motley Fool with a focus on Canada, Europe, and South America. Former: Managing Editor of Fool.com. The longer version: http://www.linkedin.com/pub/brian-richards/31/164/461/.

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