Summary
What are the biggest mistakes mutual fund investors habitually make?
What are the biggest mistakes mutual fund investors habitually make?
According to Albert Fredman, a professor of finance at California State University-Fullerton and co-author of many widely respected mutual fund books, there are four of them:
- Being overconfident in one’s ability to predict the future performance of markets and fund managers.
Hanging onto mediocre funds in the hopes of breaking even.
Being too myopic about the inevitable short-term losses accompanying stock ownership.
Being oblivious to the corrosive impact of compounding costs on long-term returns.
How can fund investors curb these tendencies? By following these five simple rules, says Fredman.
Don’t try to beat the market. Individuals who try to beat the market often find that the market beats them, says Fredman. That’s because trying to beat the market can lead to overtrading and inadequate diversification. The secret to making big money over long periods of time lies not in making the big gain, but rather in avoiding the big setback.
Accept the fact that stock prices will fluctuate. Shortsighted investors often avoid equities because they fear losses, says Fredman. Those people don’t realize that inflation’s long-term impact on wealth can be far more devastating than riding with the market’s short-term ups and downs. If you focus on the potential outcome over several decades, you’re more likely to hold the correct percentage of stocks in your portfolio.
Build a well-balanced portfolio. Portfolio diversification is still the best way to guard against the risk of irreparable financial harm, says Fredman. Build a portfolio based on your age, time horizon, earnings, net worth and risk tolerance. Being overweighted in a volatile fund or stock can cause an undue amount of emotional stress, which in turn can trigger indiscriminate selling.
Use low-cost, tax-efficient index funds. Over time, high expense ratios add up to big costs, says Fredman. Compounding high expense ratios with rapid-fire portfolio turnover is a recipe for poor fund performance, particularly in a taxable account. The way to escape the corrosive impact of high costs is to use broad-based index funds for your portfolio core, or your entire equity allocation. Favor index funds that target the S&P 500, Wilshire 5000 or Russell 3000. Exchange-traded funds provide a low-cost option for disciplined investors following buy-and-hold programs. Costs will weigh even heavier going forward as equity returns are likely to be far lower during the next 10 to 15 years.
Know when to sell. Sell decisions are often more difficult than buy decisions, concludes Fredman. You need a disciplined program for selling to avoid the financially debilitating mistakes of clinging to losers, selling winners too soon, overtrading, or panic-driven selling during a market tumble. A pattern of unfocused selling typically leads to disastrous investment results. Don’t let the prospect of regret stop you from selling a loser that could impede the performance of your portfolio.
Investor’s Notebook is a digest of investment opinion from the world’s leading financial advisers. It does not recommend any specific investments, and no endorsement is implied or should be inferred. For more information, contact the individual firms cited.
