Chapter 22

Ten Common Fund-Investing Mistakes and How to Avoid Them

In This Chapter

Designing the right plan for you

Keeping taxes and fund fees in mind

Staying away from shady advisers and market predictors

From getting your finances in order to selecting funds to maintaining your portfolio over time, various potholes and dangers can get in your way. This chapter highlights the ten most common fund-investing mistakes you’re likely to make and how you can sidestep them.

Lacking an Overall Plan

Just as you shouldn’t build a house without an overall plan, you shouldn’t start buying funds until you have your arms and mind wrapped around a sound financial plan. The plan doesn’t have to be a fancy, professionally or computer-generated one, but it should include the basics:

Proper insurance coverage, like health, disability, auto, home, excess liability if you hold sufficient assets, and life insurance if others depend on your income

A plan for paying off consumer debt on credit cards and auto loans, if you have any

Savings goals for retirement, buying a home, starting a business, putting your kids through college, and anything else your heart desires

An overall asset allocation — what portion of your money should be invested in different assets, such as stocks (foreign versus domestic), bonds, and so on

Failing to Examine Sales Charges and Expenses

Would you ever buy a car without considering its sticker price? How about checking out the car’s safety record and insurance costs? Mutual funds are like cars in one respect — you should check under the hood before you buy. But the good news is that fund fees are actually a lot easier to comprehend compared to the various car costs.

Before you consider buying any mutual fund, be sure you understand precisely any sales charges as well as the fund’s ongoing operating expense ratio. Over the long term, a fund’s fees are one of the biggest (and most predictable) determinants of the fund’s likely future returns. This point is especially true with boring old money market and conservative bond and stock funds. Please see Chapter 7 for more on fees.

Chasing Past Performance

Before anyone hires a job applicant, he likes to know that person’s track record. Ditto for professional sports teams seeking new players. Of course, when hiring a money manager, which is what you’re doing when you invest in a mutual fund, you should examine that manager’s prior experience. However, many investors simply throw money at funds currently posting high returns without thoroughly examining a fund manager’s experience.

More often than not, current hot funds cool off (especially as small funds get larger and market conditions change), and many underperform in the future. The reason is quite simple: The market forces that lead to the relatively brief period of high performance inevitably change. Peruse Chapter 7 for how to avoid tomorrow’s losers and maximize your chances of picking a consistent winner.

Ignoring Tax Issues

Do you know your current federal and state income tax brackets? When a particular type of stock or bond fund makes a dividend or capital gains distribution, do you know what rate of tax you’ll pay on that?

Many fund investors aren’t well informed when it comes to the tax consequences of their fund purchases and sales. Although you don’t want the tax tail to wag the fund selection dog, you should know how taxes work on your funds and which funds fit best for your tax situation. See Chapter 10.

Getting Duped by “Advisers”

Some people want to hire a financial adviser to help them navigate financial choices. But many so-called financial consultants or advisers have serious conflicts of interest. Their recommendations and objectivity are tainted by commissions earned from products that they sell or from their money-management services.

If you seek to hire a financial planner/adviser, it’s a good rule of thumb to hire someone who’s selling his time and nothing else. If what you’re really looking for is someone to manage your money, seek out a money manager. See Chapter 24.

Falling Prey to the Collection Syndrome

Some people buy mutual funds the way they build a clothing collection. Visits to different stores and articles recommending specific items lead to purchases. Before you know it, you may own numerous funds that don’t really go together well.

This mismatching is another reason you should develop your overall plan first. For example, after you decide that you’re going to invest, say, 20 percent of your retirement plan money into international stock funds, then you can set out to identify and then invest that amount of money into your chosen foreign funds. Check out Chapter 10, which provides a guide to putting together a sound portfolio that matches your needs.

Trying to Time the Market’s Movements

Just as no one enjoys losing a game, who wants to invest in a fund only to see it fall in value? Sometimes, though, that may happen even though you’ve done your homework and selected a good fund.

Stock and bond funds fluctuate in value, and you must accept that inevitability when you invest. Some people like examining pricing charts online to guess when a fund is about to turn around and increase in value. Don’t waste your time on such unproductive and time-consuming endeavors. Identify good funds, buy into them over time, and don’t jump in and out.

Following Prognosticators’ Predictions

Don’t make the mistake of believing that some supposed expert bold enough to make financial market forecasts on television, on radio, or in print actually has any proven talent to do so. Such blustery babblings are merely for the publicity of a given firm or individual.

Your long-term goals and desire or lack thereof to accept risk and volatility in your investments should drive your fund selection. Please read Chapter 20 to discover how to use information, not predictions, in building a winning fund portfolio.

Being Swayed by Major News Events

You’re human and have emotions. September 11, 2001, was a horrible day for Americans (and many other people around the world) that caused some people to panic and sell investments when the financial markets reopened. Similar emotions and reactions happened during the 2008 financial crisis/panic. Wars, oil price spikes, large corporate layoffs, the latest retail sales and consumer confidence reports, and Federal Reserve meetings and interest rate changes are but a few of the news reports that can move the markets.

Don’t make your investing decisions based on the news of the day. The only action you should consider taking if doom and gloom are in the air is to consider using some of your spare cash and buying when a sale is going on.

Comparing Your Funds Unfairly

While teaching adult courses and working with clients as a counselor, I’ve witnessed many people who were disenchanted with otherwise good funds. Often this effect was the result of their knowledge that other funds, often seeming similar on the surface, were doing better. Perceptions changed when these people found out that the other funds weren’t holding the same types of securities and that their funds were actually doing fine compared with a relevant market index (see Chapter 17).

Don’t be quick to assume that your funds aren’t doing well simply because they’ve gone down recently or are producing lower returns than some other funds. Compare them fairly over a long enough period (years, not months or weeks) and then decide.