Trading mutual funds can be bad for financial health
As I do every year, I read the Mutual Fund Fact Book the fund industry publishes. What caught my eye recently was that mutual fund purchases equaled redemptions last year. New purchases amounted to $12.4 trillion while share redemptions were also $12.4 trillion. What is frightening about this level of activity is that total industry assets were $7.4 trillion.Mutual fund shares are now being traded like baseball cards were traded when I was a kid. Trading fund shares can be highly injurious to ones financial well-being. In my book, there is a chapter called Never Sell in Bad Markets. It documents how many investors have been shooting themselves in the foot because of all the switching in and out of mutual funds.For example, during 1991-2000, a $10,000 investment in the S&P 500 Index would have grown to $53,000 with dividends reinvested. The average fund investor earned just $23,000 during this period because of all the switching.The same study also covered a 25-year period and further supported the harm that investors often inflict upon themselves. Starting off again with a $10,000 investment at the beginning of the 25-year period, this amount grew to $123,000 if invested in the S&P 500. The typical fund investor earned only $70,000 due to trading. Most of the $53,000 difference between the S&P 500 return with no trading, and what the fund investor ended up with came from bad in and out activities.Most investors sell their funds for two reasons. First, they get frightened out of the stock market after a severe market decline. Second, they become impatient with their particular fund because it is lagging other types of funds or the S&P 500.Most equity funds can be categorized broadly into the growth or value investment styles. Neither the growth or value styles correlates particularly well to the performance benchmark S&P 500 Index. Periods of underperformance for both styles can extend for three to five years in some cases.During the go-go years in the stock market of 1997-99, value funds went up far less than growth funds and the S&P 500. During the severe bear market of 2000-02, the typical growth fund declined more than value funds and the S&P 500.Many investors will unknowingly purchase an equity fund after a good performance run and right before an out-of-favor cycle begins. Investors will often lose patience and sell a fund with poor performance. However, poor performance is almost always related to the investment style being out-of-favor as opposed to the fund being poorly managed.Several studies using the popular Morningstar ratings for mutual funds bear out these findings. One prominent investment adviser intimated that one-star funds ranked by Morningstar outperformed the top rated five-star funds. Another study showed that two-star funds outperformed five-star funds over a four-year period. The issue here is not the Morningstar ratings, but how investors handle their investments because they lack an understanding of performance cycles.Nick Murray who wrote The Intelligent Investment Advisor stated, 95 percent of what an investor will make in his lifetime will depend upon the types of investments that are selected and what that investors does when the stock market goes down 30 percent . Truer words were never spoken. These words were reinforced by William ONeil, publisher of Investors Business Daily, who wrote, Never sell your mutual fund no matter how bad performance is over the short term.Robert Zuccaro is president and portfolio manager of Grand Prix Funds, a Wilton, Connecticut based family of growth stock funds, and author of the recently published book Dow 30,000 By 2008, Why Its Different This Time.
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