How You Can Be A Smart Market Timer

February 16, 2013

BOSTON (MarketWatch) — Investors complain a lot about the performance of their mutual funds, but they’d be a lot happier and do better financially if they simply got the same results as those funds earn.

Instead, a new study from investment researcher Morningstar Inc. shows that investors habitually get the worst from their funds, earning returns that are worse than the investment vehicles they are buying.

Worried about inflation? Hedge with gold

The prospect of inflation in Japan as the yen weakens may prompt people to turn to gold as a currency hedge. The WSJ’s Clementine Wallop talks about what to expect from gold demand in India and China as well as Japan.

You don’t have to settle for that.

To see why, consider the latest research from Russel Kinnel, Morningstar’s director of fund research, who compared a straight average of fund returns to an asset- or dollar-weighted average investor return.

Dollar-weighted returns are designed to show a fund’s results based on when money moves in or out; they show if investors are chasing performance, buying funds only after a big runup or losing faith and selling before a rebound.

Kinnel found that over the decade ended in 2012, the average stock fund returned 7.05% annually, but the average investor netted 6.1%.

In certain asset classes the disparity is much greater. Kinnel found that the average international equity fund earned almost 10% a year, but the average investor in those funds netted under 7%. The discrepancy was also large in municipal-bond funds over the last decade — surprising because this not a place where shareholders typically chase performance.

Indeed, with munis being one of the least-volatile investments, the asset class is a petri dish for the problem. Kinnel surmises that investors actually did the right thing and threw money into the category after its one year in the red (2008), and enjoyed double-digit gains in 2009. But as worries about muni defaults captured the headlines, investors bailed out to avoid the potential storm and missed big up years in both 2011 and 2012.

Time and money

Giving into fear or greed is the root cause here, but investors may not recognize that their behavior contributes to the shortfall.

“Mutual funds are long-term investments and the way to get a superior return is to hold it for a long time,” said Kinnel. “It used to be that people made decisions based on the fund’s returns over the last few years. Now it seems to be that they make decisions based on the 24-hour news cycle and what they just heard. Either way, they’re making bad decisions.”

Here’s how that plays out.

The typical investor buys funds only after a strong run of good results, thus they are buying high. Their money did not get that positive performance stretch, however; they only get what happens next. If the fund slows or falters, the fund’s performance may still be positive but the investor hasn’t really experienced those gains.

If the investor sells when the fund falters, they not only lock in a loss or poor results, but they also go a bit insane, repeating the process again — buying another fund that has been hot — but expecting different results.

Here’s how to get the performance close to what the fund provides: You must reinvest dividends and distributions and make additional deposits either regularly or when the fund seems undervalued, rather than when it has made the account statement look fat.


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