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As the April 15 tax deadline approaches, many people are deciding where to invest this year's contributions to their retirement accounts. It's a stressful decision because it can make a big difference in your quality of life in retirement. It's also one where it may be years before you know whether you've made a good decision, and by then it may be too late to change course.
Here are two common mistakes you can avoid.
One of the reasons that choosing a mutual fund is so hard is that the typical tables of one-, three- and five-year returns that are so readily available often include the returns of previous managers who are no longer there. But, if you invest in the fund the only manager who matters is the one who is there now. Don't make the mistake of investing in a mutual fund because of an impressive five-year track record that was racked up largely by a previous manager.
In November, when I did the research to come up with recommendations for my Top Core Fund report, I found that only 3,447 managers out of 10,929 domestic equity mutual funds had been at the helm for at least five years. To me, this means that for almost 70% of all mutual funds, the current manager has not been there long enough to be confident that he is skilled.
If you are looking for a skilled fund manager to invest your retirement account, I think it's a big mistake to choose one of these funds. Let the unproven managers train with someone else's money. Before I would choose a mutual fund for my retirement account I want to see at least a five-year track record for the fund's current manager. If you agree, you can eliminate almost 70% of all mutual funds from consideration without much stress.
The second common mistake I see is that many people believe that once they've selected a mutual fund, they can rely on the fund manager to make all the important decisions. But here are four important decisions that most mutual fund managers will not make for you:
- When to be in the market and when to be out.
- Which sectors to invest in and which to avoid.
- Whether to invest in small-cap, midcap or large-cap stocks.
- Your investment style -- value, growth or a blend,
By and large, mutual fund managers are required to stay almost fully invested in the stocks that match the market-cap, investment style and sector restrictions in their prospectuses. They cannot go to cash when they don't like the market, and they don't have much latitude to move from one market-cap size, investment style or sector to another.
In other words, a small-cap fund will always be invested in small-cap stocks, even when they are tanking. If you thought that the fund manager would protect you when small caps are tanking, it is inevitable that you're going to be disappointed because at some point small caps will tank.
There are a few mutual funds that will make these decisions for you, but they are not easy to find. Morningstar does not have a category for them, so you'll have to read the prospectus to find out what the fund manager is allowed to do. This was the reason I put together my Top Core Funds report at the end of last year. If you requested the report but did not receive it, please accept my apology. I've learned that many of the e-mail messages I sent out with the link to the report got caught in a variety of spam filters and did not get delivered. This time, I'm giving up on e-mail. If you would like to see the Top Core Funds report, click here.
While I'm at it, if you are an investor in the Masters 100 Fund and requested the form to start a free one-year subscription to our newsletter, Marketscope, the e-mail I sent you with the link to the form probably did not get to you. Click here to get the form.
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