Time to jettison any death-wish investment strategies

Your Funds

September 02, 2001|By CHARLES JAFFE

SEVERAL YEARS ago, I asked dozens of mutual fund experts to devise a game called "suicide fund investing."

The idea was to pick strategies that would lose money, to intentionally make the kinds of mistakes that would lead an investor to ruin. They had to avoid the weird and the obvious - like buying some high-risk fund invested entirely in the stock market of Cameroon or buying some all-time horrific loser like the American Heritage fund - and stick with concepts that turn ordinary investors into losers.

Unfortunately, many real investors have used the "suicide strategies," generally without knowing the pitfalls.

I was reminded of that recently when I spoke with an investor who has suffered mightily in the current market, despite making what he thought were "all the right moves." The more he talked, the more I realized he had pursued the kamikaze strategies laid out in that old column.

With that in mind, I decided to revisit the death-wish investment tactics first identified here in 1996. They have stood the test of time; if they describe what you did during the bull market or are doing today, it's time to reconsider your fund philosophy.

Suicide strategy: Buy from the top of the short-term performance chart.

In general, quick-hit winners are concentrated and volatile, equally capable of being at the bottom of the charts. In the late 1990s, of course, technology funds were the big winners, only to give virtually all of it back in the past two years.

Today, the worry is that you can buy from the top of the charts in the name of diversification, because many of the top funds are into bonds. But the top-yielding bond funds have their own volatility risks and may not be the safe bet you are seeking, so be sure to examine performance for consistency and more than just a recent hot streak.

Suicide strategy: Aggressively practice market timing.

Average investors generally don't have enough information to recognize market trends early. If you spot a sea change only after the tide has turned, you miss out on the sharpest upswings and get out only after the steepest drops.

Moving money around strategically is one thing, but average investors should not confuse the emotions of fear and greed with market knowledge.

Suicide strategy: Lose faith in what you are doing.

One of the most common investor mistakes is picking a fund to meet long-term goals, then bailing out if short-term results don't affirm the fund as a good selection.

If you buy a fund once it achieves the results necessary to attract you but dump it after a few months of letdown, you will consistently buy high and sell low. Worse yet, studies show that investors who bounce from fund to fund tend to have miserable long-term results to show for it.

Suicide strategy: Over-emphasize sector funds and concentrated specialized portfolios.

If you were truly playing to maximize your losses, you'd take the riskiest strategy, buying funds that invest in just a few stocks or that concentrate their portfolio in one market niche (say, the Internet). These types of funds tend to soar or crash, which is why they were so enticing in 1999 and look so awful today.

Suicide strategy: Convince yourself that you are diversified when all your funds buy similar assets.

If you only want to buy funds with great track records over a set period of time, you are likely to buy funds with a lot of overlap. There have been times, for example, when roughly 80 percent of the growth-and-income and large-cap growth funds earned four- or five-star ratings from Morningstar.

That left a lot of other fund types - small-caps, international funds, and more - earning lesser grades.

With more than 90 percent of all money flowing into funds with the two highest star ratings, it's clear that many people bought funds that all did the same job, a kind of faux diversification that actually concentrated the portfolio and made it more volatile.

The best example was the Janus funds, which not only tended to buy similar stocks, but which all moved together. That was fantastic in 1999, when the fund company was tops in the business, but it hasn't been so good since, when the firm's overall results have been dreadful.

Suicide strategy: Buy it and forget about it.

The difference between this and a successful buy-and-hold strategy is that forgotten funds get away with poor performance.

Complacency is particularly troublesome when you bought a fund for the wrong reason, such as sexy past results. You compound a bad decision into a worse one by not periodically revisiting your funds to make sure each one still fits into your plans and is worthy of your confidence.

Chuck Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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