The recent excitement over California Chrome and horse racing is a reminder that investing, in its own way, is a gamble, and that picking a mutual fund is remarkably similar to picking the ponies.
While some people pick both funds and horses based on names, hunches, and other guesswork, examining a fund the way a savvy bettor observes a thoroughbred improves your odds of finishing in the money.
In funds as in horse racing, favorites don’t always win. Past champions can come up lame, slow with age or simply not keep pace as conditions change.
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Thinking about funds the way a bettor evaluates the ponies may help you feel confident, like you’re not taking a gamble so much as picking a sure thing.
Whether you are a stock jockey, a gambler or an ordinary investor just trying to make a solid choice, weigh these factors to pick your next investment horse:
• Length of the race and style of the horse. Some funds — like horses — are bred for sprints, others for distance.
Concentrated, leveraged and specialized funds often act like speed horses, running up big early leads before faltering down the stretch; the longer the race — in this case, your investment time frame — the tougher it is for them to hang on.
Conversely, some funds only go to the front of the pack late in the race, when more trendy styles are faltering. They may not look good in the early running or all conditions, but they wind up in the winner’s circle if you give them enough time.
Pick funds that match your investment personality, that keep you feeling like you have a chance.
Unlike a horse race, you can change funds as they round the turn and head for home, but studies show that the longer you stay in the saddle and the less jockeying you do, the more likely your fund gambles pay off.
• The jockey. Like a jockey, a fund’s manager must take advantage of opportunities. As an investor, you can choose a proven winner, an up-and-comer, an unknown, or no real rider at all (as in an index fund).
• The field. In any horse race, the size and quality of the field is a factor. In funds, the field is every offering within an asset class. If you can’t find funds you’d bet on in a category, skip that race and stick with more attractive groupings; you don’t have to bet every race to be a winner.
• Track conditions. Some funds do well in all market conditions, others only seem to win when the market favors their style; that’s akin to how some horses like a clean track, while others do great in the mud or on grass.
Funds will face changing market climates, so don’t just consider what they have done lately, but how they’ve performed, relative to peers, in bad weather like the financial crisis of 2008.
• Stable, trainer, and blood lines. The same fund firms seem to consistently top the charts, just as certain trainers and stables seem to have a presence in the Triple Crown races every year.
If a brand-name firm, recognized style, or a management culture and ethic makes you more comfortable putting your money down, trust your gut.
• The weight. In certain races, some horses carry more weight than their opponents. The idea — especially in handicap races — is that the horse with the best record carries the most weight, helping lesser horses compete.
In mutual funds, fees, expenses, sales charges, and tax inefficiency all act as extra weight; they are a handicap that typically cannot be overcome. The less weight your fund carries, the more likely it makes you happy in the end.
• Track record. Past performance is no guarantee of success in horse racing or mutual funds, but it’s always worth considering what a fund has done as you form expectations for the future.
• Odds. Oddsmakers gauge the race and the public’s betting pattern to determine if a horse is a favorite or a longshot.
Morningstar, Lipper and others play that role in the fund world, evaluating funds and helping to establish the odds that a particular investment will finish in the money.
• The bet you are comfortable with. Betting it all on the nose to win is a different gamble than betting on a horse to play or show, let alone taking a shot at a quinella or an exacta; the payouts and the odds vary, as does your ability to generate consistent returns.
In both horse racing and investing, you can be rewarded without finishing first. Diversifying your wagers — rather than going all-or-nothing — tends to make you a winner over time.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at firstname.lastname@example.org or at P.O. Box 70, Cohasset, MA 02025-0070.
Copyright 2014, MarketWatch