Apples to Apples

Posted by dfederman on Dec 20, 2011 in Investor Education | Comments Off

“What do you think of these top rated mutual funds ranked in Kiplinger’s magazine?”

This was a question recently asked to us by a client. One of the funds was an “Emerging Markets Small Cap Dividend” ETF which had a “great three year track record of 16% a year.” As impressive as this may seem, this information is irrelevant and really does not explain why the fund did so well. Nor does it predict how it will do in the next three years.

When reading about a highly touted mutual fund (or any other investment) in a financial magazine, avoid getting sucked into the hype, and never assume that past performance can predict the future. It is important to compare “apples to apples.” i.e. small cap emerging markets dividend funds should be compared to the small cap emerging markets category in terms of both performance AND risk.

Instead of starting your next financial/investment conversation by asking, “what do you think about XYZ investment?” Ask, “how does XYZ investment fit into my overall financial plan?” By focusing on your financial plan, you will be forced to examine your net worth, expenses, income needs, time horizon, goals and most importantly, your personal values.

By holistically reviewing your personal financial circumstances, you will in large part be able to avoid many of the pitfalls that come from seemingly harmless investment ideas you read about in a magazine. As you examine your situation, you will then determine how much risk you NEED to take to reach your financial goals. If the analysis from your advisor determines you only need to earn 5% a year for the next 15 years, then clearly you do not need to place your entire investment portfolio into the stock market, let alone small cap emerging market dividends. With that being said, if it makes sense to add emerging market small cap dividends to the mix, then by all means include this asset class as part of a highly diversified portfolio to help you reach your long term financial goals.

Apples to Apples - comparing your funds to their respective asset class