We love lists. In fact, we have become addicted to them. Every year, magazines and newspapers publish lists of the best and worst performing mutual funds. As investors, we often have an impulsive nature to chase the latest and greatest mutual funds often without doing the proper due diligence before we invest new money or transfer our IRA accounts. What should you ask before investing in a top performing mutual fund from last year?
- Was this a sector play? In any given calendar year, one specific sector of the market may dominate versus other sectors of the market. Just because gold or technology or emerging markets were the top performing sector from the year prior doesn't necessarily mean they will repeat in the following years to come. You should be certain that particular sector matches your long term investment objectives before you invest your money.
- Is it the same manager? Sometimes mutual funds perform very well and then a given mutual fund manager may go on to manage a larger fund or a different fund that needs assistance. They may be replaced by a different manager if this scenario occurs. Thus, you should investigate who the manager will be before you invest your money based upon last year's performance. You may have the same horse, but an entirely different jockey.
- What is the tax treatment? Mutual funds often show their gross returns when ranked in performance lists. Not only do you need to examine fees and costs, but since the mutual fund doesn't know your tax bracket, you need to analyze its overall tax efficiency to compare real net rate of returns. One fund could perform less well in terms of gross rate of return, but be better net to you dependent on your federal and state income tax bracket.
At the end of the day, remember the age old adage… Past performance is not a guarantee of future results.
Written by: Ted Jenkin
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