How To Invest In The Best-Performing Funds

by Alan Lavine and Gail Liberman

Looking to make some fast bucks in a mutual fund? Recent research says to buy the funds with hot hands.

This isn't the kind of investment you should make if you are saving for long-term goals like retirement or your child's higher education. Buying the best performing fund over the past six or 12 months is for those who have extra cash to play the markets. It is speculative.

Thomas J. Zwirlein and Venkateshwar K. Reddy, both associate professors of finance at the University of Colorado, found that sticking with the best-performing funds can be profitable. Their study is published in the August issue of the Journal of Financial Planning (www.journalfp.net).

The professors assumed a total of $600 was invested each month in one or more of six categories of mutual funds from aggressive growth to balanced funds. Then they compared the return and risk for a variety of investment strategies. They looked at mutual fund performance from January 1977 to December 1992, intentionally avoiding the most recent bull market.

The best results, whether on a quarterly or annual basis, occurred using the "follow the winner" strategy. They put all current and past contributions into the category of mutual funds that had performed best in the previous timing period. The best results occurred when adjustments were made each quarter, and the category that was chosen was the one that had done the best the month before the portfolio adjustment.

For example, the strategy of moving the entire portfolio each quarter based on the most recent month's best return gained $489,023. By contrast, the investment grew to $409,294 when the category selected was the winner based on the previous three-month returns. 

If you bought and held the money, it grew to $345,838. Because of the potential tax consequences of moving frequently from one investment to another, this "follow the winner" strategy works best inside a tax-deferred IRA or 401 (k) plan.

Be advised. There are risks.

"The strategies that produces the best returns, comes with higher risk," Zwirlein says. The risk is that you can experience large swings in the value of your mutual fund, compared with making regular investments into a well-managed mutual fund. 

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show.

More articles by Al and Gail can be found here.