New Year's Resolutions for Fund Investors

I won't be swayed by the latest hot fund managers. You know the names -- Bill Gross, David Tice, Bill Miller. Those are today's stars. A few years ago it was Kevin Landis, Garrett von Wagoner, Alan Harris. These guys are more than just telegenic with pithy market observations at the ready -- we'd venture to say they're pretty smart. But even the smartest money managers aren't right all the time; and what's more important is that they don't manage money the way you should. These folks are making big bets, largely hoping for short-term gain. Individual investors are making relatively small bets and should be focused on long-term returns.

So while you can drink in whatever the talking heads have to say, keep in mind that no matter how prescient past comments seem to be, or how much you instinctively agree with what they're saying, that's not enough of a reason to pour money into their funds. Take a more circumspect view of your portfolio.

I will pay attention to taxes and expense ratios. It's hard to say which can do more damage to your portfolio -- poor internal tax management or high fees. A study released in August by Lipper, a Reuters company, documented that investors needlessly give up as much as 23% of returns to taxes. That's an astounding figure. Investors, the study found, give up an average of 1.3 to 2.5 percentage points annually to taxes. That translates to as much as 23% of the return (in dollars) getting wiped out by taxes every year.

High fees, though, can do a number on your returns as well. Low expenses are one of the major reasons that stock pickers have such a tough time beating index funds. Even if a manager can actually beat the market every year (as measured by the S&P 500 or Wilshire 5000), the price you pay for active management at best mitigates -- and often wipes out -- any so-called outperformance.

Expenses are more important than ever these days, when the stock market isn't expected to return more than 5% to 7% in the next few years. The average U.S. stock fund charges 1.45% a year to manage your money, although stock index funds often charge nearly half that. Which brings us to...