7 Costly Mutual Fund Mistakes to Avoid

   

Mutual fund investing strategies seem simple, but retirement investors should take warning. If you can avoid the deceptive claims, hidden risks and half-baked strategies, you can, in fact, use mutual funds to fund your retirement years. But before you sink another dime into a mutual fund, learn how to see through the baloney and turn your fund portfolio into the retirement nest egg you deserve. Here are seven deadly mutual fund mistakes to avoid:

Mutual Fund Investing Mistake #1: Index Funds Investing

Lots of people say that index funds are the only investment you need, but indexing is not the best answer. Take Vanguard’s 500 Index Fund (MUTF:VFINX), for example. It’s the family’s largest fund, with more than $100 billion in assets. In fact, it’s one of the largest mutual funds in the world.

But it’s not the safest index fund, nor is it the best-performing index fund. During the tech bear market, investors lost more than $40 billion with the fund. A little more than 18% of the fund’s assets are tied up in just 10 stocks and more than half of its top 25 assets are invested in just three sectors.

Mutual Fund Investing Mistake #2: Jumping Into Bubble Sectors

You’d think that after the tech wreck and mortgage meltdown, investors would steer clear of sector funds, but they still make that mistake at Vanguard. Billions are still pouring into these mutual funds.

But remember: Buying into a sector fund is actually a form of market-timing, which individuals never seem to master. What many investors also don’t realize is that sector investing is expensive (minimum investments hover around $100,000) and their performance over the long haul simply isn’t worth the price of admission — only half of the 10 major stock market sectors that Vanguard follows have generated market-beating returns.

Mutual Fund Investing Mistake #3: Taking ‘Closed’ For an Answer

Have you ever heard about a hot fund and gone online only to find out that it’s been closed? It’s happened to me and countless other Vanguard mutual fund investors, and if I’ve learned one thing it’s this: Don’t give up!

First, you can wait until the fund reopens. In the past, Vanguard has reopened several of its top-performing closed funds to investors in its Flagship program. Also, a series of well-known value investing shops, from Tweedy, Browne and Dodge & Cox, reopened their own closed funds after the markets plummeted from their previous highs.

Mutual Fund Investing Mistake #4: Not Knowing Your Funds’ True Risk Potential

Don’t think the best way to measure Vanguard mutual fund performance is the three- and five-year rankings you get from Morningstar or in the financial pages. I’ve developed a much better system called Maximum Cumulative Loss (MCL).

MCL measures the largest historical loss that a long-term investor in a fund would have experienced, from high to low, and how long it would have taken to recover from the loss. The lower the number, the safer the fund.

For example, a poorly managed growth fund has a higher MCL of 71.4. A well-managed growth and income fund that routinely beats the market carries an MCL of just 41.5.

Mutual Fund Investing Mistake #5: Thinking Tax-Efficiency Means Guaranteed Profits

Tax efficiency doesn’t necessarily translate into better after-tax returns, nor does it tell you which funds are “best.” I’m sure you’ve heard that index funds are tax-efficient, and that this makes them attractive.

Take Vanguard Growth Equity (MUTF:VGEQX), for example. Because of all the losses the fund has sustained, it’s got the best five-year tax-efficiency of any Vanguard fund, at around 99%. Does this make it a buy? Absolutely not! It substantially underperformed its large-growth peers and generated a return that was below that of the stock market.

Mutual Fund Investing Mistake #6: Relying on Vanguard’s Performance Numbers

Vanguard management isn’t lying, but it measures performance in what I consider to be a very misleading way. They average annualized returns from the start of every year.

This method assumes that investors put their money into funds at the beginning of the calendar year and keep it there for the next 12 months. But do average investors do that? Of course not, and the result is that actual returns are often much lower.

Mutual Fund Investing Mistake #7: Not Getting Independent Advice

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