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"Mutual Fund Merry Go-Round" - Part Two


1.  Mutual Fund Rating Services – Morningstar.

2.  Analyzing Past Performance Data.

3.  Newsletters, Hotlines & Fax Services – Buyer Beware!

4.  False Or Misleading Track Records.

5.  Investment Advice On The Internet – Very Risky.


Two weeks ago in “Mutual Fund Merry Go-Round” – Part One, I discussed how most mutual fund investors don’t make what the market indexes make, mainly because they hop from fund to fund to fund looking for the latest “hot” performance.  It is my strong belief that most people would be better off using professional money managers to direct their investments.

This week, we will look at the mutual fund ranking services, such as Morningstar and others.  While these services can be helpful in selecting mutual funds, they can be very expensive and they also have their drawbacks.  Just because a fund has a “5 Star” rating, that doesn’t mean it will continue to do well in the future.

Unfortunately, many people turn to investment newsletters, telephone/fax hotlines and/or various Internet services for help when they become frustrated with their own results.  This week, I will talk about these subscription services and why, in most cases, you should just say NO.  

Remember that this Mutual Fund Merry Go-Round series of E-Letters includes some fundamental principles of investing in mutual funds and other investment vehicles I will cover in subsequent issues.  You are free to share this information with others.

Mutual Fund Ranking Services

One of the do-it-yourself techniques for investing is to subscribe to one of the mutual fund rating services such as Morningstar, Value Line, or Standard & Poors.  These services provide a wealth of statistical information on each of the mutual funds they cover.  In addition, each service has a proprietary ranking of the funds that are designed to help you shortcut the process (not always a good idea).  For purposes of this discussion, I’ll concentrate on Morningstar, since they are the most well known rating service and are one of the tools we use in evaluating mutual funds at my firm.

The first thing you encounter when dealing with the Morningstar software or website is the sheer volume of information provided.  There is historical performance data, ratios, details about each fund’s holdings, etc., etc.  Because of the huge volume of information, many investors just go to the rankings and pick the top-rated funds.  But this can be very frustrating as we will discuss below.

Analyzing Past Performance Data

For those more intrepid investors who are willing to wade into the sea of data, other challenges emerge.  As with any performance information, the best any rating service can give you is a look in the rearview mirror.  You can see what the fund’s manager has done in the past, but you can’t foresee the future.

You might think that past track records are pretty cut-and-dried, since they represent actual numbers.  However, even past track records must be studied carefully to see how the returns are spread among the years and months.  Does the fund have a consistent pattern of good returns, or were there one or two fantastic years in the past that are now making the average annual rate of return look good?  This is especially true in recent years as the market declined.

Even if you find funds with superior performance in these difficult markets, you have to continue to dig through the information to see if it is suitable.   For example, did the fund have a relatively smooth pattern of gains, or were there high gains and then large losses – “whipsaws?”   Most investors are more suited to a smooth pattern of gains, and usually exit those high volatility funds that have wide swings in their performance.

Be Careful With Sector Funds

You should also be careful when looking at the various “sector” funds.   Over the years, different sectors rise and fall from prominence.  Because of their hot performance, the top-performing sector funds tend to be at the top of the rankings, and get the most inflows of new money.  This is what the Dalbar studies talked about when they said that investors hop from one “hot” fund to another, chasing performance.

The likelihood that the same sector will be the top performer in the next year or two are low, and investors who chase the hottest funds usually end up with poor results, as evidenced by the Dalbar studies.

Also look at the fund’s category.  Morningstar segregates funds into various categories based not on the stated objective in the prospectus, but on what the fund actually holds.  Sometimes funds drift from one category to another, possibly skewing the comparison between them and other funds in the same category.

Once an investor pores over the data and selects a potential fund, the work isn’t over yet.  Other things have to be checked.  For example, is the portfolio manager that produced the impressive returns still running the fund?  If not, when did the current manager take over?  Has the performance been the same, better, or worse during the current manager’s tenure?

