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For mutual fund investor, 1997 was the best of years–if you’re willing to overlook a nagging, little blemish. The good news is a soaring stock market made it difficult no to make money. For the first half of the year, the Standard & Poor’s 500 index was virtually unstoppable. In all, it finished up 33% for the year, despite a “Black Monday” sell-off on October 27 and the woes that faltering Asian economies inflicted on American companies, two factors that made the tail end of the year a bit shaky for investors. In fact, aside from a bit of turbulence in the last quarter, ’97 was the third straight year that stocks raced off to double-digit gains, following 38% and 23% leaps in the S&P 500 in 1995 and 1996, respectively. That’s a trifecta that hasn’t occurred since the mid-’60s.
Mutual fund managers had a lot to smile about last year–and not merely for the reasons listed above. Investors were in no way shy about expressing their gratitude for bull market gains, flooding mutual funds with some $180 billion in new money, according to Morningstar Inc., compared with $174 billion in 1996. And, even when the going got rocky at year’s end, the influx of money showed no sign of abating.
“In all,  ranks as one of the best years ever for net inflow into funds,” says Russ Kinnel, an editor for Morningstar, the Chicago-based company that monitors the mutual fund market. “And that should continue even if people think there’s a rough year ahead. With retirement and college tuition bills placed squarely in their laps, it’s hard to avoid mutual funds,” he adds.
With so much good news, what possible downside could funds have? Well, for all of the glorious returns that rained down on investors, 1997 underscored the industry’s dirty little secret: mutual funds underperform the market. In fact, only a precious few–225 our of nearly 2,500 stock funds around–actually outdid the benchmark S&P 500 index of the largest corporations. While index funds–those “no-frills investments” whose sole purpose is to mimic the S&P 500–had no trouble keeping up, stock funds trailed by quite a bit, mustering no more than an average annual return of 24.36%. And if a 6% gap between the index and the average fund’s performance doesn’t seem like much, consider this: over five years, that kind of differential on a $100 investment would amount to $33 (or one-third of your money). To make things worse, the run-of-the-mill stock mutual fund eats up more of your money in expenses than an index fund.
But that wasn’t the only cloud to turn up as an extremely good year came to a close. There are signs that making money in the market, almost a no-brainer over the last three years, will get a bit tougher in 1998. Besides a brief, yet sharp, down-turn in the market and troubles in Asia, a number of companies Burned in quarterly earnings that disappointed Wall Street and saw their shares slaughtered in the market.