The LIMB Method of Choosing Mutual Funds
I have been revisiting the year's top gainers list for a future post, and have looked again at the "CANSLIM" method for stocks invented by William O'Neill, founder of Investor's Business Daily newspaper and author of investment guidebooks, just for mental exercise. I always get somewhat confused and tied up in knots worrying about stocks, so funds are relaxing for me to look at. As far as mutual funds are concerned, the "LIM" are more important than the "CANS" in my view. (This is something I decided myself, and it really simplifies the process of choosing mutual funds.)
L - Leaders vs. Laggards. Choose leading mutual funds. The leadership of previous mutual fund success is easily found in fund charts (e.g. bigcharts.com) by checking longer time horizons. The bigger vista tells you more with mutual funds, as John Bogle says. This also tells you how they have fared in the most recent bubbles, and helps you invest based on how much you can afford to lose. The less you can afford to lose, the more conservatively you must invest. The younger you are, the more risks you can take with some of your money.
I - Institutional Support. Again, choose leading mutual fund companies, because they mostly are the institutional support and some have lower fees than others. Easy.
M - Market Direction. Not so easy. In fact, this is the hardest. You want a fund heading up, right? This is why Bogleheads stay in funds and won't move out. Don't get me wrong, I like Vanguard et al. But funds tend to move up and down slowly, with some exceptions giving you time to think about your moves. Certainly, it's normal to change mutual fund lanes more slowly, SUV style, than to day-trade stocks lightning fast, because diversification and staying in the market are constant themes for good reason. The idea is to put money to work at all times, if possible, and choose carefully based on "your risk tolerance."
B - Beta. Beta is the financial term for volatility. 1(One) is the baseline for mutual funds, and the more risky, the farther away from 1 the beta is. It's a factor to compare when choosing mutual funds, especially sector and commodity funds as these move fastest.
L and M especially are the most important criteria for choosing leading mutual funds because they're all we have to go on. Even Jim Simons, the legendary hedge fund owner, says he chooses stocks based on past performance because it's all the information he has. Of course, for legal reasons, stocks and funds constantly have the "beware" sign up.
Even though most of us aren't full-time day traders, there's still plenty of opportunity to do well in the market. We have lives. Full lives. With computers, we don't have to make charts by hand laboriously as we certainly used to have to do.
It's possible to invest in tax-exempt mutual funds and make off well all by yourself without spending hours and hours on it with the help of your quick online research. Morningstar.com and Fidelity.com are some online resources to check because you can compare funds and their fees (lower is usually better). You may want to spend hours depending on the size of your portfolio, but you don't have to. You can choose a mutual fund based on incomplete knowledge of a fund, and that's all right, just as you won't ever know everything about a company if you buy its stock. For most consumers of mutual funds, fund leadership and market direction are key. Like children, vigilance is everything, but less so with mutual funds than stocks.
To summarize: funds are a lot easier to manage for the average investor than stocks for the following reasons,
(L) leadership - previous fund success
(I) institutional support - lower fees
(M) market chart direction and
(B) beta or volatility.
The point is that buying anything is a whim, including investments, necessities and groceries. Sorry if this is too basic, but there are thousands of stocks and funds to buy and it's a buyer's market. I can't help giving my two cents for what it's worth.