Pick mutual stock, bond funds for performance and indexing


NEW YORK -- Two new studies that recently came across my desk help answer a question asked by millions of investors: "How do I pick a good mutual fund?"

You'll be pleased to hear that the answers are easy. (1) Pick a fund without upfront or back-end sales charges, and with the lowest possible annual fees. (2) Bond-fund buyers should pick ,, one that's indexed to the market as a whole. (3) Stock-fund buyers should pick one with a persistently good record. Superior stock funds tend to stay that way.

The word on bond funds comes from Lewis Altfest, a New York City financial planner and associate professor of finance at Pace University's graduate school of business. He studied bond-fund performance for 1974 to 1988, as well as for four shorter periods within those years.

In general, he found that bond-fund returns just about match the bond-market averages.

Adjusted for the annual expenses you pay, however, they fall below average. In general, the higher the expenses, the lower your return.

What's more, Altfest found no consistency. Just because a fund ranks above average this year doesn't mean it will repeat the trick. So looking at performance records won't help you find a superior fund.

Moral: Your best buy in bond funds is an index fund with no load (no sales charge) and the lowest possible annual fees.

(An index fund buys securities that mimic the action of the market as a whole; no attempt is made to beat the market in any way.)

The lowest-cost bond-index fund for individuals: Vanguard's no-load Bond Market Fund, with annual expenses of 0.21 percent. (For information, call [800] 662-7447 in Valley Forge, Pa.)

Looking only at high-yield bond funds (better known as "junk funds"), Altfest found that the game wasn't worth the candle.

Junk funds returned only 1.5 percentage points more than corporate funds, and the study period ended before the big "junk bond" defaults began.

The word on stock funds comes from two finance professors, William Goetzmann of Columbia University and Roger Ibbotson of Yale. They studied stock-owning mutual funds, looking at successive one-year and two-year periods from 1976 to 1988.

For stock funds, they found, winners do repeat. A money manager who did well in the past has about a 60 percent chance of doing well in the future, too.

Many academics think investment results are unpredictable and that superior performance is purely a matter of luck, not skill. Goetzmann and Ibbotson beg to differ. Some stock funds are demonstrably better than others, they say, and, in general, the higher they rank, the better they perform in the long term.

With one exception: The managers at the very top of any fund performance list aren't necessarily the best, Goetzmann says.

Moral: Look for the funds that appear consistently somewhat below the very top -- say, in the upper quarter of the mutual-fund rankings. Pick funds whose good records have lasted at least two to five years. And buy no-load funds.

Two caveats to the stock study: (1) You can't count on superior performance every year, even from a top manager. Consistency wins, but only over longer periods. (2) Although good funds tend to stay good, there's no proof that very many can outperform the stock market averages, over time.

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