Here's a few predictions of which you can be equally confident:
1) The sun will rise tomorrow morning.
2) The Tampa Bay Devil Rays will fail spectacularly in their bid to win the 2005 World Series.
3) The return for individual investors in 2005 will be worse than the advertised returns for the funds in which they invest.
In other words, if at the end of the year a fund claims a 14% return, you can be certain that the actual return for the average investor will be less than that.
The Wall Street Journal, (7-13-05, "Fund Investors Gain by Sitting Tight", by Jane Kim) once again explains this unfortunate investing phenomenon, something I call "Whack-A-Mole Syndrome". It is the dominant paradigm of today's investor, as predictable as it is insidious.
Why does this happen? In short, because human emotions confound our buy/sell decisions. When we see a fund move higher, it becomes safer, more attractive. We buy in. When a fund slumps, we tend to feel uneasy and move our money elsewhere. The problem is that this pattern virtually assures that we will buy on the peaks and sell in the valleys.
Many 401 K plans unwittingly contribute to the problem. They ditch the funds that are underperforming (gotta get rid of those dogs!) and move to "hot funds" that are a lot easier to defend to the bosses and the employees.
Whack-A-Mole by proxy.
This recently happened to me. I checked an old retirement account with a former employer to find all new holdings and my balance inexplicably lower. I called the HR department. The exchange went something like this
Frank: "What happened to my funds?"
HR Guy: "We rotated out of those funds."
Frank: "Whyja do that?
HR Guy: "They were underperforming."
Frank: "Ah. I see... well thank goodness for that!"
HR Guy (Apparently immune to New York sarcasm): "Our pleasure, sir."
So how do you combat this monster in your accounts? The WSJ article gives some simple advice supported by data: Hold onto them longer. The longer an investor has the fund, the closer their return will be to the advertised return.
There's an old expression: All roads lead to Rome. Well in the investing world the expression would be, "most roads lead to wealth". The problem isn't that people get on the wrong road. We just have this awful tendency to wander off them.
Keep that in mind next time you feel like "taking a short cut".