Chapter 8, Additional Exercise 4: Putting Your Eggs in Several Baskets

The following text, called "Investor to Investor," appeared on the website of Vanguard, an investment management company. How persuasive is it? What changes would you recommend to the writer? Be prepared to share your findings with the class.

Last year, according to the Securities and Exchange Commission (SEC), a record number of mutual funds posted returns of 100% or more. Such results have prompted the SEC to urge investors to look further than short-term performance when it comes to evaluating funds.

The SEC recently issued tips for the 83 million Americans invested in mutual funds, warning that high-performing funds often fail to repeat their gains. Instead of chasing performance, investors would be better off shopping for funds that best match their long-term financial goals and risk tolerance.

Vanguard Chairman and CEO John J. Brennan has similar concerns. "Buying last year's or last quarter's top-performing investment is a dangerous strategy," Mr. Brennan said. He offers additional insights in a recently published "In The Vanguard" interview, "Brennan Urges Investors to Tune Out Noise, Focus on Basics."

Historically, investors who follow fads and jump in and out of funds typically fare worse than those who buy and hold. In addition, buying into a well-performing fund after the fact could result in a considerable tax liability if the fund distributes its gains to shareholders—gains that recent investors didn't benefit from. Also, investors who hop from fund to fund may incur their own taxable gains.

The SEC suggests that investors thoroughly read the prospectus and annual report for any fund they're considering. Assessing a fund's cost is important—a difference of one percent in a fund's annual fee could reduce the fund's ending balance by 18% after 20 years.

The SEC offers the following guidelines for fund evaluation:

For more information, read the SEC's Mutual Funds Tips.