Rear-View Mirror Investing At Its Worst

Mutual fund companies have a lot to be ashamed of, but they can’t be faulted for their shareholders’ underperformance. Back in 2002, Jason Zweig, then a Money magazine writer who’s now with The Wall Street Journal, wrote an eye-opening piece about the different returns experienced by mutual funds compared to their shareholders. Zweig analyzed fund performance from 1998 to 2001 and found that the average fund returned 5.7% over that four-year period while the average fund investor earned only 1.0%. This huge discrepancy was due to investors’ almost universal tendency to chase performance. They buy funds when they’re hot -- i.e., when their recent performance is near the top of the charts -- and they sell funds when they’re cold. In simplest terms, most mutual fund investors buy high and sell low.

Sadly, little has changed in the intervening years. According to Morningstar, the best-performing U.S. diversified stock fund of the decade just-ended was CGM Focus Fund. Managed by the legendary Ken Heebner, the CGM Focus Fund returned 18.2% annually. Heebner’s shareholders, however, didn’t just experience lower returns -- they actually lost money to the tune of minus 11% annually. That’s a 2900 basis point differential. Truly staggering.

Heebner is a high-risk, high-reward portfolio manager who is not for the faint of heart. His fund is designed for long-term investors who can handle outsized gains and losses, but it’s clear that way too many of his shareholders tried to time the market -- with pitiful results. Here’s an example (keeping in mind that the fund’s assets now stand at $3.7 billion): After the fund rose 80% in 2007, investors contributed over $2.5 billion into the fund. Unfortunately, the fund lost 48% in 2008 -- whereupon investors withdrew $750 million and thus missed the gains of 2009.

If you’re going to place your trust in an active manager like Heebner, don’t try to outsmart him. You need to be patient and not panic. If you can’t follow that simple rule, then stick to index funds. But whatever approach you take, stop looking in the rearview mirror or you’ll never reach your intended destination.

For more investing insights, please take a look at my new book "Your Nest Egg Game Plan" or visit my website at www.HardWorkingMoney.com.