1995-96 REVIEW AND OUTLOOK : MUTUAL FUNDS : 5 Easy Lessons : Even a No-Brainer Year Has a Few Things to Teach Fund Investors

Mutual fund investors didn’t need presents this holiday season. The whole year was one big gift.

But this is one gift horse whose mouth you should look into, because inside this euphoria are important lessons that will serve investors in times when fund performance is not quite so rosy--including, in all likelihood, 1996.

Typically, investment lessons are easily learned during times of choppy performance, when ups persuade an investor to hang on and downs force shareholders to develop discipline and strategy.

A bull market, by contrast, covers up myriad sins; 1995 was rare in that investors could make both mistakes and considerable sums of money at the same time.

To take more from 1995 than just profits, pay attention:

Lesson: Stay fully invested and give up on timing the market.

No one expected the 1995 market rush. Last January, experts were almost uniformly bearish, but only the disciples of market timing--those who sell stocks and hold cash when they foresee a market decline--cashed in nearly everything to head for cover.

As the market took off, the timers still saw signs of impending doom. While stocks returned about 30%, the timers’ cash earned about 5%.

Ouch.

“If you weren’t invested and were on the sidelines, you will count 1995 as one of your biggest financial mistakes ever,” says Michelle A. Smith, managing director of the Mutual Fund Education Alliance based in Kansas City, Mo. “It’s not that you should throw caution to the wind, because nothing could be further from the truth, . . but it is pretty clear that you are better off determining the best approach for you and pursuing it than you are trying to duck in and out of the market.”

(A corollary: Buy funds that are fully invested. Like market timers, managers who held on to big wads of cash suffered this year. If you want that safe hedge as well as a stock fund, pick a good money-market issue and allocate your money between the two.)

Lesson: The consensus can be wrong.

Just because everyone agrees doesn’t make the opinion right. If it did, the ’95 market would have fallen faster than a bad souffle.

“The best financial minds can’t predict with any consistency what is going to happen in the marketplace, so take those predictions with a grain of salt,” says Don Phillips, president of Morningstar Inc. “With the consensus now turning to how the market is going to keep going up, that should make people afraid--very afraid--of what could happen in 1996. Prepare for the consensus to be wrong again, because it very well could be.”

Lesson: Develop and stick to a long-term investment plan.

This year, it was easy to stray from your plans and feel good about it. For example, conservative investors profited by becoming more daring, although their portfolios became more risky. If that risk comes full circle, however, the result could be more painful than the extra profits were nice.

“Having come through this year, it’s an important time for investors to hunker down and think about what investing really means to them,” says Betsy Treitler, editor at New York-based Fund Decoder. “Most plans are not about chasing performance or making the most out of the market, they’re about having enough to live and not risking everything . . . . The market forgave a lot of mistakes this year; more often, it pays off for the people who stick to their plans.”

Lesson: Use benchmarks; without them, the numbers lie.

Next year, some growth managers will say they were “up 20%,” which sounds pretty good--unless you know that the average growth fund, according to Lipper Analytical Services Inc., was up nearly 30% this year.

“After a year like this one, absolute performance numbers are pretty meaningless,” says Mark Riepe, a vice president with Chicago-based Ibbotson Associates, a market-tracking firm. “Just about any fund that is fully invested will look good, so the quality of past performance becomes harder to assess. Without an appropriate basis for comparison, it’s easy to make big mistakes.”

Lesson: Always invest in a year that ends in 5.

Yes, this one is a bit tongue-in-cheek. But here’s an interesting fact: No year ending in 5--like 1995--has ever been a down year, as judged by the Dow Jones industrial average.

“For every decade, it’s the only year that has never gone down,” says Thurman Smith of Equity Fund Research in Malden, Mass. “Of course, that’s a lesson that won’t help anyone for a while, but people can store it away for 2005.” (Another corollary: Years ending in 6 tend to be above average but aren’t always winners. So much for next year’s looking like another gift.)

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by electronic mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, MA 02107-2378.