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Mutual Funds
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Beware today's winners
Don't be fooled. The best funds so far this year may not be your best bets long term.
July 1, 2003: 11:20 AM EDT
By Jeanne Sahadi, CNN/ Senior Staff Writer

NEW YORK (CNN/Money) – Everybody loves a winner, right? After all, who doesn't want in on the golden touch, especially when there's the promise of money to be made?

Well, when it comes to mutual funds, there are winners and then there are winners. You'd do well to know the difference.

Every quarter you'll see reports here and elsewhere on the funds with the best returns for the past three months or, as is the case at the end of June, the first half of the year. You'll scan those lists to see if you own any of the winners. And if you don't, you might make a mental note to consider investing in them.

Save your energy – and your envy.

Why today's winners don't matter that much

Lists of quarterly or even half-year winners should not be viewed as a buy list. If anything, they might be viewed as a sell list, said Russel Kinnel, Morningstar director of mutual fund analysis.

Here's why.

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For starters, if you're looking at the top 10 funds in the broad universe of all mutual funds, "only the most volatile funds will make the list," Kinnel said. Those are the funds subject to the biggest highs and the biggest lows.

For the first half of this year through June 30, technology sector funds ruled. The average return for the category was 23.87 percent. And guess who turned in the "let's party like it's 1999" returns? Internet funds, the very same that crashed and burned when the bear broke up the party in 2000 – funds like Amerindo Technology (up nearly 65 percent) and Jacob Internet (up nearly 54 percent).

And to make money (or at least to avoid getting burned) in a volatile fund means you need to be in it at just the right moment when those outsized gains are racked up. Otherwise, please pass the aloe vera.

Secondly, a look at short-term winners -- even those that aren't as volatile as sector funds -- is a look at funds that have experienced huge runups. So if you buy into them now, you're likely to pay a premium for the privilege, Kinnel said.

And lastly, one or two quarters' performance at the top of the heap doesn't necessarily tell you much about a fund manager's skill, which is revealed with consistent category-beating returns over time, Kinnel noted.

How to pick the real winners next quarter

The funds you'll never see topping the short-term leaders lists are the steady eddies of the world such as Dodge & Cox Stock, Fidelity Low-Priced Stock, T. Rowe Price Equity Income or Washington Mutual, Kinnel observed.

These are the funds that frequently outperform their peers and make investors money over time but never punch the lights out with one swing.

So if you're looking to buy a fund in the second half of this year, you might do better to pick a fund that invests in an area of the market that has suffered the most during the bear market because you're more likely to get them at a better price, Kinnel suggested. Among his recommendations: large-cap growth stock funds, foreign-stock funds and short-term bond funds.

And when picking a fund, opt for one that has outperformed its peers for most quarters of its existence, he advised.

If you still can't resist the lure of horse-race comparisons, why not take a look at the select universe of funds to which Morningstar analysts have given the thumbs-up as solid long-term bets for the diversified investor's portfolio. They were chosen not only for their strong performance over time, but for their reasonable costs and their managers' track records. (Note: The analysts' favorite picks in each category of funds are only available to Morningstar subscribers.)

The Morningstar picks that performed best in their category in the first half of the year included: Vanguard Growth Equity for large-cap growth funds (up 17.77 percent); ICAP Select Equity for large-cap value funds (up 17.46 percent); William Blair Small Cap Growth for small-cap growth funds (up 25.07 percent); FPA Capital for small-cap value funds (up 14.18 percent); and Harbor International for foreign-stock funds (up 9.68 percent).  Top of page

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