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Avoid Making Mistakes
with Mutual Funds
By Cal Brown,
CFP
Cal Brown gives the most
common mistakes made by mutual fund investors.
Perhaps the first mistake
people make is not understanding the type of mutual fund they are using,
the investment objective, and the risks involved. Some mutual funds are
quite safe (Money-market funds, tax-free municipal bond funds), while
others are very risky (gold and other “sector” funds). There are many
different types of mutual funds, ranging from tax-free municipal bonds,
international stock, gold-mining companies, as well as several other
types.
But the biggest mistake people
make is not buying when prices are low; instead they buy when prices go
up. The best times to buy in the past two decades were in October, 1987
(right after “the crash”), during 1989, the last few months of 1990 and
in the bear market of 2000-2002. It takes courage to buy when everyone
is pessimistic, but that is always the best time because prices are
drastically reduced. We will drive all over town to buy clothes on
sale, but when stocks go down (“on sale”), most people won’t buy.
People also make the mistake
of trying to “time the market.” They try to guess when the market has
“bottomed out” so they can buy, or when it has “peaked” so they can
sell. It makes more sense to focus on long-term objectives (such as
retirement income adjusted for inflation), rather than to speculate on
the near-term market impact of current events. In January 1991, a
client called me and sold all her shares in a stock mutual fund the day
we started bombing Iraq, because she thought the stock market would go
down. But her fund went up 10.3% in less than a month! She lost out
because she did not “buy and hold.” Historically, the stock market has
spent about two-thirds of its lifespan going up, and it’s tough for
anyone to beat those odds.
People are mistaken when they
ask questions like this: “What is the mutual fund that is paying 15%
this year?” Anything that high would have to be a stock mutual fund;
the principal is not guaranteed and it won’t pay interest (although it
may pay a small dividend). There are several funds which have averaged
15% per year over a 5-year or 10-year time period. But that is an
average – the fund did not go up 15% each and every year! It may have
gone up 40% one year, down 20% the next, up 5% the next, up 12% the
next, followed by another down year.
It may have averaged 15%, but
there were ups and downs along the way. The important thing is to pick
a mutual fund with a good long-term track record. It is a mistake to
select a fund just because it was up 40% or some other extraordinary
number last year. More often than not, the best performing fund one
year has been a poor performer the next year. It is much better to look
at consistent performance over 3- 5- and 10- year time periods.
If you will avoid
these mistakes, you can do quite well investing in mutual funds. Equity
ownership (i.e., stocks) quite simply is the best way for most
individuals to beat inflation and earn a long-term return on their
savings. While there is no ideal, riskless, high return investment,
successful investors consistently apply a reality-based discipline.
Fear and greed are always your enemies; discipline is always your ally.
So, buy good quality funds on a regular basis and hold them for the long
haul.
*****
Cal Brown is Vice-President of The Monitor Group, Inc., a fee-only
financial planning firm located in the Tyson's Corner area of McLean,
Virginia. As a nationally recognized wealth management firm, The
Monitor Group provides investment and financial planning services to
more than 190 high net worth client families in Northern Virginia,
Maryland, Washington, DC and across the country. Click
here for more information about Cal and The Monitor Group, Inc.
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