Why the Fund Firms Tell You to Buy and Hold

Right now, at just about every fund company there's a kid tapping out a raft called "Investing in Volatile Markets" or "Living With a Market Decline," but taking investing advice from fund companies is a little like asking a car salesman if you need new wheels.

I should know, because I used to be that kid. When I worked at John Hancock Funds in Boston, part of my job was ghostwriting market commentaries for chief investment officer Robert Freedman, who presciently announced his retirement a week before the Nasdaq Composite peaked and started this pronounced, painful and prolonged slide.

Today most fund shops have similar postings on their Web sites. Fidelity, for instance, has a Q&A with venerable and retired fund manager Peter Lynch. In general these things prescribe the same thing: Hang on to those fund shares in your diversified portfolio.

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Yes, this vague saw is harmless, and at face value it's helpful. But it also helps fund companies whose profits are driven by the fees they charge their shareholders. If you take your money out of a fund, it makes less money. If a lot of people take money out of a fund, they make a lot less money.

The real problem is that this "buy-and-hold" message glosses over a big detail: It assumes you've built a diversified portfolio. But many investors are sitting with a sagging, tech-overdosed portfolio -- and fund companies played a part in putting them in that pickle. Between the middle of 1999 and the end of last year, fund companies jumped on the tech-bandwagon with both feet, rolling out a whopping 84 tech-sector funds, and heavily marketing those funds that focus on the once sizzling, now ravaged sector. That's 84 out of a total 137 funds. These mercurial funds, which are down more than 60% over the last 12 months, captured some 30 cents of every dollar invested in U.S. stock funds last year.

At the same time, the average growth fund, including big-cap growth funds that were core holdings in many portfolios, ratcheted up its tech bet to the point where it had more than 40% of its money sunk into tech stocks. The upshot: Investors who thought they were adding a dollop of tech exposure with a tech fund last year were often unwittingly souping-up an already high-octane portfolio.

In light of this, fund companies' "hang in there" message is not necessarily a great idea for many investors, who are probably better served by strategically using new money and exchanges to diversify their portfolio with less aggressive, tech-light value funds and bond funds. The good news is that's apparently what's been happening recently, according to recent fund cash flow figures.

In light of recent fund flows and the fund industry's huge bet on the tech sector, the buy-and-hold message reminds me of a scene at the end of Star Wars. A pilot repeatedly urges his underlings to "stay on target." Of course, he doesn't realize that he's in his enemy's cross hairs.

Blindly hanging on to a tech-overdosed portfolio could leave your portfolio like that pilot: Blown to smithereens.

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