Don't fall for some mutual fund just because of its pretty face

Your Funds

February 17, 2002|By CHARLES JAFFE

FALLING IN love with a mutual fund is silly. A fund doesn't share your feelings. It doesn't send roses on your anniversary or Valentine's Day.

But what most people really want from a fund is the same kind of long-term committed relationship they seek with a lifetime partner, someone to have and hold in good times and bad.

Sadly, most fund relationships don't work out that way. The average holding period for mutual funds has shrunk to less than three years - not exactly a lifetime partnership.

Typically, what ends an affair with a fund boils down to a lust-vs.-love thing. Investors are seduced by a fund's good looks. Once the initial spark is gone, returns begin to sag, and the picture is not so pretty, many people get turned on by finding something new.

It's worth examining how picking a mutual fund is similar to selecting a love interest. You will find out quickly that there are some funds with which you'd want to have a fling, but that you wouldn't want to marry.

As in a dating relationship, your initial points of attraction to a fund will come in a few areas. Here is how to size up each to determine if a fund is the right match for you:

Looks. Sure they're superficial, but they have plenty to do to with initial attraction. What makes a fund look sexy are attractive performance numbers, the kind that make you want to take the fund home for your own portfolio.

Unfortunately, looks tend to be deceiving.

Funds with super-model performance numbers tend to be temperamental.

Around the time you buy in and get a closer look, you may learn the ugly truth that they got their good looks by delving into the hottest segment of the market, and they will lose those looks once that sector cools.

True beauty is not skin deep. In the end, consistency, returns compared with similar funds, persistence of performance and the ability to meet expectations in all market conditions will figure into your long-term happiness a lot more than how well the fund did in the one- or three-year period before you hooked up with it.

Type. Finding a fund that's "your type" actually requires a bit of soul-searching before you invest. Growth investors, for example, want funds that show consistent sales and earnings gains, while value investors tend to seek out underpriced investments with the expectation that they will go up.

Likewise, you may prefer to invest domestically or internationally, in large stocks or small, or you might want a mix of all of the above.

The important thing to remember is that the fund needs to be what you are looking for in a new investment. If you already have a few growth-oriented funds, for example, you might not be looking for that type right now.

If a fund is not your type when you are looking, chances are it doesn't belong in your portfolio.

Personality/demeanor. A fund's character - from index fund to gunslinging stock-picker - must appeal to you enough so that you develop the conviction to stay put during the inevitable downturns. If you and the fund don't share the same goals (and ideals on how to achieve those results), it's a mismatch.

Don't go looking for love in all the wrong places. If you want a conservative income fund, you need to avoid those offerings that promise income, but which keep a significant portion of their portfolio in aggressive stocks. Check out the fund's holdings and asset allocation.

How they get along with your friends. In this case, your pals are your other funds. Ideally, you will build a diversified portfolio that addresses various risks.

But if you are feeling the need to make your portfolio more conservative, chances are you will lean toward bond and income funds, rather than adding another growth fund to the mix. If you want to stay entirely in stocks, you might look to expand your holdings internationally, or into smaller stocks, or into value investments.

Having a portfolio where all of your funds do the same thing ensures that you will have steeper peaks and valleys in performance.

Bad habits. You might be able to persuade someone to stop smoking or improve their clothing or manners, but you can forget about changing a fund's bad habits.

All too often, people are attracted only to performance. They don't realize until later how high expenses are hurting their feelings for the fund. A fund may be able to overcome a high cost structure for a year or two, but probably not over a lifetime. If you want a long-term relationship with a fund, look for an expense ratio you can live with.

Once you have evaluated all of those factors, you may not have found true love, but you should at least have found funds with which you can have a rewarding relationship.

Chuck Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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