How you can acquire the Midas touch

Shrewd investors should take a long-term view of their buying choices and avoid becoming dedicated followers of fashion
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The Independent Online

Each year I get calls from private investors who want to buy the fund that came top of last year's league tables, or ask what will be the hot stock market sector for the next few months. Approaches such as these are bad ways to invest. Here is a basic set of guidelines to ensure a better approach.

Each year I get calls from private investors who want to buy the fund that came top of last year's league tables, or ask what will be the hot stock market sector for the next few months. Approaches such as these are bad ways to invest. Here is a basic set of guidelines to ensure a better approach.

Don't be swayed by fashion

Too many people invest on the back of last year's league tables. Yet the most successful investors are "trendsetters" rather than "dedicated followers of fashion". In the first quarter of 2000 many investors piled into technology funds on the back of a storming rally for the sector and excitement about the Internet. Then the bubble burst. Since March 2000 technology shares have seen price declines of up to 99 per cent. It is rare for last year's hot sector to repeat its performance. Unfortunately the art of successful investing is more complex than buying the fund that came top last year. If that were so, we would all be sipping cocktails on a beach and collecting cheques from brokers.

You should invest in a fund or market based on a fundamental view of its prospects for the future rather than its short-term past performance.

Treat past performance carefully

Investors should be wary about using past performance as a means of choosing an investment. This year the Financial Services Authority backed our view and are investigating whether they should clamp down on the use of performance data in fund advertising.

For example, the UK fund management industry has a very active job market. Top managers regularly get poached by rivals or leave to set up their own funds. Also, City institutions are merging at a ferocious rate. It means it is not uncommon for a fund to have a change of manager every three or four years. However, it is still common for newspapers and Independent Financial Advisers (IFAs) to print five-year performance tables. Worse still, many fund companies will advertise performance history despite changes in the manager. When you view a league table of funds, or read an advert about a fund's great performance, you may well be looking at a track record that does not belong to the current manager of the fund in question.

Don't invest new money without looking at your current portfolio first

Too many investors treat choosing their annual ISA as a free-standing decision, separate from the rest of their financial affairs. Near the end of the tax year they think: "What looks good at the moment?" This leads to portfolios that have no structure and investors can end up being over-exposed to certain markets. Before you invest you should always look at what you are currently holding and your asset allocation, identify where your portfolio is weak and use that as the key for selecting a new investment.

Buy on the dips

Many private investors worry too much about whether or not the market is too high or about to crash. We can't accurately predict such events. Some of the world's biggest and most well-resourced financial institutions get these calls massively wrong with terrible consequences. If crashes could easily be predicted they wouldn't occur. As a private investor you are more likely to get these calls wrong than right.

History shows that it is better to adopt a policy of steady buying and holding rather than gambling on market levels. Even investors who put money into the market on the eve of the 1987 crash were in profit within a year and over time these blips are evened out. However, when the market experiences a steep decline it makes sense to take advantage and buy on the dips. Instinctively most investors do the opposite and avoid the stock market when they hear news of losses.

Don't own it if you can't monitor it

If you are going to invest in actively managed stock market funds, you need to keep a close eye on them. Top managers leave, fund management companies get taken over and past stars can lose the Midas Touch. All of these may force you to sell a fund that seemed OK when you bought it. Many advisers think their role is to select a good fund, sell it to you, forget about it and try and sell you something new next year. This isn't good enough - you can't afford to take your eye off the ball.

Be sceptical of new launches

Buying a fund at launch can have distinct advantages. For example, the manager can start with a clean sheetand small fund size means they can dart in and out of stocks more easily. That said, it is important to realise fund companies tend to launch new funds when the marketing department sees an opportunity that may not necessarily coincide with the best time to invest in a sector. A year ago fund companies such as Gartmore and Jupiter launched technology funds in the run-up to the end of the tax year, a period on the eve of the crash in tech stocks.

* Jason Hollands is deputy managing director of Bestinvest, an investment adviser

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