Page 525 - How to Make Money in Stocks Trilogy

394 INVESTING LIKE A PROFESSIONAL

The first thing to understand is that the big money in mutual funds is
made by owning them through several business cycles (market ups and
downs). This means 15, 20, or 25 years or longer. Sitting tight for that
long requires enormous patience and confidence. It’s like real estate. If
you buy a house, then get nervous and sell out after only three or four
years, you may not make anything. It takes time for your property to
appreciate.
Here’s how I believe you, as a shrewd fund investor, should plan and
invest. Pick a diversified domestic growth fund that performed in the top
quartile of all mutual funds over the last three or five years. It will probably
have an average annual rate of return of about 15% or 20%. The fund
should also have outperformed many other domestic growth-stock funds in
the latest 12 months. You’ll want to consult a reliable source for this infor-
mation. Many investment-related magazines survey fund performance
every quarter. Your stockbroker or library should have special fund perfor-
mance rating services so you can get an unbiased review of the fund you’re
interested in purchasing.
Investor’s Business Daily rates mutual funds based on their 36-month
performance records (on a scale from A+ to E) and also provides other per-
formance percentages based on different time periods. Focus your research
on mutual funds with an A+, A, or A– performance rating in IBD. During a
bear market, growth fund ratings will be somewhat lower. The fund you pick
does not have to be in the top three or four in performance each year to give
you an excellent profit over 15 years or more.
You should also reinvest your dividends and capital gains distributions
(profits derived from a mutual fund’s sales of stocks and bonds) to benefit
from compounding over the years.

The Magic of Compounding

The way to make a fortune in mutual funds is through compounding. Com-
pounding occurs when your earnings themselves (the performance gains
plus any dividends and reinvested capital) generate more earnings, allowing
you to put ever-greater sums to work. The more time that goes by, the more
powerful compounding becomes.
In order to get the most benefit from compounding, you’ll need a care-
fully selected growth-stock fund, and you’ll need to stick with it over time.
For example, if you purchase $10,000 of a diversified domestic growth-stock
fund that averages about 15% a year over a period of 35 years, here is an
approximation of what the result might be, compliments of the magic of
compounding: