Updated: May 3, 2013 12:14PM
Originally published: August 7, 2001
BY TERRY SAVAGE
Originally published: August 7, 2001
`I’m not worried about the stock market; I’m in a mutual fund!” I’ve heard that statement so many times that I’m getting worried.
Americans now have 4.4 trillion dollars invested in stock mutual funds, and far too many of those investors feel their job is finished. They expect that professional money managers will “beat” the market, as well as protect them from losses.
Well, here’s a Savage Truth: A mutual fund is designed to expose you to the market, not protect you from the market.
A mutual fund portfolio manager’s job is to beat his or her “benchmark” average. That benchmark may be something well known, such as the Dow Jones industrial average or the Standard & Poor’s 500 stock index.
If the stock market or the benchmark average rises 20 percent in one year, and the fund outperforms the average, rising 25 percent, then the portfolio manager expects a bonus and recognition.
If the market falls 25 percent, and the value of the fund shares drop only 20 percent, once again the fund manager feels he or she has “outperformed” the benchmark!
You may have lost one-fifth of your capital, but the fund manager feels pretty good about that track record, relatively speaking.
Today’s fund managers remember what happened in 1995 when Jeff Vinik was managing Fidelity Magellan Fund after Peter Lynch turned over the job to him. Vinik had a good track record, but was worried about the valuations in the stock market. (At about the same time, Alan Greenspan was warning of “irrational exuberance.”) So Vinik sold some positions, raised cash, and invested defensively in short term bonds and interest-bearing securities. The market continued to rise, the fund’s performance lagged--and Vinik was soon gone.
That’s why it’s so rare to find a fund manager willing to announce that he or she is sitting on cash, waiting for prices to come down. After all, they rationalize, if investors wanted cash they’d sell their fund shares and buy money market funds.
Indeed, that is a key part of a mutual fund investor’s job. If you feel worried about the market, or just recognize that you have some big gains in your fund investments, it’s your responsibility to sell some shares and transfer into a money market fund or one with less risk. In these days of fund supermarkets and no-load, no-commission mutual funds it’s easier than ever to make such a switch.
It’s also your job to know what kinds of stocks the mutual fund owns, and what categories they fall into--growth or value, large cap or small, technology or consumer cyclicals. The name on the fund is no guarantee that the contents match the label. And if you own several mutual funds, you’ll have to see if they’re balanced--or all doing the same thing.
Mutual funds are not an easy way to get rich; they’re an easy way to “average” into the market--buying regularly with a fixed amount of cash. But if you try to time the market by buying into mutual funds in one lump sum, as you would with an individual stock, then you’re equally exposed to the risks of market timing.
For example, Jack Brennan, CEO of Vanguard Funds, points out that the Lipper Science and Technology category returned 108 percent between December 1998, through October 2000. But if you looked at a cash flow, recognizing that many people bought in when the stock was at its highest price, their return would have been only 8 percent.
What looks like a fantastic numerical record for technology funds didn’t work out so well for the investors who purchased at the top of the market. For most people, sticking with a regular plan of investing over the long run works far better than trying to time the market.
That’s one great advantage of a mutual fund--the ability to “dollar-cost-average” your investments over a period of time. You also get professional management and diversification, plus liquidity and great record-keeping.
That’s a real advantage to most investors, but it doesn’t eliminate the investor’s job of watching and tracking and managing the funds he or she owns. And tracking your funds’ performance is something best done regularly, either on paper or through one of the Internet portfolio management services.
Without question, the best place to research your funds, and compare their performance and holdings is online at www.morningstar.com.
If you’re looking for diversification, discipline and dedication to a long term plan, then stick with your mutual fund investments.
That’s the Savage Truth.
Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Devon Energy Corp. You can send questions to her via e-mail at email@example.com. Her third book, The Savage Truth on Money, was recently published by John Wiley & Sons Inc.