Mutual Fund Honor Roll ? Buy High, Sell Low by Chasing Performance

Buy high and sell low -- It's not a typo.

Millions of investors guarantee their failure by selecting mutual funds and stocks based on quarterly or annual performance records. Do you chase performance? You might be buying high and selling low!

As the year draws to a close, millions of mutual fund investors begin an annual event to divine next year's winners. Yet most of these individuals rely heavily on a time-honored ? but terribly wrong ? method of evaluating strength. Whether analyzing screening tools from websites, reviewing fund honor rolls in magazines, or using star ratings from fund analysts, normally savvy business people foolishly chase the returns of last year's hottest investments.

This begs the question: Can top performing mutual funds lead two years in a row? Consider a study commissioned by Vanguard Investments Australia and released by Morningstar. The five best performing funds were analyzed from 1994 to 2003. Here are the results:

-- Only 16% of top five funds make it to the following year's list.

-- Top five funds average 15% lower returns the following year.

-- Top five funds barely beat (by 0.3%) the market the following year.

-- 21% of all top five funds ceased to exist within the following 10 years.

Academic studies and market statistics confirm the typical investor acts in direct opposition to the sage advice ? buy low, sell high. It's only after high returns are realized and reported that investors pour money into both stock and bond mutual funds. In fact, Financial Research Corporation compared investor cash flows into mutual funds. Purchases immediately following best-performing quarters exceed 14 times those immediately following their worst-performing quarters. In other words, you are 14 times more likely to buy funds at their highest price than at it's lowest. Buy high and sell low.

Just what kind of damage are they inflicting to their investment returns? DALBAR, Inc., conducted a well-known study called Quantitative Analysis of Investor Behavior. The study confirms investors' poor timing and the resulting financial carnage. Investors buy funds immediately after a rapid price appreciation. This just happens to be right before investment performance wanes. Prices fall soon after and the investors quickly dump their holdings to search for the next hot fund. The resulting returns fail to even beat inflation! When measured over the last nineteen years, the average equity investor earned a meager 2.6% annual return. Compare that to a 3.1% inflation rate and a 12.2% return from the S&P 500 over the exact same time period. Not only did investors fail to keep up with the market, they also lost money to inflation.

We've all seen the warnings on packages of cigarettes. Even smokers understand their relevance; smoking is not a healthy activity. So why do investors not heed warnings about mutual fund returns? You've all seen those statements too. But can you remember what is said? Past performance is not a guarantee or indicator of future results. Research and studies have proven this fact, yet the majority of investors choose to ignore this warning. Yes, it's an easy means of comparing funds. It also happens to be completely irrelevant. Let me evangelize these words for you. Past performance does not predict future results!

Here's how you can stop chasing short term performance and stay focused on your financial goals. Identify appropriate long-term investments by evaluating the following:
(1) Leadership: How does the fund perform relative to similar size and similar style funds?
(2) Tenure: How long have the managers and advisors been at the fund?
(3) Management: Managers well-known, highly-regarded (e.g. remember Peter Lynch)?
(4) Consistency: Are the 3, 5, and 10 year returns all above average?

Finally, measure returns based on your entire portfolio. History shows that no single investment success repeats. Accept the fact every year is different and brings new leaders and laggards. Use an asset allocation strategy to guarantee balance and increase long term returns among all your investments. Invest in a diversified portfolio to meet your financial goals - and stick with it.

Not yet learned your lesson? Consider this: Fourteen mutual funds topped the 2003 charts with returns over 100%. In 2004, these fourteen funds lost over 4% while the S&P 500 gained 3%. Congratulations, chasing performance lost 7% of your money this year.

Tim Olson

TheAssetAdvisor.com
Subscribe to our free newsletter

Mr. Olson is the editor of The Asset Advisor, a financial investment service providing proven strategies for no-load mutual fund investors. He brings 26 years of education and experience from Stanford University, Ernst & Young financial consulting, personal wealth management, and venture capital investing.

---

Good Stock Market Tip; Good Return!

Forget making a profit; instead focus on the income provided... Read More

Box Of Chocolates

Ever have one of those sample boxes of candy? Each... Read More

Outsourcing

It's about time someone spoke the truth concerning outsourcing. The... Read More

The POWER of a Proven Stock Investment Plan

When you invest in the stock market for ever-increasing cash... Read More

Online Investing & Online Stock & Share Trading: Difficulty in Taking Stop Losses in the Market

This is an extract of an article which was first... Read More

Prosperity

It has fallen upon the consumer to make our economy... Read More

Cash

How many people went to a cash position this week?... Read More

China Syndrome

There has been great condemnation recently because China has been... Read More

Hill of Hope

Just about now everyone is confused as to which way... Read More

Buy and Hold Investment Strategy

"Buy and hold" is one of the most heralded investment... Read More

Top 25 Growth Funds

On Monday, November 25, 2000 Investor's Business Daily listed on... Read More

Robert Rodriguez Weathers the Stock Market

Robert Rodriguez likes to buy stocks at their lows. When... Read More

Dont Ask Your Broker

Unfortunately, most of you who are reading my column are... Read More

Long-Term Investment In Todays Market?

The stock market is very unstable at this time going... Read More

Series 7 Exam

What is the Series 7 Exam? If you... Read More

3 Components Needed for Beating the Market

Time to look back2004 is over, now we are in... Read More

Trading Stocks ?Never Forget About A Past Trade

We all know that emotions control every decision that an... Read More

Investment Clubs

Because you don't feel too sure about which stock or... Read More

Buy and Hold: How to Perpetuate Your Investment Losses

A recent cartoon in my daily newspaper showed two guys... Read More

Different Ways of Buying Stocks

Let's say you are interested in this one company. You... Read More

Your Trading Objective: Why is that so Important?

You've decided to try your luck at trading stocks or... Read More

Its Snowing

The Winter Games for the Olympics are coming up soon... Read More

Stock Chart Reading

As an investor you will want to check out any... Read More

Wal-Mart: Discount Store, Discounted Stock?

As GuruFocus updates the stock buys and sells of gurus,... Read More

Parachute Investing

Ever jumped out of an airplane? It's OK if you... Read More

Hedge Funds: the Good, the Bad, and the Ugly

Alfred Winslow Jones started hedge funds in 1949. He was... Read More

Size Counts!

What the heck am I talking about?It is often said... Read More

Option Trading Basics

Options trading can increase the profits you make when trading... Read More

Cash Is A Position

I go to the Money Show every year to visit... Read More

What is Involved in Peak Performance Trading?

There is so much involved in developing peak performance, that... Read More

Analyzing Growth Stocks: An Important Focus For Any Investor

Analyzing growth stocks is an important focus for any investor.... Read More

Option Spread Trading

Spread trading is a technique that can be used to... Read More

Discover the Biggest Trading & Investing Online Mistake

Any online investor / trader seeks an excellent off or... Read More