Showing posts with label Investing in Investment Funds. Show all posts
When should you sell a fund?
Once you own a fund, how can you tell when it's time to sell? The standard advice is to ditch a fund if it underperforms the market (or similar portfolios) for one-or is it two?-or is it three?-years in a row.
But this advice makes no sense. From its birth in 1970 through 1999, the Sequoia Fund underperformed the S & P 500 index in 12 out of its 29 years-or more than 41% of the time. Yet Sequoia gained more than 12,500% over that period, versus 4,900 % for the index.
The performance of most funds falters simply because the type of stocks they prefer temporarily goes out of favor. If you hired a manager to invest in a particular way, why fire him for doing what he promised?
By selling when a style of investing is out of fashion, you not only lock in loss but lock yourself out of the all-but-inevitable recovery.
One study showed that mutual-fund investors underperformed their own funds by 4.7 percentage points annually from 1998 through 2001 - simply by buying high and selling low.
So when should you sell? Here a few definite red flags:
As the investment consultant Charles Ellis puts it, "if you're not prepared to stay married, you shouldn't get married." Fund investing is no different. If you're not prepared to stick with a fund through at least three lean years, you shouldn't buy it in the first place. Patience is the fund investor's single most powerful ally.
- The Intelligent Investor, Benjamin Graham
- The Intelligent Investor, Benjamin Graham
The closed world of closed-end funds
Closed-end stock funds, although popular during the 1980s, have slowly atrophied. Today, there are only 30 diversified domestic equity funds, many of them tiny, trading only a few hundred shares a day, with high expenses and weird strategies.
Research by closed-end fund expert Donald Cassidy of Lipper Inc. reinforces Graham's earlier observations: Diversified closed-end stock funds trading at a discount not only tend to outperform those trading at a premium but are likely to have a better return than average open-end mutual fund.
Sadly, however, diversified closed-end stock funds are not always available at a discount in what has become a dusty, dwindling market.
However, they are generally not suitable for investors who wish to add money regulary, since most brokers will charge a separate commission on every new investment you make.
- The Intelligent Investor, Benjamin Graham
- The Intelligent Investor, Benjamin Graham
What else should you watch for investing in investment fund?
Most fund buyer look at past performance first, then at the manager's reputation, then at the riskness of the fund, and finally (if ever) at the fund's expenses.
The intelligent investor looks at those same things-but in the opposite order.
Since a fund's expenses are far more predictable than its future risk or return, you should make them your first filter. There's no good reason over to pay more than these levels of annual operating expenses, by fund category:
- Taxable and municipal bonds: 0.75%
- U.S equities (large and mid-sized stocks): 1.0%
- High-yield (junk) bonds: 1.0%
- U.S equities (small stocks): 1.25%
- Foreign stocks: 1.50%
Next, evaluate risk. In its prospectus (or buyer's guide), every fund must show a bar graph displaying its worst loss over a calendar quarter. If you can't stand losing at least that much money in three months, go elsewhere.
It's also worth checking a fund's Morningstar rating. A leading investment research firm, Morningstar awards "star ratings" to funds, based on how much risk they took to earn their returns (one star is the worst, five is the best). But, just like past performance itself, these ratings look back in time; they tell you which funds were the best, not which are going to be.
Five-star funds, in fact, have a disconcerting habit of going on to underperform one-star funds. So first find a low-cost fund whose managers are major shareholders, dare to be different, don't hype their returns, and have shown a willingness to shut down before they get too big for their britches. Then, and only then, consult their Morningstar rating.
Finally, look at past performance, remembering that it is only a pale predictor of future returns. As we've already seen, yesterday's winners often become tomorrow's losers.
But researchers have shown that one thing is almost certain: Yesterday's losers almost never become tomorrow's winners. So avoid funds with consistently poor past returns-especially if they have above-average annual expenses.
- The Intelligent Investor, Benjamin Graham
Index funds as the best choice for individual investor - Graham
Why don't more winning funds stay winners?
The better a fund performs, the more obstacles its investors face:
What, then, should the intelligent investor do?
First of all, recognize that an index fund-which owns all the stocks in the market, all the time, without any pretense of being able to select the "best" and avoid the "worst"-will beat most funds over the long run.
Index funds have only one significant flaw: They are boring. But, as the years pass, the cost advantage of indexing will accruing relentlessly. Hold an index fund for 20 years or more, adding new money every month, and you are all but certain to outperform the vast majority of professional and individual alike.
Late in his life, Graham praised index funds as the best choice for individual investor, as does Warren Buffett.
- The Intelligent Investor, Benjamin Graham
Mutual funds aren't perfect; they are almost perfect
Mutual funds aren't perfect; they are almost perfect, and that word makes all difference. Because of their imperfections, most funds underperform the market, overcharge their investors, create tax headaches, and suffer erratic swings in performance. The intelligent investor must choose funds with great care in order to avoid ending up owning a big fat mess.
Financial scholars have been studying mutual-fund performance for at least a half century, and they are virtually unanimous on several points as below
Your chances of selecting the top-peforming funds of the future on the basis of thier returns in the past are about as high as the odds that Bigfoot and the Abominable Snowman will both show up in pink ballet slippers at your next cocktail party. In other words, your chances are not zero-but they're pretty close.
But there's good news, too. First of all, understanding why it's so hard to find a good fund will help you become a more intelligent investor.
Second, while past performance is a poor predictor of future returns, there are other factors that you can use to increase you odds of finding a good fund.
Finally, a fund can offer excellent value even if it doesn't beat the market-by providing an economical way to diversify your holdings and by freeing up your time for all the other things you would rather be doing than picking your own stocks.
- The Intelligent Investor, Benjamin Graham
- The Intelligent Investor, Benjamin Graham
