Search This Blog

Tuesday, February 16, 2010

Another Argument for Indexing

 Since index funds/etfs are by definition buy and hold they certainly avoiding having the problems listed in this  wsj article associated with your investments. Now all you have to do is keep yourself from rapidly jumping in and out of the hundreds of etfs and index mutual funds now available..In fact it seems that the more the manager of your actively managed mutual fund trades the less likely he is to produce superior performance and he is surely more likely to generate more tax headaches for you.

my bolds below

High Trading Is Bad News For Investors

Buy-and-hold hasn't looked too good lately, but churn-and-burn is no better.
Stocks are sloshing around faster and cheaper than ever. You can trade online for $7.95 or less. Nearly 2 billion shares are handled daily on the NYSE, not counting trades in rival markets. Throw those in, and trading is a tidal wave, averaging 9.4 billion shares so far in February—up from 9.1 billion in January, says Rosenblatt Securities.
Pause before you plunge. Trading costs money, raises your tax bill and can reinforce bad habits. As Benjamin Graham defined it, investing requires "thorough analysis" and "promises safety of principal and an adequate return." Trading on rumors, hunches or fears is antithetical to investing.
Mr. Graham insisted that "the typical individual investor has a great advantage over the large institutions"—largely because individuals, unlike institutions, needn't measure performance over absurdly short horizons. The faster you trade, the more you fritter away that advantage.
A new study by Mercer, the consulting firm, and IRRC Institute, an investing think tank, asked the managers of more than 800 institutional funds how often they traded.
Two-thirds had higher turnover than they predicted; on average, they underestimated their turnover rate by 26 percentage points. Even though most are judged by performance over three-year horizons, their average holding period was about 17 months, and 19% of the managers held the typical stock for one year or less.
One vehemently denied being too focused on the short term, complaining that hedge funds "have caused market-wide turnover to increase" and that "retail investors tend to look at short-term performance and move in and out of funds" too quickly.
Those who live in glass houses shouldn't throw stones; this manager, according to Mercer, holds the typical stock for about 27 weeks at a time.
Even while grousing that the market is too short-term oriented, these experts think they can beat it by being even more short-term oriented themselves. "There's a very deep level of overconfidence," says Danyelle Guyatt, one of the study's co-authors.
For individual and professional investors alike, more trading doesn't ensure higher returns....

According to Morningstar, mutual funds with the highest portfolio turnover rates have underperformed the slowest-trading funds by an annual average of 1.8 percentage points over the past decade. A study of pension-fund stock portfolios found that, on average, the funds would have raised their annual returns by nearly a full percentage point if the managers had gone on a 12-month vacation and never made a single trade.
That is probably because so many investors tend to sell winners too soon. Only later—if ever—might you notice that you replaced a winner with a stock that isn't as good. Meantime, locking in a gain makes you feel that have accomplished something.
"It is difficult to justify your existence [as a money manager] by not taking action," says Jon Lukomnik, a co-author of the Mercer/IRRC study. When markets are wrenching up and down, he adds, "It takes a very secure person to say, 'I don't have to trade.'"
It also is worth recalling what Warren Buffett wrote in February 1992, when the Dow was at 3200: "The stock market serves as a relocation center at which money is moved from the active to the patient."

No comments: