BLIND LUCK; TAKE THE GUESSWORK OUT OF PICKING A MUTUAL FUND.

Byline: Deborah Adamson Daily News Staff Writer

For many folks, wading into investment waters for the first time means dipping their toes into the world of mutual funds.

That's not surprising, since the first experience usually comes via a company 401(k) or 403(b) plan. It's also easier to invest in mutual funds than buying an individual stock or bond. Moreover, investors don't have to keep track of their performance as often.

But to make the most money out of mutual funds, investors need to find the darlings among the 8,000 funds available, not high-cost dogs. It's not too difficult, and the payoff could be enormous.

Mutual fund investors need to re-evaluate their funds if they can't answer yes to each of the following questions:

Are you invested in a good mutual fund that beats or at least tracks a market index?

Are you adequately diversified?

Can you easily keep track of the paperwork from all your funds?

Do you have a core group of funds you plan to stick with for the long term?

Are you in a low-cost, no-load fund?

Assuming you've answered no to at least one of those questions, here are five steps in managing your mutual fund portfolio.

Step 1: Figure out what you have. Look at the funds' investments, whether in stocks, bonds, money markets or other investment vehicles. Find out whether you're heavily geared toward one type of investment, such as blue chip stocks like AT&T and GM, or small cap technology stocks. Perhaps most of the money is in low-risk money market funds. Tally up where your money is invested.

Step 2: Make sure you're adequately diversified. While each mutual fund is in itself a diversification of investments, many funds invest their money in one broad sector or company type. Perhaps one of your funds mainly invests in stocks that pay out high dividends while another focuses on oil companies and the energy sector.

While allocating your assets depends on individual preferences and needs, the general rule for people with more than 10 years before they'll need the money is to be 90 percent to 100 percent invested in stocks, said Steve Merritt, president of the nonprofit National Association of 401(k) Investors in Melbourne, Fla.

Among stock funds, make sure your money is divided among large cap funds, small to mid-caps, international and riskier issues.

(``Cap'' refers to capitalization, the amount of money the company is worth on the market. That number is derived by multiplying a company's share price by the number of shares outstanding. The Walt Disney Co., for example, is a large cap company because its market capitalization is about $84 billion. By contrast, International House of Pancakes' market cap is about $410 million, making it a small to mid-cap stock).

For those who are getting ready to retire in a few years, he said a classic allocation is to put 65 percent of your money in stocks, 25 percent in short- to intermediate-term bonds and the rest in money market funds.

Bonds provide income while paying higher rates than money markets. Merritt prefers short- and intermediate-term bonds because they are less volatile than long-term bonds when interest rates rise.

Step 3: Build a core group of mutual funds. The foundation for your portfolio should be at least three main funds that represent half or more of your holdings, according to ``A Common-sense Guide to Mutual Funds'' by Mary Rowland.

One sample allocation: Between 25 percent and 50 percent of the money in a large-cap fund, 12 percent to 25 percent in a small-cap and the rest in an international fund.

Why an international fund instead of a global fund? Because they invest in equities outside the United States, whereas global funds invest in companies worldwide, including those at home. So you haven't diversified as much with a global fund as you have with an international fund.

Add other funds and investments to fit your financial needs, but try to stick with a number of funds you can track easily, whether it's a handful or a dozen.

Use the same philosophy when you see a fund touting its ``five-star'' rating. Is the rating only for the past quarter? Again, look for long-term performance.

One yardstick is to compare the fund's return against a market index. For large cap funds, use the Standard & Poor's 500 Index. Small caps could be measured against the Russell 2000; international funds against the Morgan Stanley Europe, Australia, New Zealand, Far East Index; and bonds vs. the Lehman Bros. Aggregate Bond Index.

Make sure you compare returns for the same time period.

Don't know which fund to buy? Books on low-cost or no-load funds, available at many bookstores, are a good resource.

Don't automatically buy a fund recommended as the hot fund of the year. Often, it's hot because of recent stellar performance. Look for funds that have performed consistently well for a longer period of time, say five to 10 years.

Many banks offer funds, but they're not safer or necessarily better. Unlike a savings account or certificate of deposit offered at a bank, mutual funds - even those sold at banks - are not insured by the government.

Or buy into index funds, whose investments mimic the market indexes, Merritt said. Index funds outperform 90 percent of other funds over 10 to 15 years.

Many mutual fund families offer index funds. A Merritt favorite is the Vanguard Index 500, at [phone].

Step 4: Make sure you're not overpaying to keep the fund. Avoid load funds as much as possible. Loads are sales commissions an investor pays to join, get out of or while invested in the fund. An A, B, C or other alphabet designation means they're charging the sales commission in different ways.

``Paying a sales commission is simply a very expensive way to invest your money,'' said Sheldon Jacobs, editor of the No-Load Fund Investor newsletter in New York, adding that there are 2,500 no-loads from which to choose.

Loads generally range from 3 percent to 6.5 percent of the money invested, but that doesn't mean investors don't pay any fund fees. The mutual fund manager has to be paid, and the fund incurs operating costs as well. Then there's the 12b-1 fee for advertising, marketing and distribution expenses.

Obviously, it's to your best interest to pay as little as possible.

For stock funds, total annual expenses shouldn't exceed 1.3 percent, according to the ``Common-sense Guide.''

But there are varying rates among different types of funds. Try to pay from 0.2 percent to 0.3 percent for index funds, 0.5 percent to 0.75 percent for actively managed stock funds, about 1.5 percent for small caps and 1 percent to 2 percent for foreign equities, Merritt said.

A fund's turnover ratio - whether the fund manager buys and sells a lot - also determines the amount of capital gains taxes an investor pays. A 50 percent to 60 percent turnover is about average, while 100 percent is high, the guide said.

However, the cost of the fund should be balanced against its performance. You have to decide whether paying higher expenses justifies the return.

Step 5: Review your funds once a year. Make sure they still fit your needs. You may consider selling if your investment goals change, when the fund manager leaves, the fund's return lags its peers (other mutual funds that invest likewise) or the fund shifts its investment strategy.

If it's a new fund and the return is lackluster, don't sell it before checking out its history. If its past long-term performance has been consistently above average, Merritt said, the fund manager's investment style might just be out of favor. It doesn't mean it's a bad fund.

However, if the fund's history shows a consistently mediocre return, then it's time to sell it.

FOR MORE INFORMATION

``Eight Ways to Make $1 Million With Your 401(k) Plan'' is available free by sending a self-addressed, 32-cent stamped envelope to the National Association of 401(k) Investors, P.O. Box 410755, Melbourne, FL 32941.

``Morningstar Mutual Funds,'' a guide that details performance, is at public libraries.

For a directory of more than 200 no-load funds, send $5 to the 100% No-Load Mutual Fund Council, 1501 Broadway, Suite 1809, New York, NY 10036.

``The No-Load Fund Newsletter'' is $129 for 12 issues. Subscibers get the ``Sheldon Jacobs' Guide to Successful No-Load Fund Investing'' and a list of no-load funds and performance. [phone].

ON THE INTERNET

www.morningstar.net

www.golfsw.com/findafundh.html

www.thewebinvestor.com/mfcomp.html

www.brill.com

www.kiplinger.com

And be sure to visit the Web site of your mutual fund family.

CAPTION(S):

Photo, Box

PHOTO (Color) no caption (Blindfolded man with dartboard)

Photo Illustration by the Orange County Register

BOX: FOR MORE INFORMATION (see text)