Our 7 Mutual Fund Investing Mistakes!

[This post is written and copyrighted by FIRE Finance (http://firefinance.blogspont.com).]

We would like to share some of our mistakes committed during our early years of investing. Hopefully many of our readers would be able to avoid them by leveraging on our experiences.

What is it about men on knowing directions?

Okay that's for humor, no offense intended. On a serious note, without a goal, a direction and a plan, our efforts may go to utter waste. We should be aware of the following:

• Our earnings and expenditures i.e. cash flow
  
• Have proper insurances
  
• Know our savings goals with respect to our own education, marriage, house, travel, kids, kids' education, retirement, health, etc.
  

Based on the above goals, we should design an asset allocation strategy. In our first couple of years (of investing) we were simply over-enthusiastic. Consequently we rushed into investing without a plan. We purchased individual stocks which we felt were good! Pretty soon we realized how clueless we were. Our portfolio had a dismal asset allocation and we had no idea about investment risks. Fortunately our investments were of modest amounts else we would have been in deep waters.

Water, water everywhere but not a single drop to drink!

Well, almost. Advisers, consultants and self proclaimed investment gurus thrive at every corner but we wonder how many of them are truly trustworthy. Advisers earn commissions on their recommended sales and most gurus have no clue or control over future market behavior. As a result, most personal finance advices might be unreliable due to reasons varying from conflict of interests to conn artists, and fake certifications to selfish motives.

We are sure our readers have their own tales to share. There was a time when we pounced upon any tip dished out by the Wall Street marketing crystal ball and so-called gurus. Some pertinent questions that made us realize the reality behind the hype were:

• Do the gurus walk the talk?
• Who sponsors the campaigns or promotions?
• After all, it is our money and our lives. Should we expect anyone else to understand our objectives in a sincere and heartfelt way? Rather not!

From these reflections emanated a goal of learning the ropes to self manage our finances. Experience taught us that it is best to consult fee-based financial planners. But a lot of due diligence might be needed to discover such trustworthy services.

But Miriam, this fund did so well last 5 years!

Sure the past is important when hiring a new employee. For an actively managed mutual fund it is very important to examine it's performance along with its manager's past track record. It is, rather was, one's dedication and expertise which contributed largely towards the fund's success. But

• What if the fund's parent company shuffles its fund managers across the board?
• Is the hot-shot manager making a career move to another fund company?
  
• It has also been observed that funds tend to have a cooling period after a "bull-run"; being a consistent top performer is extremely difficult!
• Besides, should we buy a top performing fund at its peak and sell low later? This is a classic mistake!
  

As young investors we often used Yahoo or Morningstar's fund screening tools to gauge a fund's past returns and got excited at high rates of returns offered by top performers, blissfully oblivious of the accompanying high risks. On hind sight, it was a blessing that in those years we did not have enough money to invest. Else we would have made costly mistakes in those euphoric moments. Little learning is indeed dangerous!

Who is having my pie?

Stellar returns are a dream that we are after but expenses and fees are a reality. No matter what the performance is, we have to pay for the operating cost of the fund and perhaps for the fund manager's new Cadillac. No we are not saying that mutual fund companies should act like charitable organizations.

Since expenses are a certainty, it makes every sense to minimize them without much loss of quality or performance. There are thousands of no-load mutual funds with very low expense ratio. Almost always there exist multiple no-load mutual funds that are at par in performance with their actively managed counterparts. Why pay extra for unproductive efforts of some fund managers?

Initially we toyed with the idea of investing in few big name funds. But upon due diligence we discovered that they carried deferred sales load (commission during sale of fund shares) and the expense ratios were much higher than the category average. Since then we have always stayed clear from such actively managed funds.

Sweetheart, this fund title is sooo exotic!

Try these: PowerShares Lux Nanotech Portfolio (PXN) or Claymore MACROshares Oil Down Tradeable Shares (DCR). Oooh! So exotic and mouthful, aren't they? But friends let us not do window shopping of mutual funds and ETFs. There are quite a few of them with such fancy titles. We ought to look beyond the names and evaluate them thoroughly.

Even if it is an otherwise good fund it still needs to fit our asset allocation strategy. We certainly don't want unintentional multiple coverage of same assets. Indiscriminate buying of funds would indeed lead us to that trap. Nobody wants to be in double jeopardy. As for us we are firm believers in index investing over a long time period. Choosing the right indexes for appropriate coverage of assets and distribution of risk is of utmost importance.

No news is good news.

In the literal sense we often don't listen to news. Seriously we mean it. This mind of ours is a difficult beast to tame. A slight provocation by a news or worse a rumor can wreak havoc to our mind's peace. Such unnecessary worries simply waste time and cause stress.

Let us illustrate this with an example. Last summer, we were traveling across the US via eleven different metropolitans in order to raise funds for charity. Our schedules were so hectic that we had no time to catch up with news. We were blissfully unaware of the market's downfall during late July to early August. Did we miss something? Absolutely nothing! Our portfolio was rebalanced last April. No trading is planned till end of this year. Had we got wind of the crash, we might have panicked. Our minds might have fruitlessly run thousands of what-if scenarios. Any emotional buy-sell would have been akin to market timing which does not work in the long run. Market forces beyond anyone's control will always exist. Knowing that we have done our homework and selected appropriate funds, why lose sleep over temporary ups and downs of the market?

Apple to Apple, my dear!

Sometimes we may get disappointed with the performance of an otherwise good fund. Why? Oh that Fidelity Fund (which we don't own) is doing so well! Careful! Are we comparing apple against apple? Its wise to check if these funds have invested in similar securities else it is not a fair comparison. Rather we should look at funds in the same category and category averages. We'd further compare a fund against an index or ETF for the same class and style over a long time horizon. Often the best place to look for reliable information is the fund prospectus.

Yes, we know , many of us just trash the prospectus (including ourselves not long ago) but it has wealth of authentic information about the fund. We specifically take note of the Performance Summary and After Tax Returns section. The performance summary for Vanguard Utilities Index Fund (VUIAX), Fund taken from the prospectus of the fund is shown in the following figure. The graph and the table both compare the fund's performance with respect to appropriate indexes. Now that is a fair comparison we should pay attention to.

Once we read somewhere that smart people learn from other people's mistakes. Our sincere hope is that sharing our own mistakes will add to the collective wisdom of the personal finance blogosphere. That in turn will enable our audience to become wiser and help them avoid some costly personal finance mistakes. As always you are most welcome to share your own thoughts, experiences and opinions that will further empower us in this game of investing.

Image Source(s): iStockPhoto

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