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Long-Haul Investing

If you have confidence in your fund manager, ignore short-term underperformance.

It's nearly 3,000 years since Aesop first told the story of the tortoise and the hare. And a lot of investors still don't get it.

Last week, someone who was invested in a successful long-term mutual fund emailed to ask if she should sell it because it had a bad year. She's not alone. All the data show that lots of people jump out of funds when they have a bad run and jump into those that have done well for a couple of years, or even a couple of quarters.

The data also show that most ordinary investors have done far, far worse over time than those who just stuck their money in an index fund and forgot about it. The numbers aren't even close.

My apologies to the many readers who already know this stuff, but there are lots who don't, and it's worth revisiting the basics.

The question to ask yourself before you invest in any mutual fund is this: Do you have strong reasons to believe that the people running it are going to do better than the average? Are you confident they are smarter than Wall Street -- and that they will be free to put that intelligence to work for you?

If you don't, do yourself a favor: Don't invest in the fund. Ignore what it did last year. Invest in an index fund instead. You'll do better, and you'll pay a fraction of the fees. Most funds do worse than an index fund, such as

(VTSMX) - Get Report

Vanguard Total Stock Market(VTSMX), over the long haul.

But if you are confident that your fund managers are better than the average, then pay no attention to one quarter or even one year's performance. Over short periods, the average investor may bid up some shares way beyond their real value and sell others for much less than they're worth.

During that period, your manager will "underperform." But over time, truth and value will out.

Look at

Krispy Kreme


a few years ago. Anyone who wasn't on board when it skyrocketed looked like a fool. Then the dough hit the fan. For that matter, look at any stock chart. A company that was apparently "worth" $15 a share in May is miraculously "worth" $30 six months later -- or vice versa.

When it comes to investment horizons, Warren Buffett put it best. The stock market, he said once, is a remarkable mechanism for transferring wealth "from the active to the patient."

The tortoise and the hare.

Get-rich-quick schemes usually turn out to be get-poor-quick schemes. Investment, like winemaking, takes time. And if you just want to bet on red because it's come up three times in a row, go to Foxwoods and head for the roulette table.

The good news is that successful investment isn't harder than it sounds: It's easier than it sounds. You just have to cut out all the noise about "hot hands" and funds "on a roll" and ignore your lucky neighbor who happened to make a killing in a penny stock.

If I were forced to invest only on the basis of the last few years' performance, I'd rather invest in the types of funds that had done worst, not those that had done best. Asset classes swing in and out of fashion. Who wanted to buy precious metals funds in 1999?

Nobody. Everybody wanted ... technology.

There are no prizes for guessing which funds have done the best since then, and which have done the worst.

How do you find these really good fund managers? There's no sure-fire mechanism, but I haven't yet found anything better yet than looking at long-term performance.

And I mean really long-term. I want to see 10 years' worth of numbers, or more. If someone's up over one, two or three years, it doesn't mean much. They may just be lucky, or surfing a wave.

Sure, someone who's beaten the market over 10 years may just have been lucky too, but it's a lot less likely. There's an excellent chance they really know what they're doing. Successful investing is an art as much as a science.

Among the domestic fund managers with this kind of record are Bill Miller at

(LMVTX) - Get Report

Legg Mason Value Trust (LMVTX) and

(LMOPX) - Get Report

Legg Mason Opportunity Trust (LMOPX), Bill Nygren at

TST Recommends

(OAKLX) - Get Report

Oakmark Select (OAKLX), Ron Muhlenkamp at

(MUHLX) - Get Report

Muhlenkamp (MUHLX), David Williams at


Excelsior Value and Restructuring (UMBIX), Manu Daftary at

(QUAGX) - Get Report

Quaker Strategic Growth (QUAGX), Richie Freeman at

(SHRAX) - Get Report

Legg Mason Partners Aggressive Growth (SHRAX), and Saul Pannell at

(ITHAX) - Get Report

Hartford Capital Appreciation (ITHAX).

Jeff Bruce at

(BRUFX) - Get Report

Bruce Fund (BRUFX) has a truly stunning record lasting more than 20 years. Over the past 10 he has turned $10,000 into $63,000. You can only invest by mail -- and that keeps most people out.

Those with excellent long-term records also include Will Danoff at

(FCNTX) - Get Report

Fidelity Contrafund (FCNTX), but he now manages more than $50 billion, and it's tough to make an elephant dance. Marty Whitman at

(TAVFX) - Get Report

Third Avenue Value (TAVFX) also has a terrific long-term record, but he is now moving toward retirement. The same goes for the all-time champ, Warren Buffett at

Berkshire Hathaway



It helps when fund managers are given freedom to follow their intellect. That includes the ability to hold lots of cash when they can't find enough bargains. Too many funds hamstring their managers with benchmarks and quarterly figures. They make them invest fully in the market, even if they can't find anything good to buy.

That makes business sense for the fund managers' employer, because it cuts down on the wave of redemptions they would get after one or two quarters of "underperforming" the market.

But it makes bad sense for long-term investors. Buffett has frequently remarked that such quarterly reviews would have prevented him from achieving what he has. Some good fund managers, like Danoff at Fidelity, also get burdened with too much money to handle. Again, it makes sense for the fund management company but not for you.

I also have a soft spot for fund managers who "underperformed" during the mania of 1999. If I want to gamble my savings at the track, I'll go to the track.

Guarantees do not come with the stock market. All you can do is make your best estimate of the balance of probabilities. I personally have money invested in Legg Mason Value, Quaker Strategic Growth, Muhlenkamp and Oakmark Select.

As I wrote in December, most of these fund managers underperformed the average, as measured by the stock market indices, in 2006. I don't take that as a sign that they have "lost their touch," though of course that is always possible. I take it as a sign to be wary of what the average investor is willing to pony up for stocks right now.

In keeping with TSC's editorial policy, Brett Arends doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Arends takes a critical look inside mutual funds and the personal finance industry in a twice-weekly column that ranges from investment advice for the general reader to the industry's latest scoop. Prior to joining in 2006, he worked for more than two years at the Boston Herald, where he revived the paper's well-known 'On State Street' finance column and was part of a team that won two SABEW awards in 2005. He had previously written for the Daily Telegraph and Daily Mail newspapers in London, the magazine Private Eye, and for Global Agenda, the official magazine of the World Economic Summit in Davos, Switzerland. Arends has also written a book on sports 'futures' betting.