How You Could Make a Million Owning Mutual Funds

Mutual funds are outstanding investment vehicles after you learn how to utilize them correctly. Most people, however, do not have a solid understanding or conviction about mutual funds.

The first absolutely essential point to understand is that the big money in mutual funds is always made by sitting through several business cycles.

In other words, to reap large returns from funds, you have to have the strong belief and patience to sit tight for 10 or 15 years or longer. It's like real estate. You may not make anything if you buy and later become impatient or shortsighted and sell out after only three or four years. It simply takes time. Nervous Nellies are not good fund shareholders.

Investors in open-end investment companies, as mutual funds are sometimes called, tend to buy the best-performing fund after it has had a huge performance year. The next year or two will probably show slower or poorer results followed by an inevitable economic recession. This is usually enough to scare out those with less conviction or the "I want to get rich quick" fund holders.

Sometimes shareholders will switch to another fund that someone convinces them is much safer (usually at exactly the wrong time) or has a "hotter" recent performance record. Switching breaks up your long-range holding plan. I suppose you should switch if you have a really bad fund or the wrong type, like an income or industry fund when you should own a diversified growth fund, but too much switching quickly destroys what must be a long-term commitment.

Bear markets can last from nine months to two years or more and if you are going to be a successful long-pull investor in funds, you'll need to acquire the courage and perspective to live through numerous discourag ing bear markets. Have the vision to build yourself a great long-term growth program, and stick to it.

I have sold mutual funds, known many top fund portfolio managers, provided research to hundreds of mutual funds, managed two mutual funds myself, and started the New USA Mutual Fund in 1992. In 1966, one of the funds was up over 10%, when the Dow was down 23% in a bear market. The other fund set a performance record for diversified growth funds of + 116% in the following year. A huge number of stocks in its portfolio doubled. We had even planned that our goal at the beginning of the year was to be the number one fund for the year.

The fund did not do as well the next year. We had size problems, as assets under management in the fund and individual accounts increased dramatically. We also owned too many thin, volatile holdings, as we had just invented Datagraphs in January 1968 and, for the first time, had information on microfilm of several thousand smaller companies no one had ever seen before.

Some people thought we were a "flash in the pan" with one lucky year, but most were unaware that twice before, in 1963 and 1965, we had also made 100% or more in many individual accounts.

In 1963, the lowest-performing individual account I managed was up 115%. It was a cash account. From its inception, the fund ranked in the top 22% of all common stock funds until the day it was sold to another investment organization. This is an important fact most media people overlooked. An even more important point is that those original shareholders who held onto their shares as they were merged into the new company had a total increase of over 1,100%, which is the vital point I'm trying to make. The super big gains from mutual funds come from compounding over a span of years. Funds should be an investment for as long as you live. Diamonds are supposed to be forever—well, so are your mutual funds. So buy right and sit tight, period!

How to Become a Millionaire the Easy Way

Here is what I regard as the ideal manner for a shrewd mutual fund investor to plan and invest. Pick a diversified domestic growth fund that performed in the top quartile of all mutual funds over the last three to five years. It will probably have averaged an annual rate of return of about 20%. The fund should also have a better-than-average record in the latest 12 months when compared to other domestic growth stock funds.

Steer away from funds that concentrate in only one industry or one area like energy, electronics, or gold. The investment company you pick does not have to be in the top three or four in performance each year to give you an excellent profit over 10 to 15 years.

The fund can be either a no-load, with no commission, or load, or one where a sales commission is charged. If you buy a fund with a sales charge, discounts are offered according to the amount you invest and some funds have back-end loads which you may want to check. The commission paid is substantially less than the mark-up you pay to buy insurance, a new car, a suit of clothes, or your groceries. You can also sign a letter of intent, which will allow a lower sales charge to apply to any quantity purchase made over the following 13 months.

When you purchase a mutual fund, you are hiring professional management to make decisions for you in the stock market.

Most diversified funds should be treated differently from individual stocks. A stock may decline and never come back in price. That's why the loss-cutting policy is necessary.

However, a well-selected fund run by an established management organization will, in time, almost always recover from the steep corrections that naturally occur during numerous bear markets. This is because mutual funds are broadly diversified and should participate in each recovery cycle in the American economy.

Therefore, I believe an extraordinarily different strategy should be employed with mutual funds. Each time you get into the thick of an economic recession and the newspapers and TV tell you how terrible things are, why not add to your fund when it is off 25% to 30% from its peak price. It might even be a possible time to borrow a little money and buy more shares. If you are patient, within two or three years the shares should be up sharply in price.

