ROANOKE TIMES
Copyright (c) 1996, Roanoke Times
DATE: Monday, November 11, 1996 TAG: 9611120130
SECTION: MONEY PAGE: 6 EDITION: METRO
DATELINE: NEW YORK
SOURCE: JANE BRYANT QUINN WASHINGTON POST WRITERS GROUP
After watching the stock market rise so high over the past couple of years, you might have contracted a burning case of mutual-fund envy. Your own funds (you think) are sticks-in-the-mud. Other investors seem to be having all the fun. So why not (you think) plunge some money into the flashier funds, hoping they'll fly you over the moon?
Conventional wisdom says that's dumb. Supposedly, a fund's past performance doesn't tell you how it's likely to fare in the future. But surprise, surprise - maybe it does. Some recent academic studies suggest that a hot hand persists, at least for a short period. In theory, you can fatten your investment returns by switching your money, every year, into the funds that have done the best.
Some caveats before I tiptoe into this controversial thesis. I'm talking only about well-diversified funds - not international, single-industry or aggressive small-stock funds.
Furthermore, what works on paper won't necessarily make you rich. You'll need time and discipline to pursue the hottest hands. Your reward may be marginal, after costs. Your quest will almost certainly fail if you pay sales charges when you buy and capital gains taxes when you sell.
A hot-hands strategy works best - if it works at all - for investors who purchase no-load (no sales charge) funds, in tax-deferred plans that offer a wide investment choice. Typically, that means an Individual Retirement Account or Keogh plan that you run yourself.
In a 401(k) plan that offers only a handful of funds, your best choice is still a combination of stocks and bonds that you buy and hold.
But let's say you'd rather bet on some diversified funds that are rising fast. If they play them right, that's a gamble you won't regret, said Martin Gruber, chairman of the finance department at New York University's Stern School of Business.
In a recent, risk-adjusted study of diversified U.S. stock funds during the 10 years ending in 1994, Gruber found that success breeds success, over short periods.
The study identified each year's top funds, all of them managed by investment advisers. Top funds tend to attract new money from investors. New money invested in managed funds earns, on average, 0.4 percent more than money invested in comparable index funds (an index fund follows the market as a whole).
After the first year, however, the picture begins to change. The gains on the money that was invested in managed funds begin to slow. In the third year, your hot fund probably won't be beating the market anymore. On average, Gruber said, the money that stayed in the managed mutual funds he studied underperformed the index funds by 0.45 percent.
In other words, if you want top performance, you have to switch mutual funds each year. If you don't want to move your money around, you're better off in plain-vanilla index funds.
What if you'd rather buy stocks and hold them? For you, the hot funds run by money managers pose a risk, Gruber said. The longer you hold them, the greater the chance they'll underperform an index fund.
Gruber thinks buy-and-holders should keep their core investments in index funds -specifically, those with annual expenses under 0.3 percent. For the largest low-cost selection-stock funds, bond funds and internationals - try the Vanguard Group in Valley Forge, Pa. at (800) 662-7447. Over time, low-cost indexers outperform most managed funds.
A few managed funds have defied the odds and yielded superior results, said Kurt Brouwer of Brouwer & Janachowski in San Francisco, who invests clients' money in mutual funds. His star list of stock funds now includes Brandywine, Harbor Capital Appreciation, Oakmark, Selected American Shares (a no-load version of New York Venture) and Vanguard Wellington.
LENGTH: Medium: 72 linesby CNB