Shopping for funds: Apply your fine-tuned consumer instincts

Dollars & Sense

March 23, 2003|By Brian Portnoy | Brian Portnoy,MORNINGSTAR.COM

Several months ago, the newly appointed CEO of Janus, Mark Whiston, in an interview with The New York Times, gave investors a revealing glimpse into the way the fund industry works. Among other comments about the importance of branding and "best-in-breed" offerings, he remarked: "When it comes to the business side of mutual funds, distribution is paramount. ... It's no different in mutual funds than it is at P&G."

Branding is also an important part of the business because a good image and reputation sells. Under the stewardship of Ned Johnson in the 1970s and 1980s, Fidelity was an industry pioneer in leveraging a company brand in the selling of mutual funds, by using the Fidelity name or touting star managers such as Peter Lynch.

My guess is that most investors might think it a bit crude to approach the investing process in the same way they approach choosing toothpaste at the grocery store.

But should you buy funds like you buy toothpaste? If Whiston's parallel between fund companies and Procter & Gamble is appropriate, and fund companies are selling branded consumer products (albeit complicated ones), perhaps you should apply your fine-tuned consumer insights to your portfolio.

Here's a list of rules a knowledgeable customer might follow when shopping for the best products. We'll show you how these rules might also apply to mutual-fund investing.

1. Pay close attention to cost.

Any regular Morningstar reader could have guessed that cost considerations would top this list. In numerous Morningstar studies and other academic inquiries, it's plain as day that low-cost investing is a ticket to long-term success. The evidence clearly shows that the funds with the lowest expenses are much more likely to outperform competing funds. That's because the fund's costs - both the sales load (if there is one) and the annual expense - are deducted directly from your investment returns, which is essentially the product you're buying.

To put it in the simplest possible terms, the less you pay, the more you keep. And realize that saving even a few basis points - fractions of 1 percent - can add up to thousands of dollars of difference in long-term performance.

2. Treat advertisements skeptically.

As a rule, investments you see advertised in the popular financial press are yesterday's winners. Investors tend to chase performance; whatever has been hot lately often seems most appealing. Generally, be wary of ads for funds that splash return numbers on a page. Past performance is truly no indication of future performance.

3. Comparison shop.

The complement to the warning about ads is to maintain discriminating tastes. And that involves weighing your choices carefully. Of course, mutual funds shouldn't be impulse purchases. If one fund immediately strikes your fancy, take a step back and compare it with others that attempt to achieve similar goals, such as beating the same benchmark.

Make apples-to-apples comparisons among the many choices out there. One way to do that is with Morningstar.com's Fund Compare tool. It's easy to enter the tickers of the funds that interest you and then compare across numerous portfolio, performance, expense and risk metrics. Morningstar.com also features a Similar Funds tool, which can help you find a cheaper or better-performing alternative to a fund that strikes your fancy.

4. Don't buy (or sell) impulsively.

The investing world's equivalent to the shopaholic is the frequent trader. Resist the temptation to tinker excessively with your portfolio. If it's well-balanced, and it matches your risk tolerance, time horizons and investment goals, leave it alone. Fund junkies will always be looking to nip and tuck their lineup, but more tinkering tends to produce greater costs, which I've already pointed out is a major portfolio downfall.

Likewise, avoid "hot" investment products that cater to short-term desires. In 2000, the fund industry launched 160 new technology funds. Three years later, the same industry is banking on investors' fear by churning out "principal protection" funds that promise upside equity potential with no downside.

Those funds, which amount to extremely expensive bond funds, have raked in billions from investors so spooked by the bear market that they're not reading the fine print.

5. Caveat emptor.

The analogy between toothpaste and mutual funds has its limits, of course. With toothpaste, you know right away if your teeth feel squeaky clean. With funds, your consumer satisfaction is not determined for years, even decades. That uncertainty can make investing seem so daunting, and there's nothing that can be done about the future's uncertainty. Applying a smart consumer's mindset to your investment portfolio, however, will likely make for a happier outcome.

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