Ah, February. If you're anything like me, it's time to dust off the gym shoes, clean out the broom closet, and generally get down to the business you resolved to take care of at the beginning of January, when the new year was as fresh as, uh, a white blanket of snow.
Just as you're counting your calories, reining in your budget after holiday excesses, and color-coding your sock drawer (hey, let's not take things too far), now's a good time to review the investing pitfalls you hope to gracefully sidestep in 2005.
So, without further ado, here are the five common mistakes fund investors make:
1. Buying a fund with high expenses. You've heard it from us before, and that's because there's no getting around it: Steep fund fees will gradually eat away a big chunk of your returns. With plenty of great actively managed funds available that carry expense ratios of 1% or less, there's no reason to pay up for a pricey pick. And beware of funds of all stripes that charge too much for what you can get cheaper elsewhere. Case in point: Vanguard 500 (FUND:VFINX), one of our favorite index funds, carries an expense ratio of just 18 basis points. Meanwhile, the S&P index -- based on offerings from AIM and Atlas, which, like Vanguard 500, hold their biggest positions in household names such as General Electric (NYSE:GE), Microsoft (NASDAQ:MSFT), ExxonMobil (NYSE:XOM), Citigroup (NYSE:C), Wal-Mart (NYSE:WMT), and Pfizer (NYSE:PFE) -- charge .65% and .50%, respectively. Over an investing lifetime, even that relatively small fee difference adds up.
2. Buying a fund with rookie management. Many fund managers can turn in impressive results for a year or two, but it takes a real pro to succeed year after year, in varying market climates. Generally speaking, you want to invest in a fund whose manager has been at the helm for a minimum of five years. Beyond that, buy from a shop that has a substantial research and management staff, so you're not relying on the talents of one or two star managers. Big shops such as Fidelity, T. Rowe Price, and Vanguard employ fleets of analysts and managers, and while there are plenty of fine "boutique" shops out there, these big boys clearly have the resources to get the job done.
3. Buying a fund with high portfolio turnover. Though there are a handful of exceptions, funds that buy and sell their holdings at a rapid-fire rate can spell bad news for shareholders. All that trading ratchets up transaction costs and is often a sign that the managers aren't taking the time to get to know the stocks in their portfolio. What's more, you can wind up with a big capital-gains tax bill if you hold such funds in a taxable account.
Look for turnover rates on the fund company's website or in the fund's most recent annual report. (A fund with a turnover of 100% has an average holding period of just a year; a 25% turnover rate indicates an average four-year holding period.) Opt for funds whose managers keep their eyes on the horizon by buying to hold. (For more on the fund industry's best and brightest managers, check out Champion Funds, the Motley Fool newsletter service that gives you the real deal.)
4. Buying a fad fund. Fund shops want your money, and the shoddy ones will market most anything to get it. In recent years, investors have been urged to buy, among others, principal-protection funds, highly leveraged funds, gold funds, timber funds, and single-country funds -- all bad ideas. Be wary of funds that focus on one part of the economy, one foreign market, or that bet on the economy or the dollar going one way or the other; such calls are way too hard to get right. Investors who poured into hot tech funds in the late 1990s learned this lesson the hard way; most were already getting plenty of exposure to technology stocks through their diversified stock-fund holdings.
5. Buying a fund with stars in your eyes. Fund research firms such as Lipper and Morningstar offer a broad spectrum of valuable fund data, but it's important to look past simple indicators, such as Morningstar's star rating, when choosing a fund. The star rating is purely backwards- looking, and doesn't account for such things as management tenure and attitudes toward shareholders. Simply buying a five-star fund won't guarantee a smooth and profitable investing experience if you haven't done some deeper digging on the fund.
One last bit of advice: If you happen to find any offenders in your portfolio, weigh the tax consequences of selling and, if practical, don't wait until March to kick them out. In the meantime, here's hoping for minimal investing regrets when 2006 rolls around!
Fool contributor Josie Raney is a shareholder of Vanguard 500. The Motley Fool is investors writing for investors.
