Mutual Funds and Long-Term Investing
There was a time when you invested your money in Certificates of Deposit at your local bank and left the money there until your retirement
. Banks offered safety and a minimal return on investments.
Then, along came mutual funds...
During the go-go 1990s, mutual funds were the rage, and returns of 25% per year were not uncommon. Without any real knowledge of how mutual funds worked, employees plowed billions of dollars into their 401(k) plans and funded those plans with mutual funds. At the time, many funds were springing up and specialized in a variety of investing disciplines. It wasn't long before funds that specialized in narrowly focused industries were common and many fared very well. Of course, during a spectacular bull run investors became accustomed, if not spoiled, with the fantastic returns they received. Who can forget Peter Lynch and the fantastic returns on the Fidelity Magellan Fund?
Somewhere along the line people forgot that the market does not stay in a perpetual bullish state. In my opinion, most unsuspecting investors can be forgiven for this oversight. Our last bull market was one of the longest in recent history, though it was funded by deficit spending at a national and personal level. Like all good things, it came to an untimely end as in recent years stock prices have skidded and home values have plummeted precipitously.
But a lot of folks stuck with their funds and their 401(k) plans...
The problem with most open ended funds is that they can only buy stocks, and cannot sell short. The end result for the investor is that unless the market goes up he or she does not make money. As I mentioned earlier, many funds evolved with tightly focused investment objectives and if the particular sector in which a given mutual fund was forced to invest did not do well, there was nothing that the fund manager could do besides mitigate the level of overall loss. Investing in perpetually long positions definitely has its disadvantages. Of course, during a recession the market as a whole tends to decline, so it does not particularly matter what investment sector you invested in, the results will be disappointing. This makes investing over the long term, or using the "buy and hold" strategy difficult to implement.
So now the mutual fund industry finds itself in a bit of a quandary. During the rip roaring bull market of the last decade mutual funds were the investment of choice, especially for the uninitiated. Now that the market has cooled off some, which is an understatement, the allure of funds have waned. Worse yet, there are millions of investors with money in their 401(k) plans invested solely in mutual funds. Though we have had a nice run up in the last year, the long-term prospects, at the present, are not so encouraging. Worse yet, many employees jumped out of their funds, especially in 401(k) plans, at or near the bottom of the last market correction. They stand little chance of returning to the original high account balances they once enjoyed. The lesson is a simple one, during bull markets mutual funds are a wonderful investment and very profitable. When the market is correcting, however, funds can be a distinct liability because they are, by law, required to invest in only long positions. If you are holding funds during a market correction your options are very limited; you can stay in the fund or you can opt out. There are no provisions in fund investing that allow you to effectively take advantage of a correcting market.
In my opinion, the recent volatility in the markets negates the old adage, "buy and hold investments." I suppose over a 50 year time frame this investment strategy may pay dividends, but currently the average holding time in mutual funds is just under three years. Needless to say, a great many people have been burned of late in mutual funds. Absent a rip roaring bull market, the mutual fund industry must develop a mechanism to protect investors in down markets. If not, they risk losing a great number of investors. Already the number of mutual fund investors has declined nearly 40%. The industry needs to become more nimble to survive in volatile market conditions which punish investors severely.
Mutual Funds and Long-Term Investing
By: David S Adams
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