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How Not to Buy Growth

By John Rosevear - Updated Apr 5, 2017 at 7:54PM

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There's a right way -- and a money-losing way.

Everybody loves a growth stock. If you buy the right ones at the right time, it's not uncommon to double or triple your original investment -- or more, if you hold them long enough.

Stories of "10-baggers" and even bigger gainers are what drew many of us to the stock market in the first place -- often with a tinge of wistfulness. If' we'd only bought Apple (NASDAQ:AAPL) at $20 (and since we're fantasizing, let's assume we sold at $200 earlier this year), we'd be rich now, so let's find the next Apple and get in early!

Of course, some folks hear that story -- and instead of looking for the next 10-bagger, they rush in and buy Apple at $200, hoping the growth trajectory won't change. That's a classic mistake -- the tendency of the "average" investor to buy high and sell low is one of Wall Street's most-cherished stereotypes and a big part of how the investment advisory industry tries to justify its fees.

Like many stereotypes, there's a lot of truth to it -- research has shown that humans do have deeply ingrained tendencies to chase performance and flee losses. Fortunately, most investors learn to overcome those tendencies and seek to buy promising stocks before they take off.

So why do even savvy stock investors make the same mistake with mutual funds?

Don't you read the fine print?
My first job in the investment business involved writing "disclosure" -- the legal gobbledygook that appears at the bottom of mutual fund ads. I must have written the words "Past performance is no guarantee of future results" thousands of times. Those words appear every time a fund company says anything about its investment performance -- they're required by the SEC.

And yet, how do we select mutual funds? Entire businesses are devoted to helping customers with that, such as Morningstar (NASDAQ:MORN) and its fund star ratings, which are based on how the fund's past performance compares with that of its peers. We look at average annual total returns, which tell us -- again -- how the fund did in the past. We chase performance!

Past performance is a big thing, but not the only thing
Hyperbole aside, there are good reasons to consider past performance when selecting funds. When you buy a fund, you're really buying a manager's services, and the manager's past performance through a variety of market conditions is extremely relevant information. No question.

But what some people overlook when evaluating funds is this: You're also buying an investment objective -- a specific investment focus. How much of that hot fund's performance over the last few years was due to its management, and how much was due to its objective -- being in the right corner of the market at the right time?

Decide on your focus, then hire a manager
Put another way, the best large-cap growth manager in the world isn't going to beat the market during periods where large-cap growth as a category is way out of favor. Or as Champion Funds advisor Amanda Kish notes in the new issue of that newsletter, assets have rushed in recent months into "bear market" funds that go up when the market goes down -- because their performance in recent markets has been very strong. But is there reason to think they'll be as strong next year?

Only if you think the market is going to fall another 50%.

A focus -- and a fund -- for right now
So what will be hot next? If you like growth stocks -- and who doesn't? -- there's a strong case to be made for large-cap growth. Think about it in the context of the current economy: Larger names like biotech giant Genentech (NYSE:DNA) and Chinese telecom leader China Mobile (NYSE:CHL) just feel safer right now than smaller, more thinly funded companies in the same spaces -- but still offer exposure to areas that are primed for significant long-term growth.

If you like that thesis, you'll especially like the large-cap growth fund that Amanda recommends in the new issue of Champion Funds. It's a relatively new -- and small -- fund with a proven veteran management team, an uncommon combination of wisdom and flexibility. With big positions in names like database monster Oracle (NASDAQ:ORCL), biotech star Amgen (NASDAQ:AMGN), and scrappy Southwest Airlines (NYSE:LUV) and a lower expense ratio than many competitors, it looks like a solid bet for 2009 and beyond.

What's the fund? I don't want to spoil the surprise -- check out Amanda's full article in the new issue of Champion Funds for all the details. Not a member? No worries -- a free trial gives you complete access for 30 days, with no obligation to subscribe.

Fool contributor John Rosevear owns shares of Apple. Morningstar and Apple are Motley Fool Stock Advisor picks. The Fool owns shares of Morningstar. Try any of our Foolish newsletters free for 30 days. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
$165.19 (0.20%) $0.32
Southwest Airlines Co. Stock Quote
Southwest Airlines Co.
$38.21 (-2.23%) $0.87
Oracle Corporation Stock Quote
Oracle Corporation
$76.89 (0.56%) $0.42
China Mobile Limited Stock Quote
China Mobile Limited
Amgen Inc. Stock Quote
Amgen Inc.
$248.88 (0.64%) $1.58
Morningstar, Inc. Stock Quote
Morningstar, Inc.
$246.55 (-1.06%) $-2.64

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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