The Major factor that causes performance differences in stock mutual funds is the choice of allocation between domestic stocks and foreign stocks. The value of U.S. stocks makes up about half of all stocks traded around the globe; the rest of the world’s markets make up the other half. The returns of various markers around the globe are not in perfect sync with each other. This is due to currently fluctuations, economic factors, laws, customs, trading procedures, and other issues. As a result, there are times when U.S. stocks perform better than foreign stocks and there are times when foreign stocks perform better than U.S. stocks. Some investors try to follow the flow of money into various regions of the world. For example, there was huge demand for Japanese stocks in the late 1980s; then the demand shifted to emerging markets like Latin American stocks in the early 1990s, and then again to Europe in the late 1990s.
As people try to make the best investment decisions and choice of allocation they can with the minimum information they have, tend to focus on past performance numbers. If investors notice their funds are not keeping pace with the more popular trends in the market, they will sell their funds and buy funds that are in style. Not only will investors buy a hot fund style near its peak, but they are also likely to sell an out-of-favor style near its low.
Its important to mention the implication of the major factors affecting the performance of a stock mutual fund are its size bias, growth or value bias, and its country bias. These factors have moved in relation to one other over the years. Studying the implications of these factors is educational, but using it to predict the future is somewhat impossible.
Just when you think you see a pattern in the numbers and feel you can predict where the next gains will be made, you notice another time period where following that strategy would have resulted in a loss. For example, Japanese stocks had miserable performance during most of the 1990s, but they looked like they were staging a comeback in 1999. Based on this observation, you may have decided to invest heavily in Japan. Bad move Japanese stocks were the worst-performance market in 2000 and 2001. Trying to time sectors and styles does not work.
Finally, we shall illustrate the dangers of selling one type of mutual fund style and buying another simply because the investment strategy is out of sync with the short-term thinking of a herd mentality. Chasing the hot dot may feel right at the time, because that is what everyone else is doing, but it is almost always the wrong decision. Trying to catch the wave on a hot style guarantees poor performance in a retirement account. The most reliable strategy is to own all types of mutual funds, all of the time, and keep the amounts you have in those funds balanced. Broad diversification is a key to success in any long-term investment plan.
Choice of Allocation and Key Points To Note
- The overall performance of mutual funds is much higher than the average investor experiences. Every two to five years, the public herds from one fund type to another, chasing the best-performing funds. During this migration, investors tend to sell out-of-favor funds at low prices and buy in-favor funds at high prices, undermining the long-term performance of their retirement account.
- The three elements of equity mutual fund holdings that explain nearly all the return of a given fund are size (large vs. small stocks), style (growth or value stocks), and geographic region (U.S. or foreign stocks).
- It is impossible to predict which type of fund will outperform the other. Therefore, the best strategy is to hold a diversified portfolio that contain all types of stocks and stick with a constant mix