Everyone wants the best. Mutual funds are no exception. But what does that mean, really? What makes a mutual fund “the best?” When you take a step back and look, the mutual fund industry is a lot like the Westminster Kennel Club dog show. Maybe if more mutual fund investors looked at it like that, their lives would be easier.
Here’s what I mean: At the Westminster Kennel Club dog show, the dogs primarily compete against others of their own breed. So you don’t have the Toy Poodles competing against the Great Danes or the Dachshunds competing against Yorkies. Each breed has its own characteristics upon which it is judged, and each individual dog is judged on those characteristics against the other dogs of the same breed.
And then there is the “Best in Show” which is awarded to the most outstanding specimen in the eyes of the judges, regardless of breed.
In the mutual fund world, the best mutual funds are those that have come to the top of the heap against all of the other mutual funds of the same “breed.” So bond funds should only be judged against other bond funds, and small cap growth funds should only be judged against other small cap growth funds. Of course, there is always one mutual fund that outperforms all the others (regardless of breed), but that is probably NOT where you’ll want to put your money.
Even the Best Mutual Funds May Not Be the Best for YOU!
How can this be?
Well, the main thing that everyone wants to know when they buy ANY investment is “How much am I going to make?” And so, they look for the best mutual funds according to how much the mutual fund made… IN THE PAST!
And what does every single mutual fund advertisement say?
“PAST PERFORMANCE IS NO INDICATION OF FUTURE RESULTS” or something along those lines. This is a standard “CYA” statement (C = cover; “Y” = your; “A” = …you can figure that one out). And it is true. There is absolutely NO way to tell what any risk investment will do from day to day, much less from year to year. And every single mutual fund is a “risk” investment – you can lose money.
How to find the best mutual funds… for YOU
1) You must have a plan. I’m sorry – I know you’ve heard this over and over and all you want to know is “HOW DO I MAKE MONEY???!??!” But it’s a cold hard fact. You have to know where you want to go before you can decide which way to turn. What are your goals? When will you need the money and what will it be used for? All this will guide your decisions.
2) You must decide which “breed of dog” (i.e. which type of mutual fund) is best for you. If it turns out that a Cocker Spaniel is the best breed for you, you’ll never be happy with a Poodle. If you’re not going to use the money for 15 or 20 years, then a more “active” breed like a emerging growth fund or small cap growth fund may be the best for you. If you need the money in the next year or two, then you’ll want a “calmer” breed like a short-term bond fund or something with more stable returns and less fluctuation.
3) Look for the “Best in Breed” and not the “Best in Show.” Don’t focus on the best return overall… that is a losing proposition. Historically, if you had bought the mutual fund with the best return for the previous year, you would have lost most of your money by now. Focus on the best blend of factors – low expenses, low volatility, good management, mutual fund ratings – and remember your plan. Forget trying to win “Best in Show” every year and you’ll end up a lot further ahead with your own best mutual funds – best for YOU.