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Online Investing Hacks by Bonnie Biafore

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Hack #63. Evaluate Short-Term and Long-Term Returns

Examine mutual fund long-term returns and risk characteristics to avoid getting burned by funds on a momentary hot streak.

For fund companies, attracting investors is as easy as shooting fish in a barrel. They just advertise recent short-term returns for their best-performing fund and watch fund investors fall for the oldest trick in the mutual fund book. Buying based on short-term performance is a loser’s game, as you buy one fund at the top, and sell it when it falls in order to buy the next hot fund. It’s no wonder so many are soured on investing. But don’t be fooled—buying based on short-term performance isn’t investing, it’s gambling. And like the addict who keeps running back to the lottery ticket window, mutual fund gamblers won’t have much to show for all their efforts. In fact, a recently released Morningstar study shows that short-term mutual fund performance doesn’t predict future results. Many funds that top category averages in one short period are likely to trail going forward. Even good three-year and five-year average annual returns are not enough. For true winners, look to longer-term returns—average annual returns for 10, 15, and 20 years. By calculating rolling returns, you can smooth out the volatility of yearly returns and see growth trends more clearly.

Warning

Long-term returns are worthwhile only for predicting future performance when the same manager has directed a fund the entire time. With fund manager ...

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