Originally created 02/19/01

Study: Mutual fund jumping a losing bet



NEW YORK - The phrase "buy and hold" doesn't describe the style and mind-set of mutual fund investors the way it used to.

It seems those who buy funds these days aren't holding onto them nearly as long.

In the past decade, the amount of time investors kept funds dropped to an average of three years from 10, according to a study by Financial Research Corp., a Boston consulting firm. Five years ago, the holding period was 5 1/2 years, FRC said.

Some short-term fund investors might want to rethink their strategy, because they could be cheating themselves out of substantial profits. Most financial advisers subscribe to the theory that buying and holding for the longer term yields bigger returns.

Not everyone agrees that the amount of time investors hold onto funds has dropped. The Investment Company Institute, a fund industry trade group, says a small number of highly active fund traders has skewed the overall profile of average investors, who still buy and hold.

Still, the notion that investors are moving in and out of equity funds more quickly is prevalent throughout the industry, and it raises some important issues. The FRC study found that fund investors who sell their shares after three years forfeit up to 20 percent in portfolio returns.

"Investors who make investment decisions based on emotion, not logic, in pursuit of big stock market gains, are more likely to lose out in the long run," said Jack Sharry, president of Phoenix Investment Partners' Private Client Group, a Hartford, Conn., money management firm that commissioned the FRC study.

The study, released last month, said that as investors move more quickly in and out of funds, they're breaking basic investing rules. First, they're chasing performance by going after funds that have had the best and most recent gains. That typically is considered a losing bet, because there's no guarantee a fund will repeat its previous performance.

And, in trying to time the market, investors often ended up buying high and selling low, says the FRC. That is never a smart idea.

Mr. Sharry said investors "were doing the exact opposite of what they should have been doing."

Of course, investors believe they've had good reason - the desire to profit from the surging tech sector and to curb their losses when it started its plummet last spring. In the second half of the past decade, investors were particularly eager to latch onto the hottest tech investment.

Although the ICI disagrees with the study's findings, others in the industry say they're right on the money.

"It's not just a mutual fund phenomenon. It is a broader market phenomenon. We have done studies. ... volatility in the market is much higher than it has ever been," said Martin Weiss, chairman of Weiss Ratings Inc., a Palm Beach Gardens, Fla., firm that rates mutual funds.

"There is fickleness," agreed Patricia Jennerjohn, a financial planner who heads Focused Finances in Oakland, Calif.

Financial experts say investors should look closely at performance over the long term, ideally at least five years.

"Many of the mutual funds that had a stellar performance in 1999 did a total 180-degree turn in 2000. That is the dark side of normal market behavior," Ms. Jennerjohn said. "This doesn't mean that it is a bad fund. ... But rather than do research about what fund would work well with their particular strategy, people get dazzled by the most recent returns."

The FRC findings support the case against performance chasing. The study found that investors who held funds for just three years in the 1990s had a 20 percent lower return than if they stuck with their holdings for 10 years.

The average return for these shorter-term investors was 10.9 percent, at the lower end of the average annual rates of return of broader market indexes.

The study also found that, on average, mutual fund shareholders socked $91 billion of new cash into funds after their best performing quarters. But only $6.5 billion went into funds that had just had their worst performing quarters.

Investors, the study also contends, let their emotion get in the way of their buying and selling decisions, which also can cause more trading and more losses.

"It's a keeping up with the Joneses mentality," Mr. Sharry said. "It always seemed like someone was doing better and that contributed to their jumpiness in terms of moving in and out of funds."