One of the most common mistakes investors make is to rush into a fund simply because it gets hot for a year or two.
Before investing your hard-earned money, you need to know why a fund has put up such good numbers.All too often a fund languishes for years with little attention from the financial press or the investing public. Then it has a good streak for a year, maybe two or three years.
Money pours in from eager investors, but the fund's performance peters out. Sometimes this phenomenon is inevitable.
Choosing good mutual funds is as much art as science. At times, even the most painstaking analysis falls flat on its face.
But looking behind the numbers can help you avoid funds unlikely to repeat their recent success.
Take SAFECO Equity (800-624-5711), a solid, if unexceptional, fund that's been managed for a decade by Doug Johnson.
Johnson, 40, hunts for beaten-down stocks with solid businesses that he thinks will revive.
He doesn't usually visit a company and "kick the tires" before buying. But one evening after work he ended up, in essence, kicking the tires on a company by serendipity.
Hitting golf balls at a Seattle driving range, Johnson, an avid golfer, tried a new kind of club made by Callaway Golf. He liked it a lot.
"It's more forgiving of mis-hits than other clubs," he says.
After detailed study, Johnson loaded up on Callaway when it went public a few months later, making the stock a full 5 percent of his portfolio, his biggest bet ever.
The stock soared more than 200 percent last year and is up about 30 percent more this year.
In large measure because of Callaway, SAFECO Equity trounced the Standard & Poor's 500-stock index by 21 percentage points last year.
"That's shooting the lights out," Johnson says. "It'll never happen again."
But many investors didn't get the message. Assets of SAFECO Equity have nearly quadrupled since the end of 1992 from $84.5 million to $331.9 million.
Much of that new money will likely depart in disappointment if Johnson doesn't repeat.
The bottom line: If you don't know why a fund has had a good streak, you may end up betting on something that's highly unlikely to happen again.