20 Rules for Investing in Mutual Funds

1. Form a plan—always have a plan
   Having a plan means you took the time to stop and think about what you're trying to accomplish. If you have trouble forming a plan, go see a financial professional.
2. Get Educated
   Whether you're a do-it-yourselfer or you get advice from a financial advisor, you will want to be well-informed. There are many companies out there that have already done the research for you (Morningstar, Lipper, Value Line, etc.). Just get on the internet and type mutual fund in your search engine or go to your local library.
3. Don't invest in last years best performing fund because it was last years best performing fund.
   Don't just buy performance. Magazines and newspaper that highlight certain over-achievers only list a small percentage of the over 9000 mutual funds available. It is important to take criteria besides last years performance into account when choosing a mutual fund. These other criteria will be covered by later rules.
4. Diversify Yourself
   Diversifying your portfolio can help reduce your risk. You should diversify yourself among different fund types as well as different investment styles (growth, value, etc.). During certain periods different styles will come in and out of favor and if you are properly diversified you won't be left out of the movement.
5. Don't Get Married to a Fund
   Mutual funds are generally long-term investments, however in this day of the proliferation of mutual funds there are instances where you should consider selling a fund. If the manager of the fund changes and the new manager has a poor track record at his previous fund you should consider a change. You should also consider selling your fund if it begins to underperform its peers for several quarters.
6. Buy Management
   Always know who managing your fund and understand his/her style. If that style goes out of favor but you are confident with the management, remain in the fund. Also, watch for changes in the management of your fund.
7. Don't invest solely on track record
   This is similar to rule #3 about buying on performance, however, it is just the opposite. Rule #7 refers to those times you may pass up a mutual fund because its past performance may not look very enticing. There may have been mitigating circumstances that have corrected themselves. Perhaps it is a sector or investing style that is coming back into favor.
8. Be cautious of very large Funds
   They've probably grown large due to their success and popularity. Large funds are very hard to maneuver. Money managers have a hard time moving the assets around quickly which can lead to underperformance.
9. Be Cautious of New Funds
   Recent statistics show that two new funds are brought to the market everyday. This rule does not mean “don't invest in a new fund.” It means that before you invest in a new fund find all the information you can on the management team of the fund and what their investment style is.
10. Be Careful of Sector Funds
    One can't stress this rule enough. Bad press can absolutely destroy a sector fund. A good example of this is the Lexington Troika fund. This hot Russian sector fund was up a sizzling 60% in 1997. If you then invested in this fund at the start of 1998 you would be down 70% in just six months.
11. Beware of the Media
    Bad news sells newspapers. Do not allow the media to persuade you to making an emotional decision. That's not to say that you should totally disregard the facts. The media's sensationalism of an event should warrant further investigation. Remember, the two emotions that get investors into trouble are fear and greed. So keep a cool head.
12. Will it Pay for Itself?
    Whether you invested in a fund and paid a commission or invested into a no-load fund, your fund still has management expenses. The bottom line is simply this; you can compare every funds annual expense until you're blue in the face, but what really matters is, “are you getting what you paid for?” This doesn't mean that comparing expenses isn't important, just don't be afraid to pay for good management. It should be like any other service you are willing to pay for to make sure the job's done right.
13. Get Help
    If you don't think you have the knowledge to pick among the 9000 funds available, by all means, go find help. You wouldn't try to fix your plumbing if you truly didn't know how. There are many investors who have confirmed the old adage “a little knowledge is a dangerous thing.” If you don't think you can tackle this increasingly complicated world of mutual funds, please get help!
14. Be Careful of Proprietary Funds
    Let's say you walked into Company X to seek investment advice and Company X shows you their family of mutual funds; managed by Company X's own money managers. These are proprietary funds. Proprietary funds generally make more money for the company in the long run because of internal management fees. I'm not suggesting that all of Company X's funds aren't good, solid, proper investments or that Company X's motives are sinister. But would it hurt to ask their investment representative how their funds compare to other 9000 funds which are available. It's a fair question.
15. Use Your Common Sense
    Ask yourself, “How will this investment effect my overall financial situation? Am I educated enough to be comfortable with my decision or am I going to lose sleep over it?” When it comes down to a final decision about a specific funds, if it doesn't feel right, just don't do it. We have to admit that this is the abridged version of our fifteen rules for investing in mutual funds. But this is all the rules. This full version with the full explanation of all the rules will be coming to you soon.
16. Be wary of too much of a good thing
    It is important to diversify your portfolio in order to limit risks. However, owning 10 large cap growth funds is NOT diversification. You must look at the stocks in your funds to see if you are duplicating. If all your funds own GE, MSFT, INTC and DELL in their top five holdings you are probably duplicating and not diversifying.
17. Dollar Cost Average
    For the typical investor dollar cost averaging is a great way to accumulate mutual fund shares. This means investing the same dollar amount each month into the same fund on the same day. Using this method you will take advantage of the short-term fluctuations of the stock market. When your fund is high in price you will be fewer shares, and when your fund is lower in price you will buy more shares.
18. Know what you own
    You don't lose money because your mutual fund went down. You lose money because the stocks your mutual fund invests in went down. This is an important distinction. There are many reporting services which can help you keep track of the stocks your funds own (Morningstar, Lipper, etc.). Keep an eye on the stocks your funds are buying and selling. This will also help you prevent against duplication.
19. Focus on the Long-Term
    Don't sell a fund because it had a bad month. If you own a quality fund with excellent management don't let a correction in the overall market scare you out of the fund. Compare your fund to its peers, and as long as your fund remains in the top of its category continue to hold it.
20. Know your tolerance for Risk
    If your stomach churns every evening when you see the volatility in your portfolio then you might want to find some less volatile funds. If you need current income and want safety of principal then a Science and Technology fund may not be for you. Find a level of risk you are comfortable with and then choose your funds accordingly.

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