Reaching For The Stars

As I mentioned above, many investors want to take a shortcut around analyzing all of this data and just go by a single performance indicator.  In Morningstar’s case, this is the “Star Rating.”  Their top ranking is 5 Stars; their worst is 1 Star.  Much of the new money flowing into funds goes into only funds with a “5 Star” rating from Morningstar.  However, are the star ratings an effective shortcut to finding superior funds?  Recent studies suggest that they are not.

The Wall Street Journal recently featured a story about a study by Matthew R. Morey of New York’s Pace University.  The study found that funds rated highly by the various independent mutual fund ratings firms did not tend to perform any better than funds with moderate ratings.  Professor Morey stated, “Mutual fund ratings services can’t really predict winners.”  Professor Morey’s study was not the first to come to this conclusion.

While Morningstar has recently revamped its rating system to be more effective, Professor Morey doubts that it will affect the final outcome.  Others agree.  Don Cassidy with Lipper, Inc., another well-known market research firm, said: “Whatever rating system you use, there’s a degree of performance-chasing…you can’t predict how long one fund or another will do well.”

The moral of this story is that there is no shortcut to effective investing and financial planning.  Rating firm recommendations and hot tips from a co-worker in the break room are not effective means to build a diversified portfolio.  Either investors have to pore over detailed information, crunch numbers, and do periodic comparisons, or they need to hire professionals to do the job for them.

Investment Newsletters & Misleading Advertising

There are hundreds of so-called “investment newsletters” out there that give advice but leave it up to the reader to take action.  Some have relatively small readership and are targeted at their local audience.  Others are quite large in terms of subscribers, all across the country, and advertise widely.  Most people reading this E-Letter have received direct-mail promotions for these types of services.  Since I subscribe to so many investment-related publications, my name is on most of the mailing lists that are rented, so I receive hundreds of these direct-mail promotions every year.

There are several problems with trying to invest based on a weekly or monthly investment newsletter, which I will discuss below.  By far and away the biggest problem, in my opinion, is FALSE OR MISLEADING ADVERTISING.  Question: have you ever seen a direct-mail promotion for an investment newsletter (or trading system) showing poor performance results?  Of course not!  They always look great, don’t they?

Some people read these ads and assume the results are real.  Sometimes they are, but more often than not, the results are either flat-out false or very misleading.  You might wonder how these promoters get away with this.  First of all, most investment newsletter writers and promoters are NOT REGULATED.  Even though they give investment advice and recommend securities, they can avoid registration if they simply do not deal directly in securities or manage money directly.  Ditto for newsletters that give commodity futures advice or info on “hedge funds.”

If they deal in securities, they must register with the Securities & Exchange Commission (SEC) and in most cases must become members of the National Association of Securities Dealers (NASD).  This subjects them to rules and regulations and compliance oversight (periodic regulatory examinations).  Because of this, most newsletter writers and publishers elect not to deal in securities, but rather just give advice.  In this case, they are not currently required to register with anyone.

[As noted in the past, my company is registered with the SEC, the NASD, several other regulatory agencies and in all 50 states.]

Hypothetical Track Records – Buyer Beware!

As noted above, the track records you see advertised may be flat-out false, just simply made up.  Other track records may be constructed via a method called “back-testing.”  In this method, the person(s) goes back in time and constructs a track record with the benefit of hindsight.  Unfortunately, they often fail to warn the subscriber that the track record is “hypothetical” and was never used in real time.

Still others (and I can name a bunch in this category) advertise only their profitable investments and do not disclose their losers.  I see lots of promotions where they boast of their winning trades, even giving you the actual dates when they bought this or sold that.  Of course, these promotions always look spectacular.  But that’s because they don’t tell you about all (or any) of their losing trades.

You should never assume that any direct-mail advertisement is 100% accurate or honest!  You should make them prove that the record is accurate and not misleading.  Unfortunately, this is very tough to do.  Many times, the promoters give misleading answers to cautious inquirers, like the following:

“Well, we don’t have an actual track record, because we only give advice, and we don’t know exactly what our subscribers do with that information.   You should just subscribe and see how you do.  We’re sure you will be delighted.”

