Boomer Money
  • About
  • Fine Print and Privacy
  • Glossary – Definition of Financial Terms

How Not to Pick a Mutual Fund.

December 5, 2016 by Linda Vaughn

Boomer, today’s post is a cautionary tale on what to avoid if you want your money to last longer than you do.  Consider my early forays into buying mutual funds as Exhibit A.  Exhibit A is how not to do it.  Exhibit A was me.

And, as we’ll discuss, how I did it is exactly how mutual funds are marketed and sold today. 

In my single-minded (i.e., desperate) focus to reach financial independence, I made mistakes.  Luckily, I had plenty of earning years left to recover.  If I’d made these mistakes today, there wouldn’t be enough time to make back the money I’d lost.  Don’t make these mistakes!

Exhibit A:  How it went down.

It was a mutual fund called PBHG.  The year was 2000.

Highly respected Lipper Analytic Services (now Reuters) had rated it the top growth stock fund for the past decade!  

Yes, Boomer.  The past decade!  

It had a 3-year annualized return of 30%.

With returns like 30%, I’d be doubling my money in 2.5 years.(See the Rule of 72 for calculating how often your investments double.)

  What could go wrong?

Plenty.

The instant I bought it, it tanked.  It lost 34% in 2001 and 30% in 2002 before I sold.  It remained a loser until it eventually went out of business.  Its sordid history is told here for all the world to see.

The folly of chasing a mutual fund’s investment returns.

Boomer, what I did is called “chasing investment returns” or “chasing performance.”

I looked at a bunch of mutual funds, just like the ones the salesman, financial adviser, or your HR rep shows you.  I then picked the one with the highest investment returns.  That’s called chasing performance.

It sounds counter-intuitive, and it is. 

Hear me well, Boomer, that’s not how you pick a mutual fund.

Again with feeling.  That’s not how you pick a mutual fund.

If it were that easy, everybody would be rich.

Why do mutual fund companies always say past performance is no guarantee of future results?

They say it because it’s true!

It’s true because investing takes place in an overall economic business cycle, which consists of four phases:

  • expansion,
  • peak,
  • contraction, and
  • trough.

It is not uncommon for a fund’s performance to excel in one phase of an economic business cycle, but not another.  Further, a business cycle can last anywhere from 2 to 15 years.  We don’t generally know where we are in the business cycle until about 6 months after the fact.  That’s when the National Bureau of Economic Research lets us know! 

Will the fund’s performance rise or fall as the business cycle progresses?  Who knows. 

Add to this the uncertainty that at any time—without informing you, dear Boomer—a new fund manager can be brought in to replace the old one.  The new one may not be as good as the old one.   

Chasing returns:  the road to heartbreak.

You see the problem?  You now see how my torrid affair with PBHG ended in heartbreak.  I bought PBHG at the tail-end of a 10-year economic expansion, the longest in U.S. history.  I thought the fund would continue to perform as it had been for-the-past-10-years.  But no.  Once the business cycle tanked, so did the fund—right out of business. 

Sigh.

Does this mean don’t invest in mutual funds or the market?

No!

Unless you:

  • have at least twice the cash you think you’ll need for retirement,
  • are an A-list celebrity, or
  • work on Wall Street

you must invest some of your money in mutual funds if you don’t want to outlive your funds.  Stock mutual funds are an excellent hedge against inflation.  (Every bit as good, and most say better, than real estate.)  But you don’t pick a fund by chasing investment returns. You don’t do it by chasing performance.

You do it by:

  • looking long and hard at index funds;
  • realizing that fees kill investment returns; and
  • using online calculators like those at FINRA to easily choose low cost funds and boost your investment returns. 

We’ll talk about all of these in future posts.  

In the meantime, Boomer, resist the dazzle.  You don’t want to be Exhibit A.

Hi there! If this post helped you, could you consider sharing it on Facebook, LinkedIn, or Twitter? It's not easy being a small blog in a sea of a million blogs!! Share on FacebookShare on TwitterShare on Linkedin
Posted in: Investing Basics Tagged: chasing investment returns, chasing performance, mutual funds
← How to Make Money in Residential Real Estate: Or Not
Index Funds: Loved by the Best! →

Categories

  • A Boomer Manifesto (1)
  • Annuity series (6)
  • Asset Allocation Series (8)
  • Book Reviews (12)
  • Boomer Reinvention (11)
  • Don't Outlive Your Money Series (10)
  • Investing Basics (7)
  • Long-Term Care Series (14)
  • Managing Retirement Money and Accounts (5)
  • Money Thoughts (5)
  • Real Estate Series (3)
  • Social Security (1)
  • Uncategorized (4)

Recent Posts

  • Resilience: Your Most Valuable Retirement Skill. Here’s How to Build It. (Book Review.)
  • To Not Outlive Your Money, You’ve Got to Know Where it Goes
  • How to Stop the Sting of Retirement’s Out-of-Pocket Medical Bills. (Or at Least Reduce the Pain.)
  • My Encounters in the Wild with Long-Term Care Sales Agents
  • The Three Factors Affecting Your Long-Term Care Insurance Costs
  • How to Evaluate a Long-Term Care Policy. (Hint! Know These Three Things.)
  • Staring Down Your Long-Term Care Odds—Much Better News Than You Thought.
  • Getting Medicaid to (Maybe) Pay for Your Nursing Home Costs: The (Updated) Guide.
  • That Time a $2,000 Price Tag Cost Me $60K.

Archives

  • March 2023
  • January 2023
  • December 2022
  • November 2022
  • July 2022
  • October 2021
  • August 2021
  • July 2021
  • April 2021
  • March 2021
  • February 2021
  • January 2021
  • December 2020
  • November 2020
  • October 2020
  • September 2020
  • August 2020
  • July 2020
  • June 2020
  • May 2020
  • April 2020
  • March 2020
  • February 2020
  • January 2020
  • December 2019
  • November 2019
  • October 2019
  • September 2019
  • August 2019
  • July 2019
  • June 2019
  • April 2019
  • March 2019
  • February 2019
  • January 2019
  • December 2018
  • October 2018
  • September 2018
  • August 2018
  • July 2018
  • June 2018
  • April 2018
  • March 2018
  • February 2018
  • September 2017
  • May 2017
  • April 2017
  • March 2017
  • February 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016

Copyright © 2023 Boomer Money... and More.

Lifestyle WordPress Theme by themehit.com