When the market's blowing up, mutual fund companies will tell you: Hold on. Sit tight. Remember you're a long-term investor.
But with the markets roiling and the
down 17.8% since March 10, the idea of ditching some losers -- or even shifting assets into safer holdings -- may have crossed your mind.
Pulling the trigger in a panic isn't a good idea. But actively trading your mutual funds isn't the taboo it used to be.
"A few years ago, the average investor held a stock fund for about 10 years before redeeming the investment," writes
chairman John Brennan in an April 3 message to investors posted on the company's
Web site. "Today, the average holding period is only about 2 1/2 years."
This trend is obviously disturbing to Vanguard and other fund companies. But to some financial advisers, this active approach is a perfectly acceptable way to invest in funds.
"I am more active than I am passive," says David Petersen, an adviser with
Financial Services Advisory
in Silver Spring, Md. "We're all timing
the markets. All of us do it. It just becomes a question of how quickly or slowly."
Vanguard preaches a very deliberate approach to dumping a fund. If an
actively managed fund is performing poorly, you should ask: "Is it just out of favor
or style or how much of it is poor stock selection?" says Jack Brod, a principal in Vanguard's asset management and trust services division. "Even if it's the latter, you should give a fund at least a year or two before you necessarily make any changes and give the fund an opportunity to turn itself around."
Instead, some advisers suggest that you should be out there looking for opportunities instead of waiting months or even years for some unloved sector to make a recovery.
"Do I want to hold a fund for two years while it's out of style?" asks Petersen.
Petersen says his holding period varies widely, from a month or two to a year or longer, depending on how long he thinks an investing style or sector will remain in favor.
"In an ideal world, I would hold something forever. But what's in favor rotates," adds David Lucca, an adviser with
Rhoads Grunden Lucca Capital Management
in Lancaster, Pa., and president of the
Society of Asset Allocators and Fund Timers
. "It's totally out of my control. I can tell you when I should be in something based on its strength or I can tell you when to get out when there's something better."
These advisers aren't proponents of simply buying the hottest funds and selling the cold ones. Having a strategy to identify these trends is paramount, they say.
If you're trading your funds based on a feeling, "you will always want to do the wrong thing at the wrong time," Lucca says.
The average investor can get a feel for whether a fund is in favor by charting the 50-day moving average of its net asset value. That initial step should at least give you something objective to study, says Lucca.
"When good things are happening, the line is above the 50-day moving average," he says. "When it drops below that average, it's a period of consolidation or decline." On March 31, the Nasdaq fell below its 50-day moving average, he notes.
Another way of measuring whether a sector or area of the market is coming into favor is to track the flow of money into funds and sectors, says Petersen.
About a week and a half ago, Petersen started moving into financial funds like
Rydex Banking. He also lightened up on technology. (The Rydex funds are built for active fund traders and don't carry redemption fees.) Both Petersen and Lucca have about 50% of their portfolios in cash now.
Note that these advisers' methods are pretty aggressive, not to mention complex. Your indicators don't need to be so complicated. They simply need to be based on objective measures rather than impulses and feelings.
If you don't think you can be this aggressive on your own, you can hire a financial adviser or invest with a fund manager who is willing to change and move with the market.
Or you can start by actively trading only a portion of your existing fund portfolio -- say 25%.
Mutual fund companies don't condone such behavior. In fact, they despise it.
Not surprisingly, numerous fund companies are discouraging short-term investors by adding redemption fees -- charges for selling shares owned for less than a specified period of time.
Last week, for example,
announced plans to slap a 1% redemption fee on shares of its
Worldwide Health Sciences fund held for less than three months.
"The mutual fund industry always says buy and hold because that serves their interests," Lucca counters. "They get paid for every dollar in their accounts. Managers are paid to beat a certain bogey but that doesn't necessarily benefit you."
Frequent trading can, however, be detrimental to investors. For one, money flowing out of a fund can force a manager to sell securities, thereby generating capital gains for the remaining shareholders.
Such trading can also diminish your returns, writes Vanguard's Brennan. "First, transaction fees add up over time. Second, the more you trade in a non-retirement account, the more taxes you'll pay on your gains. But by far the biggest risk is that, historically, many investors have jumped into a hot fund or hot sector just in time to see it cool off," Brennan writes.
Indeed, a study conducted by Boston research firm
revealed that the typical stock fund investor earned less than half the return of the
index over a 15-year period ending December 1998. The firm attributed the shortfall to frequent, irrational buying and selling.
If you're going to buy and sell your funds more actively, keep in mind that the tax collector, the averages and the mutual fund industry are stacked against you. So don't go into battle without a clear idea of how to beat them.