If you hear a CROCK like this, or anything along this line, you should hang up the phone.  If they have a good service, they will be all too happy to send you performance information.  If they won’t give it to you, or tell you they don’t have one, just hang up.

Telephone & Fax Services Can Be Just As Bad

There are many expensive “hotline” services out there.  You pay a monthly or annual fee to get the “secret” hotline phone number.   Each day or each week, the hotline promoter gives new advice on which stocks or funds (or futures) to buy and sell.  Most of these services are very expensive, some as high as $5,000-$10,000 a year.

Some of these hotline promoters advertise widely with very professional-looking mail packages.  However, some that I know of advertise only their profitable trades and are generally silent about their losers.  Again, you should never assume that any direct-mail advertisement is 100% accurate or honest!

Other Problems With Newsletters & Hotlines

In addition to the obvious problems with false and misleading advertising, there are other problems with trying to follow newsletters or hotlines.  The most obvious is that you must read or hear the information as early as possible, and then be able to act on it very quickly.   Second, the information is dated by the time you receive it, especially in the case of newsletters which are typically written at least a week before you receive them.  Even if you follow a daily hotline, market conditions can change dramatically overnight. Third, some of these services put out pretty complicated advice.  If “this, that and the other” happen, then you buy or sell.  If they don’t happen, then you don’t buy or sell.   This can be very complicated and confusing, and there’s usually no one to call for clarification.

A Few Good Ones

While I don’t recommend that you try to invest by following a newsletter, fax service or telephone hotline, there are a few good ones out there.  Our old friend, Richard Band, writes a very good monthly newsletter with lots of good information.  But Richard’s investment newsletter is one of the few good ones I have seen over the years.

There are a couple of services that track investment newsletters and hotlines; they read or listen to the advice and then track the performance by “paper trading.”  The oldest and largest of these tracking services is Hulbert Financial Digest (now a part of CBS Marketwatch).  Hulbert tracks 150 or more newsletters and other services and estimates their performance.  You can subscribe for $59 per year at, but I don’t recommend it.

Why not?  With all of these subscription services, you have to: 1) be available to get the information, usually on a daily or weekly basis, even during vacations; and 2) you have to make the trades and/or implement the advice yourself.  This just doesn’t work for most people, even if the information and advice are good.

Internet Investment Services

I couldn’t begin to name all, or even most, of the many investment services now offered online.  There are probably thousands of various services on the Web.  People are selling all types of investment advice, trading programs and systems on the Internet, most all of which advertise that they will make you wealthy.

When it comes to shopping the Internet for investment advice, you really have to be careful.  In this case, it is more important than ever that the firm you deal with be registered with at least the SEC and/or the NASD.  The Internet is UNREGULATED, so people can put anything on the Wed they choose, no matter how false or misleading.  However, those of us registered with the SEC and/or the NASD are required to comply with the same rules and regulations on the Internet as we do elsewhere. 

Registered Investment Advisors

As discussed last month, I strongly believe that most investors would be better off by using professional money managers (and I don’t mean your broker) to direct most of their investments, especially stocks and bonds and mutual funds.  These professionals are known as Registered Investment Advisors (“RIAs”) and they are registered with the SEC.

Because there are over 20,000 RIAs in the U.S. alone, it is very difficult for most investors to find and evaluate those professional money managers that suit their objectives and accept the amount of money they have to invest.

At ProFutures Investments, we provide this valuable service.  We search the universe of RIAs to find those with impressive performance records.  We conduct on-site due diligence visits for every RIA we recommend.  We have RIAs that specialize in selecting mutual funds in both stocks and bonds.

If you would like to learn more about these professionals, click here.

In the next couple of weeks, I will discuss in detail how we find and evaluate RIAs and how a select few make it onto our recommended list.

I hope this information is helpful.

Best wishes,

Gary D. Halbert


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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