How to Choose the Best Mutual Funds

There are a trillion different ways in which you can pick mutual funds, unfortunately there are only three way that have a long track record of success.  The first method is also the worst method in that it is based solely on good luck.  Some investors get lucky, make a lot of money, and then think that they are now investing experts.  While this works for some, it is disastrous for most.  So what can we do to find the best performing mutual funds?

If you don’t want to put it all on red and hope for good luck then you might want to take a look at strategies that have a long track record of performing well.  The beginning of any successful mutual fund investing strategy is to look at fees.  In the mutual fund world there are load and no-load funds.  We are only looking at the best no load mutual funds.  By only looking at no-load funds we are skipping the high commission brokerage funds that almost always underperform over the long run due to fees.

How to Choose the Best Mutual Funds

Now that we have narrowed our universe to only no-load funds lets look at the actual strategies.  The first successful mutual fund strategy that is not based on luck is that of in depth research.  You want to find funds that have had the same manager for several years and that have a good long term track record.  When researching the fund manager you will want to make sure that not only has the manager posted good returns but that the manager has a legitimate investment methodology. If he claims to be a value manager does he actually buy value stocks?  Or does he just go buy things that have been beaten down?  Take a look at Bill Miller at Legg Mason.  He beat the SP500 for 15 years straight and then basically blew up by doubling down on junk like Fannie Mae, Bear Stearns, Lehman Brothers, and AIG.  These are all companies that were not value but instead were beaten down junk.  By chasing losers he was setting his investors up for a return of -70% in 2008.  Instead you want a manager like Bruce Berkowitz at Fairholme Funds.  Not that you should go buy his fund but he is a good model to emulate in that he does the same thing over and over as well as managing risk in a reasonable way.  He does extensive research buying stocks that he understands and is able to value.  Seat of the pants is not a successful investment method.

Another investment strategy that has a long record of success is that of momentum investing.  Some people call it chasing performance but when done in a methodical way it is a very powerful performer over the long run.  There is a lot of academic research behind this approach and the basic idea is that you buy the resent winner and then switch out when the start slowing down.  You will never buy the bottom and sell the top but over time you do well.  One strategy that has done well over the years is to take the top 5 Fidelity select sector funds based on the previous 12 months performance and then at the start of each month rotate into the top 5 again.  This is one simple method that has done well over time.  Not perfect but it has done well.

Likely the best strategy is to do a bit of both of these basic approaches.  By diversifying strategies as well as diversifying the actual mutual funds you will be in a better position to outperform over time and take less risk.  How much diversification is enough?  Most people agree that if you can split your money into the 5 or 10 best mutual funds you are in good shape.  By using solid strategies you can find the best mutual funds to invest in.

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