2 Smart Ways to Lose Money

I recently browsed through SmartMoney magazine's list of its top 100 mutual funds.

Although some that made the cut match up with those I'd recommend, I was taken aback with a majority of the list for two main reasons.

1. Pay to Play
An overwhelming number of the funds -- a full 43% of those recommended -- come with a front-end load that the authors fail to address. A front-end load is a fee that some mutual funds charge you before you're even invested into the fund, taking a percentage of the money you'd like to invest with them.

Of the load funds that made SmartMoney's list, they take an average 5.4% of assets off the top. Seems trivial, but because of the laws of compounding, it adds up to a lot of money over time. Check out this table:

Returns assume the market's average long-term rate of return.

50 years after an investment in the average fund on the SmartMoney list, you would have missed out on nearly 8 times your initial investment.

Now, to be honest, some of the funds on SmartMoney's list are able to be had without the load through your company's 401(k) plan or select IRA plans, but the article failed to mention this fact.

2. Attribute the unattributable
The list of 100 funds purports to be those representing "the highest total returns since the stock market bottomed after the 1987 crash," some 21 years ago.

Unfortunately, the average management tenure for the list of funds is only 12.5 years.

This means that the vast majority (85%) of the uber-impressive track records the funds on the list boast are in no way attributable to the current manager. In fact, mutual fund track records are useless unless they represent the performance of the current manager in charge.

Take, for instance, Columbia Mid-Cap Growth, one of the no-load funds on the list that currently owns stakes in PotashCorp (NYSE:POT), Activision Blizzard (NASDAQ:ATVI), Yum! Brands (NYSE:YUM), and Apollo Group (NASDAQ:APOL). Though its long-term record of beating the market by more than 1.2 percentage points annually over the last 10 years is indeed impressive, the most recent managers came onboard only in 2006, meaning they can't boast about those long-term numbers. And in fact, the performance of the team is less impressive -- over the last year, they're losing to the market by 3 percentage points.

Looking under the hood
Although the rounded number of 100 funds makes for a good cover story, it would be unwise for readers to go out and purchase a bulk of these funds solely on the facts the article presents.

Unfortunately, a good portion of mutual fund recommendations are based on facts similar to these -- running a screen for impressive past performance, with no more in-depth analysis.

However, at Motley Fool Champion Funds, we make a point to do exactly what most other publications fail to do, and that is how we find the market's best funds.

For instance, in our December issue, we looked at the recently reopened Schneider Small-Cap Value -- which owns Take-Two Interactive Software (NASDAQ:TTWO), D.R. Horton (NYSE:DHI), and Huntington Bancshares (NASDAQ:HBAN). Though on the surface its record might woo new money (it has beaten the S&P 500 by 10.5 percentage points over the past 10 years), advisor Amanda Kish pointed out that nearly all of that impressive record is attributable to "an eye-popping 106% return in 2003." It's exactly that kind of insight that could save investors from the pain of a bad fund.

To browse through more of our in-depth fund research and to check out the exclusive list of funds that have passed our rigorous analysis, I invite you to check out our newsletter in a free 30-day trial. Click here for more information.

Fool analyst Adam J. Wiederman owns no shares of the companies mentioned above. Activision Blizzard is a Stock Advisor recommendation. Take-Two Interactive is a Rule Breakers recommendation. The Motley Fool's responsible disclosure policy is here.