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Some caution signals for fund investors

Richard Loth

While investing in mutual funds requires some know-how, it is not rocket science. If you need some help, be sure that the helper is putting your interests first and that any fees involved are reasonable. In addition, use some common sense and watch out for these caution signals: Stay away from the recommendations coming from the ubiquitous lists of the top performing funds. These are usually found in personal finance magazines and in the advertising from some of the fund companies that tout their own wares.Just be aware that research studies have shown that this years top performers are like shooting stars. They get a lot of attention in the financial press, but with few exceptions burn out very fast, never to be heard of again. Select and/or stick with those funds with above-average, steady performance records over an extended period of time. My preference is to see consistently good returns over a 10-year period. I dont like sales charges, whether theyre front-end, back-end or continuing (12b-1). However, if you have no other choice, remember that these costs affect (i.e., reduce) your investment returns. Ive found that many investors fail to remember that, with the exception of 12b-1 fees, sales charges are not included in a funds expense ratio. Many investors are drawn to sector funds that are performing well and getting attention in the financial media. The problem with jumping on a sector funds bandwagon is timing. Generally, investors timing is awful. Morningstars Russell Kimmel has advised that if your local newspaper has an article about a great trend and the folks who made a killing in it, its probably too late. My experience in any investing scenario is that as the momentum builds, so does the risk, which, more often than not, ultimately diminishes your investment return. Size matters. A lot depends on the investment objective of the fund and whether it is actively or passively managed (indexed). Fund companies like to accumulate assets. The more money under management, the more they earn. Asset growth in index funds is not a problem because this type of fund usually covers a broad market segment. However, for funds that cover segments of the market that are less liquid, e.g., small-cap stock and specialty sector funds, bigger is not necessarily better. Managers cant maneuver as well and a large-size portfolio can become less efficient, thereby hurting returns. International investing has a risk most individual investors dont understand fluctuating exchange rates. For the past year, foreign stocks and mutual funds have been touted by investment professionals; portfolio diversification and better returns than those found in the U.S. market have been the main arguments.Ive seen portfolio allocation recommendations ranging as high as 40 percent to 50 percent for foreign securities. As one who has lived and worked in international markets for most of his professional career, I know that currency exchange-rate fluctuations can turn gains into losses. It works the other way too, but this year, its the latter and not the former thats at work. The Philadelphia Inquirers Jeff Brown recently reported that the Dow Jones Stoxx 50, an index of 50 European blue-chip stocks, had a year-to-date increase of 2.4 percent, which significantly outperformed the S&P 500 for the same period. However, for investors using U.S. dollars, the Stoxx index had a loss of 4.5 percent, significantly underperforming the S&P 500, once currency fluctuations were taken into account. Investors need to know that over the long term the ups and downs of exchange rates even out. But be aware that what the experts refer to as temporary trends often last for several years.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing and an independent registered investment adviser. Loth can be reached at 827-5591 or mentorinvesting@comcast.net.


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