By Ben Baden

While it's important to monitor the performance of broad-based indexes and the returns of your mutual funds, a number of other indicators can help you understand how the investment climate is changing. Investor sentiment surveys and records of fund flows, for example, can help you make prudent decisions. It's important to track a variety of indicators, however. "Not one of them will give you a perfect answer or an obvious signal," says Lipper Senior Analyst Jeff Tjornehoj. "You have to develop your own mosaic of market conditions that will help feel your way into a buying or selling position."

Here are six numbers every investor should follow:

Investor returns.

Look beyond your mutual funds' trailing one-, three-, five-, and 10-year returns. Morningstar calculates "investor returns," which measure the average investor's returns in a particular fund, versus its published returns. These returns reveal how much money investors actually make or lose in a fund based on when they buy and sell. "Generally, people tend not to time their decisions very well," says Russel Kinnel, Morningstar's director of mutual fund research. For instance, in 2010, the average domestic fund returned 18.7 percent, compared with 16.7 percent for the average fund investor. Investors fare much better when they invest in "boring, steadier funds" like balanced funds, which include a mix of stocks and bonds, Kinnel says. More volatile funds generally have lower investor returns because investors make emotional decisions to buy or sell at the wrong times.

Fund flows.

By tracking fund flows each week, investors can determine which asset classes are seeing the most inflows, and possibly overheating, as well as those that are the most unloved, and potentially poised for a turnaround. "[Fund flows] are a contrarian indicator more than anything else," Kinnel says. At times, it can be a bad sign if a certain asset class experiences huge inflows, and a positive sign for funds that are being ignored. Each year, Morningstar compiles fund flows to pinpoint the three least popular stock fund categories, and advises investors to consider allocating a greater amount of their portfolio to the "unloved" funds of the year.

Historically, "unloved" funds tend to outperform their benchmarks over the next three- and five-year periods. At the same time, the "loved" funds, or the three best-performing asset classes, generally lag their benchmarks. From the beginning of 1994 to the end of 2010, the "unloved" funds earned an annualized 9 percent, compared with an annualized 6 percent gain for the "loved" funds, according to Morningstar. (By comparison, the S&P 500 returned an annualized 8 percent over that time period, and MSCI World Index returned an annualized 4.6 percent.)

Sentiment surveys.

The American Association of Individual Investors releases a weekly sentiment survey which asks investors whether they're "bullish," "bearish," or "neutral" on the stock market over the next six months. Generally, when individual investors become overly bullish or bearish, the market tends to head in the opposite direction. That's what happened in early March 2009, when the stock market bottomed. On March 5, a record 70 percent of investors surveyed said they were bearish. (The historical average for the survey, which began in 1987, is 39 percent bullish, 31 percent neutral, and 30 percent bearish.) The S&P 500 reached its low point the next day.

The VIX.

The Chicago Board Options Exchange Volatility Index, or VIX, uses options prices to measure expected volatility in the S&P 500 over a 30-day period. It's often referred to as the "fear gauge" because it measures how fearful or complacent investors are at any given time. Professional money managers often use the VIX as a hedge against volatility because the VIX generally moves in the opposite direction of the S&P 500. Investors can follow the VIX on the Chicago Board Options Exchange website. Tjornehoj says it's useful for investors to use the VIX to get a reading on the pulse of the market.

Rate of inflation.

Investors should always factor the current rate of inflation into their expected returns. In March, the Consumer Price Index (CPI), which measures the average change in prices of goods and services over time, rose 0.5 percent. Over the past year, the CPI has risen 2.7 percent. John Diehl, senior vice president in the retirement division of The Hartford, says fixed-income investors in particular have to make sure they are earning enough yield in their funds so their returns aren't eaten up by inflation.

Interest rates.

The rate of inflation and interest rates have an important relationship. The Federal Reserve monitors inflation closely. "If the Fed observes increased economic activity, then it's only a matter of time until they begin to fear inflation, and they will begin to feel pressure to increase interest rates," Diehl says. The Fed controls the Fed funds rate -- or the interest rate at which banks lend to each other. It's been set at virtually zero for more than two years, and that's why many money market funds or savings accounts are yielding only pennies on the dollar.

When the Fed raises rates, it can mean trouble for some bond funds. "Although a progressing economy sounds like a good thing, for bond holders it usually isn't," Diehl says. No one can predict when the Fed will raise rates, but when it does, the value of existing bonds falls, which can lead to losses for certain types of bond funds. Investors should be aware of the duration (a measure of interest-rate sensitivity) of their portfolios so they are well-prepared when interest rates begin to rise again.


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