Question: What is one of the most important ways to choose a mutual fund? Answer: Look at past performance. Although, as the advertisements say, this is no guarantee of future performance, it is perhaps your best judge of how the fund might do in up and down markets.
Why, then, when there are more than 500 equity mutual funds to choose from, would anyone invest in a new one, with no performance history? And if there are so many funds, why has this been a record year for the introduction of new ones?
Among the reasons for the growth of new funds, industry observers believe, are the strong bull market on Wall Street, an interest in cutting the tax bite, new investment ideas, and a desire to specialize in new, growing industries, such as high technology.
Whatever the reasons, they were enough for the industry to introduce 38 new funds through mid-September of this year, according to Paul Reed, editor of the United Mutual Fund Selector, a fund newsletter published in Boston. For all of last year, only 32 new funds were introduced. There were also 38 new funds in 1981, but only 22 in 1980, and 11 in both 1978 and '79.
''The stock market has certainly played a part,'' Mr. Reed suggests. ''Also, there are a great many more specialty funds going after specific segments of the market. Instead of all-around growth or bonds funds, we have things like Prudential-Bache's Option Income Fund or the variety of science-technology funds. That kind of approach.''
''That kind of approach'' does seem to be enough to attract new investors to the new funds, despite arguments against them.
''I don't see why (there are so many new funds), due to the inherent defects in strategy,'' said Sheldon Jacobs, editor of the No-Load Fund Investor, a Hastings On Hudson, N.Y., firm that publishes a newsletter and handbook on these investments. ''Even with bond funds, the newer ones tend to perform somewhat worse than the old funds.''
In one section of the Handbook for No-Load Fund Investors, Mr. Jacobs analyzes the performance of new funds from 1971 to 1981. Of 30 new aggressive growth funds, 57 percent underperformed the average fund of the same type in their first year of operation. And of 47 new growth funds, 60 percent were below average in their first year, while 41 percent of new equity-income funds were below average.
All of these comparisons were for the funds' first-year performances, and several of the funds have done well over the long haul since they were introduced. In addition, if only new funds introduced by established investment companies with proven management are included, the performance averages would improve.
One of the arguments for new funds is that the initial offering may generate a large influx of new cash. If there is enough money, the fund can do a better job of diversifying its investments, supposedly one of the big advantages of a mutual fund. On the other hand, there may be too much money for the managers to invest wisely.
Also, a new fund has not yet made any mistakes it has to correct. But it hasn't done anything right, either.
Finally, unlike ''getting in on the ground floor'' with a new stock that subsequently does well, there is no similar advantage to a new mutual fund. Whether the fund is bought early or late, a share is still only worth its net asset value; it is the long-term appreciation that makes the fund worthwhile. And unlike new stock issues, which have a limited number of shares, new shares in a common open-end mutual fund are created every time someone makes a purchase.
For many of the established companies that are introducing funds, the name of the new-fund game in the past couple of years has been saving taxes. This means either giving investors a way to find shelter from state and federal taxes, or helping them build their individual retirement accounts (IRAs).
At the Fidelity Group, for instance, the Freedom Fund was introduced this year for IRA, Keogh, and other tax-qualified retirement plans. Because all investments in Freedom can grow free of taxes, the investment managers can pursue an aggressive policy of frequently buying and selling stocks without having to pay higher short-term capital gains taxes. Of course, the same exemption also applies to the lower long-term capital gains taxes.
Aggressive investment has not been confined to IRA and Keogh-type funds. With the proliferation of new companies in fields like computers, biotechnology, and aerospace, the number of funds designed to pursue these companies' stocks has grown almost as fast. Some of the newer funds in this category include the Stein Roe Discovery Fund, Seligman Communications and Information Fund, and the Prudential-Bache Research Fund.
Another popular form for new funds in the last year or so has been the kind that shelters income from state and federal taxes - and city taxes, if possible. In general, investors should be in at least the 25 percent tax bracket before considering these municipal bond funds.
One such fund, introduced in March, is Putnam's California Tax-Exempt Income Fund. Californians can also try National Securities & Research's California Tax-Exempt Bonds, or the Franklin Tax-free Income Fund.
There are a number of similar funds that offer people in New York State double tax exemption, or triple tax exemption if they also live in New York City. Single-state funds like these can also be found in Florida, Maryland, Massachusetts, Michigan, Minnesota, New Jersey, Ohio, and Pennsylvania. Although some of these have been around for more than two or three years, they are getting more attention lately as people look for new ways to shelter investment income.
If you are going to try a new fund, the experts suggest sticking to an established, well-managed investment company, particularly one with several other funds in the ''family,'' so you can quickly switch to a safer-looking, proven fund if the new one should have trouble. It may take several days to redeem shares in a particular fund, but if the company offers telephone switching, a shift can be made in the time it takes to complete the phone call.