Remember, you're going to hold through many economic cycles, so why not be smart and add to your investment during each bear market? You can also reinvest your dividends and capital gains distributions and benefit from compounding over the years. When you buy your growth mutual fund, you should make up your mind at the outset that you are positively going to sit through the next three or four bear markets or economic recessions. This will give you the maximum opportunity to make really big money.

How about Income Funds?

If you need income, you may find it more advantageous not to buy an income fund. Instead, you could select the best possible fund available and set up a withdrawal plan equal to l!x>% per quarter or 6% or 7% per year. Part of the withdrawal would come from dividend income received and part from your capital, but the fund should generate enough growth over the years to more than offset the withdrawal of capital, if it is limited to 6% or 7% per year.

There are many organizations, such as Fidelity, Thomson, AIM, Scudder, Twentieth Century, Oppenheimer, Dreyfus, United Funds, Vanguard Group, and IDS Mutual that offer a family of funds with varied objectives and the right to switch to any other fund in the family at a nominal transfer fee. These families could offer you the added flexibility of making prudent changes many years later. The mid- to small-cap growth funds in a family are generally the better performing choices.

How Many Funds Should You Own?

As time passes, you may discover a second fund you would also like to begin accumulating in another long-term program. If so, do it. At the end of 10 or 15 years, you might own a worthwhile amount of two or even three funds, but there is no reason to diversify broadly, so don't overdo it. Those rare individuals with multimilliori-dollar portfolios could spread out in more funds which would allow them to place almost unlimited sums into a more diverse group of funds. If this is done, some attempt should be made to own different-style managers. For example, money may be spread among one value-type growth fund, one aggressive growth fund, one small cap fund, one global fund, and so on.

If you own a growth fund which, by definition, invests in more aggressive growth stocks, it should go up more in bull-market years and fall off more in price than the general market in some bear market years. This is fairly common and in keeping with the nature of most growth portfolios, so don't get alarmed and panic out at the wrong time. During the poor periods, try to look ahead several years. Daylight follows darkness.

When Is the Best Time to Buy a Fund?

Any time is the best time. You'll never know when the perfect time is and waiting will usually result in your paying a higher price.

Should You Buy a Global or International Fund?

Yes, these could be a sound investment and provide further diversification, but I would definitely limit the percent of your total fund invest-

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investments. International funds can, after a period of good performance, suffer several years of laggard poor performance.

The Size Problem of Large Funds

Asset size is a problem with most funds. If a specific fund has billions of dollars in assets, it will be less flexible in retreating from the market or in acquiring meaningful positions in smaller, better-performing stocks.

Therefore, I would generally avoid most of the very largest mutual funds. However, if you have a fund that has performed well for you over the years and it has now grown large but still performs reasonably well, maybe you should sit tight. Remember, the big money is always made over the long haul.

Checking Management Fees and Turnover Rates

Some investors try to evaluate the management fees and portfolio turnover rate of a fund. In most cases this nit-picking is not necessary.

In my experience, some of the best-performing growth funds have higher turnover rates. The Fidelity Magellan Fund, during its three biggest performance years, averaged an annual turnover rate of over 350%. COM Capital Development Fund, managed by Ken Heebner, had a turnover rate of 272% and 226% in 1990 and 1991 respectively and was the top-performing fund from 1989 to 1994. You can't be active and on top of the market and do nothing. A good fund manager will sell stocks when he or she is worried about the overall market or a specific group, believes a stock is overvalued, or finds another, more attractive stock to purchase. That's what you hire a professional to do. Also, institutional commission rates that funds pay are extremely low, only a few cents per share of stocks bought or sold.

Are Monthly Investment Plans for You?

I do not generally favor monthly investment plans, where an investor adds $100 or so every month to a fund program. My reason is practical. Most people do not stick with them religiously. Therefore, they delude themselves by thinking they are going to achieve substantive long-term goals with such plans. If, on the other hand, you can have money automatically

If you can, it is best to evaluate your choices very carefully, then try to make a larger initial purchase and have the courage to stay with it. I also do not think people should make long-term investments in bond or preferred funds. Common stocks perform better.

If you want to check performance records, most magazines produce an annual survey that evaluates the performance of most of the funds. Your stockbroker or library should have special fund performance rating services such as Arthur Weisenberger or the Lipper service. Investor's Business Daily rates the prior 3-year record and shows the year to date and the prior year's percentage change in asset value for all mutual funds that are quoted daily in the newspaper. Additionally, several times a week it carries an article on a different fund and its investment activities.

