How to Pick Stable Mutual Funds

- Alan Lavine and Gail Liberman

A recent study by Dalbar, a Boston-based research firm, shows that investors who chase after hot-performing funds earn less than inflation after all is said and done.

The average stock fund investor earned just 2.57 percent annually compared to inflation of 3.14 percent and the 12.22 percent the S& P 500 index earned annually for the last 19 years.

The average bond fund investor earned 4.24 annually compared to the long-term government bond index of 11.70 percent.

Dalbar examined investor returns from stock, bond and money funds from January 1984 through December 2002. It evaluated how long investors remained in the mutual funds based on the cash flow in and out of the funds. It's not an exact way to tell how each investor did, but it's a good approximation. A lot of money goes into funds when prices are rising. Then a lot of money leaves funds when their prices turn down.

So why do we screw up so much?

"Motivated by fear and greed, investors pour money into (stock) funds on market upswings and are quick to sell on downswings," says Anne Hacket, spokesperson for Dalbar. "Most investors are unable to profitably time the market and are left with (stock) fund returns lower than inflation."

So what should we do?

The answer is simple. Stick with a well-managed diversified mutual fund that own stocks, bonds and some overseas securities. You can own an "all-in-one fund" to make your record keeping simple.

Best bets for such funds, according to Morningstar Inc., Chicago, include: Dodge & Cox Balanced Fund, Fidelity Puritan Fund, Gabelli Westwood Balanced Retirement, Leuthold Core Investment, Oakmark Equity Income, T. Rowe Price Capital Appreciation, Vanguard Asset Allocation and Vanguard Wellington.

All these funds have historically returned about 80 percent of the return on the S&P 500, but they are half as risky. That's a fair tradeoff in these uncertain times.

If you are not a do-it-yourself investor, find an experienced financial adviser. Before you invest, however, understand all the fees you are going to pay. You may pay front-end or back-end commissions or ongoing fees. Registered Investment Advisers charge about 1 to 2 percent of assets under management as an annual fee.

If they are going to charge you, they had better do a good job! The adviser should keep tabs on your investments and recommend changes as investment conditions or your personal circumstances change.

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Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).