When the stock market goes through a crisis in confidence, so do ordinary investors. It's hard to have much faith in a financial plan when...
When the stock market goes through a crisis in confidence, so do ordinary investors. It’s hard to have much faith in a financial plan when all of the news is bad.
The standard advice is “Hang on, for dear life,” which is the hardest advice to follow at a time when your investment mettle is being tested. While trading in and out of funds is frequently a recipe for disaster, there are moves that investors can make to improve their confidence and portfolio without blowing up the long-term returns.
To see why that is, consider that the standard advice warns against riding trends or timing the market because it’s hard to use those strategies to improve returns consistently over the long haul.
The evidence supporting the idea that investors are supposed to stay put in funds during downturns is a long-running study from Dalbar Financial Services, which shows that the Standard & Poor’s 500 had an annualized average gain of 11.8 percent over the last two decades, but the typical equity-fund investor was able to capture just 4.3 percent annually.
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But if you talk to the guys who study behavioral finance they are not opposed to small moves to boost confidence. They’ll warn of the dangers of portfolio overhauls, where an investor claims to be making faith-inspiring moves but is really just tilting a portfolio in the direction of what has been hot lately.
“If you can build a better portfolio today — if you’re not happy with a fund you own and can now buy something you believe is better — you’d be foolish not to try,” says Leonard Goodall, editor of the No-Load Fund Portfolios newsletter.
“You need to worry about taxes and about sticking with your asset-allocation plan, but if you could look at your portfolio tomorrow and say ‘This is better than what I have today,’ that’s certainly good for you.”
Even Lou Harvey, president of Dalbar, acknowledges that investors may be able to make a change without becoming the statistic, one of the guys who get that lousy return because they made a jump.
What the Dalbar study fails to account for is where the investors put their money next.
An investor may bail out of a fund at the “wrong time” — defined as just before the fund takes off — but that makes it the “right time” to buy the better fund in the same asset class, capturing the rising tide that lifts the entire category.
“It’s OK to switch from a fund that you think has lower prospects of return to one with higher prospects of return,” says Harvey, “but what you are really betting on is the rate of recovery. You are saying, ‘Here are funds in the same category; which one do I think will recover the best and fastest from this downturn?’ You’re keeping your asset allocation — which is the key to getting the long-term performance you expect — but in funds that give you more confidence than the ones you own today.”
Chuck Jaffe is senior columnist at MarketWatch. He can be reached at firstname.lastname@example.org or Box 70, Cohasset, MA 02025-0070.