An open-end fund continually issues new shares when people want to buy diem. Shares are normally redeemable at net asset value whenever present holders wish to sell. This is die most prevalent form of mutual fund.

A closed-end fund issues a fixed number of shares. Generally, shares are not redeemable at the option of a shareholder. Redemption takes place through secondary market transactions. Most closed-end fund shares are listed for trading on exchanges. There are ordinarily better long-term opportunities found in open-end mutual fund investing than in owning closed-end funds that are subject to the whims and discounts below book value of the auction marketplace.

A few people successfully trade aggressive no-load growth funds on a timing basis, using moving average lines. There are several services that specialize in fund switching. This requires considerable experience, timing, skill, and emotional discipline. I do not advise the typical investor to attempt to trade no-load funds, because mistakes would probably be made in timing of buy and sell points. Get aboard for the long pull.

Finally, some individual or professional stock traders use growth stock funds for their IRA or Keogh retirement plans.

Why Many People Lose Money in

Top-Performing Funds

Believe it or not, half of the people invested in some of the best-per-forming funds in the country may lose money. How can that happen? Very few people buy during a bear market. They're afraid. Far more people buy much later, during a bull market, when they feel much more assured. Some of these people then sell out over the next year or two when performance is slower or down. Why not buy and sit tight for the rest of your life and make a big fortune?

The Five Dumbest Mistakes Mutual Fund Investors Can Make

1. Failing to sit tight for an absolute minimum of 10 to 15 years.

2. Worrying about a fund's management fee, turnover rate, or dividends paid.

3. Being affected by news in the market when you're supposed to be investing for the long pull.

4. Selling out during bad markets.

5. Being impatient and losing confidence too soon.

Here are some strategies from a few of the smartest and best mutual fund portfolio managers in the business:

AIM Aggressive Growth Fund's Harry Hutzler and Jonathan Schoolar emphasize companies with a small market capitalization of $200 to $300 million. They evenly divide assets among 200 or so holdings to avoid having a bomb detonate in the portfolio if they had 4% or 5% in any one stock. They like stocks posting accelerating and better than expected earnings and also prefer to see both sales and earnings growing vigorously. Earnings reports are "where the rubber hits the road." Hutzler and Schoolar do not visit companies and will sell when earnings start decelerating or come in below expectations. They stay glued to the news wires for indications that earnings will be a lot higher or lower than expected.

Donald Chiboucas of Thomson Opportunity Fund states that their investment process is based on the theory of positive momentum-posi-tive surprises, which asserts that a good company doing better than generally expected will experience a rise in its stock price. Conversely, a company falling short of expectations will experience a drop in its stock price. Thompson looks for signs both on a company level and an industry level including capacity utilization rate. They break down every industry and company to their bellwether indicators that will signal surprises. They closely watch about 12 areas of a company's business.

Twentieth Century Ultra's forte is picking the very best growth stocks and they too look for companies showing strong earnings and sales growth. Their policy of remaining heavily invested at all times does, however, create volatility.

Michael DiCarlo of John Hancock Special Equities says they start by ranking each industry sector based on expected earnings per share growth as well as current business conditions. Then, within roughly the top five groups, he picks the companies with the best potential for price appreciation using a bottom-up approach. Generally, DiCarlo looks for companies with growing revenue and earnings of at least 25% per year, preferring those that are able to do this consistently.

To summarize, the way to make a fortune in mutual funds is almost always by your long-term sitting, not your thinking. If you purchase $10,000 of a diversified domestic growth stock fund that is able to average about 15% a year over a period of many years, here is what could occur, compliments of the magic of compounding and time:

First five years $ 10,000 goes to $ 20,000

Next five years $ 20,000 goes to $ 40,000

Next five years $ 40,000 goes to $ 80,000

Next five years $ 80,000 goes to $160,000

Next five years $160,000 goes to $320,000

Next five years $320,000 goes to $640,000

Next five years $640,000 goes to $1.28 million

Now suppose you also only added $2,000 each year to your program and let it compound over the years and you also bought a little extra during each bear market while the fund was temporarily down from its peak 25%. What do you think you'd be worth?

Although there are no absolute guarantees in this world, and yes, there are always taxes, the example above is somewhat close to what's been happening with the better growth mutual funds over the last 50 years and the American Stock Market has been growing since 1790. (See the chart on page xiv at the front of this book.) So, in my opinion, faith and confidence in America's long-term future is a very shrewd and intelligent position to take and stick with for as long as you live.

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