Is Your Mutual Fund a Clunker?

By: Jonathan D. Pond | Source: AARP.org | May 8, 2009

The stock market doesn’t respect calendars.

After suffering the worst single-year decline since the 1930s, the 2008 stock market dashed all hopes that 2009 would start with a rebound. January was a downer, and the first half of February wasn’t any better.

That being said, some mutual funds fare better than others in both rising and falling markets. Of course, faring “well” last year might have meant that a fund lost 20 percent rather than 40 percent.

Striving to own above-average funds in both up and down markets is a very important goal. But many investors and, dare I say, investment advisers, don’t do very well in declining markets. One major problem is that so many previously excellent mutual funds performed horribly last year. Investors were—and are—none the wiser.

That’s why it’s very wise right now to evaluate how your mutual funds performed last year.

You may be horrified to find that some big-name funds with excellent track records had miserable years in 2008. In fact, hundreds of mutual funds that consistently performed in the top 25 percent of their peer groups before 2008 performed in the bottom 25 percent last year, much to the horror of their investors—or more accurately, the few investors who bothered to check their funds’ performance. That’s a shame, because it only takes a few minutes to find out how a particular fund has performed.
Here’s how:

Reuters' Web site has an area where you can fill in either the name or the symbol of a mutual fund you would like to evaluate.

Once the data for that fund appears on your screen, click on the “Performance” tab and then scroll down to “Total Return Performance.” You should evaluate two key performance indicators:

• One-year “percentile rank”
• Three-year “percentile rank”

Ideally, the fund will have a percentile rank of 25 percent or less over the past one- and three-year periods.

If the fund  has a percentile rank of 51 percent or more compared with its peer group over the past year, this is a red flag. Unless you have confidence that the fund will come back to its previous glory days, consider replacing it with a better fund. If the fund has performed in the bottom half of its peer group for the past one- and three-year periods, there’s no compelling reason to continue holding on. There are many excellent funds from which to choose.

For Your Employer’s Retirement-Savings Plans

Your 401(k) or 403(b) plan at work may have precious few, if any, choices that are consistent top performers. The same goes for those who work for nonprofit organizations or government agencies who are saving for retirement through TIAA-CREF or the Federal Thrift Savings Program (TSP).

The trick here is to emphasize the best choices within the plans available to you and to round out your portfolio allocation in other investment accounts (such as IRAs or brokerage accounts) that give you a wider investment choice, including some really outstanding funds. For example, if the small-company stock fund offered in your plan at work is a clunker, avoid investing in that fund. Instead, find a top-notch, small-company fund for your brokerage, mutual fund, or IRA account.

While top-performing funds are more likely to perform very well compared with their lower-ranked brethren, there's still a possibility that they'll fall out of bed later on. You need to periodically check up on them, but no more than once a quarter. Poor performance relative to peer group over a prior month or quarter does not necessarily mean you should sell the fund. All funds periodically go through tough months or quarters, only to rebound later.

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