We all intuitively know that picking actively-managed mutual funds solely based on past performance is a bad idea. In fact, mutual funds are legally required to disclose that past performance is not an indicator of future performance. However, emotions can get in the way as our brains are wired to believe that mutual funds that have done well in the past will continue to do well.
Multnomah Group has a few suggestions to help investors avoid this trap.
- Investors should set goals based on their age and risk tolerance. This process includes devising a diversification strategy that utilizes the appropriate asset classes to achieve an investor’s long-term goal. Things to consider include: domestic international allocations, equity vs. fixed income investments, and growth vs. value style of investing.
- Investors should identify and purchase funds with strong philosophies, processes, and management teams that fit their investment strategy. These funds should also be attractively-priced as the more expensive a fund is, the more difficult it is to beat its benchmark. Above-benchmark performance typically follows funds that embody these characteristics.
- It is critical for investors to stick to their plan despite periods of underperformance as asset classes can go out of style. But over the longer term, asset classes that have had several years of strong returns generally revert to the mean. Thus, re-balancing one’s portfolio is critical to keep investors from selling asset classes that have underperformed and buying asset classes that have performed well. This can be done using a time-based or percentage-based method.
- Investors should revisit their funds to make sure the philosophy and process remain sound. Check to make sure the management team remains intact and dedicated to the fund’s strategy.
Hence, investors should set investment goals, identify competent fund managers that offer attractively-priced funds, and stick to their long-term plan to help ensure they are not letting emotions get in the way of investing. Thus, following a buy and hold strategy of the ‘right’ line-up of funds is a better plan than jumping ship to find the next hot fund.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.
Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.