Mutual funds used to offer a way to simplify your investing. Instead of choosing from a multitude of stocks, you could choose one of a handful of funds. Today, however, Canadian mutual funds outnumber the sort of established, dividend-paying Canadian stocks that most fund managers want in their portfolios.
How to buy mutual funds: some key points to keep in mind
• Avoid extraordinary short-term performance. If a fund’s value soars 50 per cent in a year when the market as a whole rises five per cent, it may mean the fund manager stumbled on an extraordinary opportunity that escaped the notice of the rest of the industry. Similar opportunities will be hard to find. This may lead the top performing mutual funds manager to take extraordinary risks, if he hasn’t already done so. Risks like that eventually backfire. Unlike the fund’s early investors, new buyers won’t have that initial 50-per-cent profit as a cushion. Then too, extraordinary short-term performance leads to a second problem — see below.
• Avoid funds that have undergone a huge expansion of their assets. Many mutual fund investors swarm to the top performers. If the manager of a $25 million fund earns 50 per cent for his investors one year in, say, biotech or junior oil and gas stocks, he may find he has $300 million to invest the following year. By then, the stock group of the top performing mutual funds that gave him the 50 per cent yield may be at a peak. He may still feel pressured to put most of the $300 million in it — he’ll have to buy at the top, in other words.
If stocks in the hot group go into a swoon and drag down the value of the fund, investors who flocked to it may leave just as quickly. This forces the manager to sell at the bottom.
• Avoid ‘balanced’ funds. Funds that invest in bonds charge fees of perhaps one to two per cent of assets a year; stock funds cost two to three per cent. Balanced funds own stocks and bonds, and they too may charge you two to three per cent. But you needn’t pay fees (nor sales commissions) on the fixed-return portion of your portfolio if you buy GICs with terms staggered between one and five years.