Excerpted from Common Sense on Mutual Funds by John C. Bogle, pages 98-99
Here, I refer primarily to the recent emergence of fund portfolio managers as stars. Alas, the fact is that there are precious few, if any, mutual fund superstars who have had the staying power of Michael Jordan or Arnold Palmer or Robert Redford or Laurence Olivier. The few who may have fitted into this category were never, as far as I know, identified in advance of their accomplishments. Who had ever heard of Peter Lynch or John Neff or Michael Price in 1972, before they had achieved their splendid records?
Even though their light may shine brightly for a time, many superstars seem to limit their association with a given fund. The average portfolio manager lasts only five years at the helm of a fund, and, in one of the largest, most aggressive - and formerly hottest - fund organizations, the average stint has been only two and a half years. (Turnover in the fund portfolio, which inevitably accompanies a change of managers, results in truly onerous cost penalties.) These superstars are more like comets: they brighten the firmament for a moment in time, only to burn out and vanish into the dark universe. Seek good managers if you will, but rely on their professionalism, experience, and steadfastness rather than on their stardom.
Be careful, too, about star systems (as distinct from star managers). The best-known stars are, of course, those funds awarded top five-star billing by Morningstar Mutual Funds. (I call these funds Morning-stars.) The fund world has embraced - and has encouraged investors to invest on the basis of - a system in which a fund with four or five stars is a success. (One or two stars - sometimes even three - mark a failure.) But, as the editors of Morningstar Mutual Funds candidly acknowledge, their star ratings have little predictive value. The Hulbert Financial Digest has demonstrated that buying five-star funds as they emerge, and redeeming them when they lose their top rating, produces below-market returns at above-market risk. Not a good combination! Based on the frequent fund switching implied by the Hulbert methodology, I accept that conclusion. But I would be more forgiving. I have little doubt that most of today's three-, four- and five-star funds, if held over time, will outpace their one-star peers. Even as you ignore star portfolio managers, then, be skeptical of funds with the lowest star ratings, and focus on funds with the higher star ratings. (But don't trade them!)
YAHOO! FINANCE TIP
Yahoo! Finance reports a mutual fund's Morningstar star rating on its profile page. For an example, see VFINX's profile page.
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