“On the second day of Christmas my broker gave to me…
two active traders…”
“I have held these mutual funds for 5 years; I am in it for the long haul.” This is a comment I hear every once in a great while. Part of the problem with that statement is that you may be in an investment for the long haul, but the mutual fund manager does not have the same philosophy you do! A mutual fund is basically a basket that holds many different kinds stock. It could be as specific as a technology fund, or as general as an allocation fund. The idea behind a mutual fund is that you can purchase a single share of a fund and own tens if not hundreds of companies. So, in essence, you are spreading your money around that way you are not focused on any one individual company. This is good; it is what we call diversification.
“In finance, diversification means reducing risk by investing in a variety of assets.”
There are a couple of problems we, as investors, can run into. The first is TURNOVER. If you do a little research of the mutual funds you hold, you will eventually see something called turnover. This measures how frequently assets within the fund are bought and sold by the fund manager. The number is relative to the year. So, a mutual fund with a 100% portfolio turnover is telling you that every single stock that was purchased that year was sold and replaced by something else. If the fund has a 50% turnover, then half of the stocks in the portfolio was sold and replaced. What is interesting about this number is that it DECREASES the return on the portfolio. Why is this? Well, when there is a trade within the mutual fund, there are still fees that they have to pay to trade their stock. It’s not free! So, for every 100% turnover, it takes away on average 1.00% of the mutual fund return. If the turnover was 50%, then 0.50% is taken away from the return. Get the idea?
The second problem is that your strategy of buy-and-hold could actually be a strategy of get-in/get-out, get-in/get-out. Instead of passive you are now active without being aware of it. If you are investing for the long haul, then invest yourself in a strategy that you understand. A PASSIVE investor will look for funds that have LOW TURNOVER and therefore will naturally have lower fees and a better expectation of how their portfolio will perform. If you are looking for someone to be active with your money, buying and selling constantly, so as to make a greater return than the stock markets then you must understand that your risk will increase as well as fees and possibly taxes. Remember though that activity DOES NOT equal control!
Philip A. Guske