Long-term investors have heard the admonition many times before: "Once you've decided upon your investments, don't pay attention to how they are doing day-to-day". Sometimes we are told to check on their performance no more than once per quarter, or even just once annually when you receive your end of year statement.
Otherwise, it is suggested, you are contradicting the very purpose of having long-term investments: You may fret needlessly over short-term movements that when looked at over a longer period of time will most likely cancel each other out. Or, you may even be tempted to act rashly on the basis of temporary price changes that you will later regret.
And it appears that many mutual fund investors have listened. I find this especially true for investors who regularly invest in their tax-deferred employee programs such as a 401k. It is not uncommon for such investors to check their statements only periodically and to make changes only extremely infrequently.
But how good is this advice? If you regard yourself as a buy and hold investor, as many people do, then apparently little will be accomplished by the more frequent checking of your funds' performance. Although it may serve to satisfy your curiosity, by your own choice you may have committed not to change your on-going strategy midstream.
Although from its inception in May '99, this publication has agreed that a long-term approach is the best approach for reaping the largest returns, we tend to disagree somewhat with the above advice. And we disagree even more with those who tell you that if you just leave your investments alone, they will take care of themselves. We say this unless, of course, you plan to be entirely content with earning the identical results to those achieved by each of your particular funds. And during extended periods, as many of us are painfully aware, those returns may not always be pretty.
So, for example, if you buy and hold a well regarded large cap growth fund, you will obviously be receiving the same return as any other investor who bought that fund on the same date as you. As long as the fund is doing well, all is well and good.
But suppose that growth fund comes on hard times - while it had been exceeding the average growth fund at the time of your purchase, it since has started to underperform many other comparable growth funds. Or further, suppose, as has been the case over the last year or more, that large cap growth funds in general have not been performing nearly as well as many other categories of funds, such as perhaps small cap funds, real estate funds, or value funds.
Without some effort to regularly monitor your fund's performance as compared to other similar funds or those from other categories, you might not even be aware that such changes had occurred. So perhaps unlike before, a different growth fund or another fund of a different category might currently offer a better choice for at least some of your existing or new investment dollars.
The same can even be said for index funds. Thus, although you will earn nearly exactly what the particular index earns, the index that you previously chose may have entered into an extended period of poor performance.
For example, had you invested most or all of your stock investments in a S&P 500 fund within the last two or three years, your returns may have turned out far below what you had expected. Had you recognized along the way that the large cap funds within this index were falling out of favor, perhaps you might have re-directed at least some of your investments to an index fund based on a small or mid-cap index.
Would you still have been able to notice and react to these trends by monitoring your funds on a quarterly basis or even yearly? Perhaps. But we feel that if you pay little attention to your funds over these extended stretches of time, it can be harder to recognize that a trend has emerged than when following events and performance more closely. And in certain cases, the trend may emerge so markedly within a period of up to a year that it's easy to get the feeling that it may already be too late to make any corresponding adjustments.
There are those that would argue that even if one was able to spot changing trends in a timely fashion, it wouldn't be worth the effort to try to change one's investments to capture these fleeting trends. If you just buy and hold, they feel, you will be rewarded for your patience. And your tax bill, except in tax-deferred accounts, may be lower as well.
Perhaps, but obviously, there have been many exceptions to that "time heals all wounds" advice. One has only to look overseas to see how stock investments held for 10 years or more have drastically underperformed many other categories of investment. And there have been several equally long periods in the U.S. too where being in the wrong category of investment would have hurt you far beyond many people's ability to just wait it out.
The reason that buy and hold investors tend to do better than frequent traders, in our opinion, is that the buy and hold strategy tends to avoid the common pitfall of buying funds when prices are already high and selling after they have already significantly gone down.
Although the buy and hold strategy can be used successfully, it tends to work best when a good portfolio is already in place - we define such a portfolio as one that tends to use low cost funds, including index funds if desired, that is well diversified by fund category, and that has an appropriate asset allocation for the investor's circumstances and for the prevailing economic times.
If your portfolio does not closely match these characteristics, but rather, was centered around the purchase of funds merely because they were good performers prior to your purchase, then buy and hold may indeed NOT be the best strategy.
As has been shown in the current market downturn, any once "hot" set of funds can readily go out of favor. Retaining such an outdated portfolio may not enable you to capitalize on the invariable ebb and flow of performance from in favor categories to out of favor categories, and then vice versa.
Especially in such cases, by spending just a little more time on your investments each month, you should be able to begin to spot the imbalances in your portfolio and then act in such ways that can improve your long-term performance.
Frequent traders, on the other hand, are often mesmerized by upward price movements into thinking that such movements, if acted upon, will lead them to additional gains. It seems to be part of investor psychology to think that the past will generally be repeated. As a result, funds tend to be bought on upswings.
On the contrary, the wisest long-term investment decisions are usually made by investors who can counter the prevailing psychology and buy from fund categories where prices have been deeply depressed, but as a result of the cyclical nature of investing, have a reasonably good chance of reversing themselves.
Unfortunately, the majority of mutual fund investors, including those who merely direct the same percentages year after year to the same funds in their 401k, are usually not paying enough attention to the on-going, changing trends nor to the repetitive, cyclical nature of fund investing.
In short, they are not spending enough time to allow themselves to periodically update their past decisions. As a result, they are too often stuck with decisions that may have been good at the time they made them, but are insufficiently responsive to present circumstances.
What specifically do we suggest that will enable you to do better than the average mutual funds investor, who frankly we feel, pays too little attention to his investments, but yet often seems to unrealistically expect that he will make out better than average in the end?
Like in nearly all facets of our lives, time is the commodity most of us seem to have far to little of. And having a high degree of interest in the details of what makes the financial markets tick is yet another roadblock. But make the effort to free up a few extra hours each month.
Then, start by tracking your investments on a minimum of a monthly basis. Be aware of which fund category each of your funds falls into and also track how these fund categories are doing and how your funds are doing in relation to the category averages. (Such information can easily be located on the morningstar.com site.)
Finally, read your daily newspaper for information on how the economy is doing, or if you have time, read daily articles of special interest to investors such as provided by sites such as the Money section of usatoday.com or cnnfn.com.
In sum, although we believe a long held, well-balanced portfolio is certainly one of the keys to long-term investing success, we also believe that if you can carve out a little more time to spend on your investments than the average investor, you should be able to do enough better than that average investor as a result to amply reward your efforts, whether in good markets or in bad.
The few extra hours you spend each month can be thought of as an investment in your future as much as your actual funds themselves are. It's a little like going to school - you've got to do a little regular homework to get the most out of it!
Tom Madell, PhD
