You can't open a newspaper or read a
magazine without seeing ads promoting the stellar
performance of "hot" mutual funds. But past
performance is not as important as you may think,
especially the short-term performance of relatively new
or small funds. As with any investment, a fund's past
performance is no guarantee of its future success. Over
the long-term, the success (or failure) of your
investment in a fund also will depend on factors such as:
- the fund's sales charges, fees, and expenses;
- the taxes you may have to pay when you receive a
distribution;
- the age and size of the fund;
- the fund's risks and volatility; and
- recent changes in the fund's operations.
So, look at more than the fund's past performance when
making your investment decisions. Read the fund's
prospectus and shareholder reports, and consider these
tips:
| Scrutinize
the fund's fees and expenses. |
| Funds charge investors fees and
expenses. A fund with high costs must perform
better than a low-cost fund to generate the same
returns for you. Even small differences in fees
can translate into large differences in returns
over time. For example, if you invested $10,000
in a fund that produced a 10% annual return
before expenses and had annual operating expenses
of 1.5%, then after 20 years you would have
roughly $49,725. But if the fund had expenses of
only 0.5%, then you would end up with $60,858
– an 18% difference. It takes only minutes
to use the SEC's
Mutual Fund Cost Calculator to compute
how the costs of different mutual funds add up
over time and eat into your returns. |
| Know
how the fund impacts your tax bill. |
| The law requires a fund to make a
capital gains distribution to shareholders if it
sells a security for a profit that can't be
offset by a loss. If you receive a capital gains
distribution, you will likely owe taxes on it
– even if the fund has had a negative return
since you invested in it. For this reason, you
should call the fund to find out when it makes
distributions so you won't pay more than your
fair share of taxes. Some funds post that
information on their websites. |
| Consider
the age and size of the fund. |
| Before investing in a fund, read
the prospectus to find out how long the fund has
been operating and the size of the fund. Newly
created or small funds sometimes have excellent
short-term performance records. Because these
funds may invest in only a small number of
stocks, a few successful stocks can have a large
impact on their performance. But as these funds
grow larger and increase the number of stocks
they own, each stock has less impact on
performance. This may make it more difficult to
sustain initial results. You can get a better
picture of a fund's performance by looking at how
the fund has performed over longer periods and
how it has weathered the ups and downs of the
market. |
| Think
about the volatility of the fund. |
| While past performance does not
necessarily predict future returns, it can
tell you how volatile a fund has been. Generally,
the more volatile a fund, the higher the
investment risk. If you'll need your money to
meet a financial goal in one year, you probably
can't afford the risk of investing in a fund with
a volatile history because you will not have
enough time to ride out any declines in the stock
market. Read the fund's prospectus and annual
report, and compare its year-to-year performance
figures. These figures can help tell you whether
the fund earned most of its returns in a few
small bursts or whether its returns came in a
steadier stream. For example, over ten years, two
funds may have gained 12% per year on average,
but they may have taken drastically different
routes to get there. One might have had a few
years of spectacular performance and a few years
of low (or negative) returns, while the
performance of the other may have been much
steadier from year to year. |
| Factor
in the risks the fund takes to achieve its
returns. |
| Read the fund's prospectus and
shareholder reports to learn about its investment
strategy. Funds with higher rates of return may
take risks that are beyond your comfort level and
are inconsistent with your financial goals. For
example, a fund that invests primarily in stocks
whose prices may change quickly – like
initial public offerings or high-tech stocks
– will usually be riskier than other types
of funds. But remember that all funds carry some
level of risk. Just because a fund invests in
government or corporate bonds does not mean it
does not have significant risk. For example, the
fund's investments could be very sensitive to
interest rate changes. Thinking about your
long-term investment strategies and tolerance for
risk can help you decide what type of fund is
best suited for you. |
| Ask
about recent changes in the fund's operations. |
| Has the fund's investment adviser
or investment strategy changed recently? Has the
fund merged with another fund? Operational
changes such as these can affect future fund
performance. For instance, the investment adviser
or portfolio manager who generated the fund's
successful performance may no longer be managing
the fund. |
| Check
the types of services offered and fees charged by
the fund. |
| Read the fund's prospectus to
learn what services it provides to shareholders.
Some funds provide special services, such as
toll-free telephone numbers, check-writing
privileges, and automatic investment programs.
You should find out how easily you can buy and
sell shares and whether the fund charges a fee
for buying and selling shares. You can expect
funds that require extra work by their managers,
such as international funds, to have higher
costs. |
| Assess
how the fund will impact the diversification of
your portfolio. |
| Generally, the success of your
investments over time will depend largely on how
much money you have invested in each of the major
asset classes – stocks, bonds, and cash
– rather than on the particular securities
you hold. When choosing a mutual fund, you should
consider how your interest in that fund affects
the overall diversification of your investment
portfolio. Maintaining a diversified and balanced
portfolio is key to maintaining an acceptable
level of risk. |
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