You are your portfolio's worst enemy

Having the best results is less important than having a strategy that is good enough.

By MSN Money Partner Aug 25, 2014 3:05PM
Image: Arrow Down © Image Source/SuperStockBy Chuck Jaffe, MarketWatch

Fund shareholders should know what bad investment behaviors look like. To find them, most people simply need to look in their own portfolio.


Whether it's buying funds with above-average expense ratios or chasing performance by rotating toward hot funds -- instead of trying to "buy low" by purchasing whatever the market has put on sale -- hyper-actively managing a portfolio, or going for money managers who haven't proven capable of living up to their fund's promises, there's hardly anyone out there who without one or two classic blunders thrown into their investment history somewhere.


The question is whether that's actually so bad.


That question was raised for me most recently by some new research by the Vanguard Group -- the world's largest fund company -- on the effects of performance-chasing.


The report analyzes "more than 40 million return paths" to cover every possible trade that could have been made among diversified domestic stock funds from 2004 through 2013. Vanguard used a three-year holding period, because that is roughly how long the typical investor hangs onto the average equity fund.


Effectively, the research assumes that anyone whose fund delivers below-average performance over three years would dump the lagging fund in favor of something that has done better in the same asset class.


It’s not a real surprise that the trading investor -- the one who gives up on a fund after three years to buy something "better" -- does worse than the one who overcame their disappointment to let the money ride.


The differences are big, too, with buy-and-hold delivering a 7.1 percent average annualized return in large-cap growth, for example, compared to 4.3 percent for a performance-chasing strategy.


There's some fault in the methodology. I have seldom heard from an average investor who was interested in swapping a lagging large-growth fund for another one in the same asset class; normally, they're so disappointed with results that they are dumping the fund and either rebalancing or just going for what's been hot lately. That's why so many investors left stocks as the financial crisis of 2008 was unfolding, moving into bonds and, in many cases, missing out on the subsequent bull market as a result.


There's not much fault, however, with the conclusion that investors typically hurt themselves by trading, rather than helping themselves.


Now we could argue the reasons that investors make mistakes; because they're irrational, not particularly knowledgeable and more. We can show that the numbers suggest that they would "do better" if they invested in lower-cost funds and held them for a long time.


But just because it's right doesn't mean the average investor can do it.


Intuitively, by now, investors know that buying index funds makes sense, because so few money managers consistently beat their benchmark.


But buying an index fund is a bit like riding a rollercoaster in the amusement park; you may know that the coaster is the biggest, best ride, but plenty of people simply can't buckle themselves in and take the ups and downs.


Right or wrong, using an active manager instead of an index fund gives many of those people a sense of controlling their downside risk. If they are able to buy-and-hold the active fund -- when a downturn might convince them to bail out of the index -- then their results are likely to be better in an active fund, regardless of what any study says about which is the "best investment."


Simply put, some people would rather ride the Ferris wheel and the carousel, others want only the coasters, and still others want to ride everything. All can have a good time in their own way doing the same thing in the investment theme park.


What most of these studies miss is that no one actually sets out to make investment blunders; most of the time, you are looking at honest mistakes.


If those errors blow up the portfolio, it's a disaster; if they result in "sub-optimal returns," it's more like an unfortunate circumstance.


"People are given the tools to hurt themselves on a daily basis these days," said Karl Mills, president of Jurika, Mills & Kiefer in San Francisco. "Your portfolio can tweet at you now . . . You get messages about every market move and you can have stock advice sent to your phone . . . The temptation is to do something which almost always will backfire on your long-term thinking.


"For a lot of people, they keep hearing 'This will help you' and 'This will make your portfolio better,' and they look at this like 'I'm making my portfolio better,' even if they're not," he added.


In short, investing is like the proverb in which perfect is the enemy of good. If you are always in search of something better, there's a good chance you'll hurt your portfolio precisely by doing things you expect to help it.


So long as you reach your financial goals -- whether it's because of those maneuvers or in spite of them -- and you can sleep at night along the way, that's okay.


Having "the best results" is less important than having a strategy that is "good enough" for you.


More from MarketWatch

32Comments
Aug 25, 2014 7:40PM
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There's are  ZERO reasons to buy and hold to Infinity when Global Debt and Leverage is out of Control. Yellen says it's not her Job to prevent Bubbles. But she doesn't have any problem creating them. Oh what a wicked Web we Weave.
Aug 26, 2014 10:21AM
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Your portfolio's greatest enemy - 
Your bank account's greatest enemy -
Your future's greatest enemy -
Your prosperity's greatest enemy - are all DEMOCRATS!!!

A political party does whatever it takes to stay in power.

In order for the Democrats to stay in power, they NEED massive poverty and social strife.

In order for the Republicans to stay in power, they NEED economic growth, prosperity and more self-sufficient people.

Which of these are better for America?? 


Aug 25, 2014 5:27PM
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SO there's another reason for buy and hold
Sep 1, 2014 1:10PM
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Buy and hold is the best... select funds with a good 10 year avg. and forget about them for about 25//30 years, plow the earning back into the same funds and add extra cash as it comes around. It doesn't take a genius.... you can do it with positive result...
Aug 26, 2014 12:05PM
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Obama is my portfolio's worst enemy.
Aug 25, 2014 6:32PM
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if you go golfing all over the world have been divorced and changed woman 5 times you need your millions supplement to your retirement.
Aug 25, 2014 10:13PM
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You are also your own worse critic with exceptions of course.
Sep 1, 2014 1:52PM
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"You are your portfolio's worst enemy." No. Another MSN lie. The government is your worst enemy. They have convinced themselves that your money is their money. Americans are just revenue streams.
Sep 1, 2014 9:18PM
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Here is how the rich are getting richer.  The Feds under the Army Corp of Engineers is giving each homeowner  on a Island off New Jersey where the average home is worth $4 million, $100,000 to build sand dunes.  That's my tax money.  It is not going to save me anything.  I don't see the Feds giving us Midwesterners $100,000 to build tornado shelters for our schools.
Aug 26, 2014 8:50AM
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OK, you take your "better strategy", and I'll take the absolute returns. 
You can't spend a strategy, but at least you can explain to people why your strategy was better.
Aug 26, 2014 10:42AM
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"U.S. consumer confidence rose in August to its highest level since October 2007 on improved feelings about the current state of the economy, according to a private sector report released on Tuesday."
$$$
Right below this yellow journalism article- it says- "people stopped buying homes because they don't have confidence in the economy". 
Sep 1, 2014 7:08PM
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Don't ruin your portfolio by listing or participating in any republican organization, as this affiliation won't fly as far as getting jobs, accounts, or loans. Don't even list it on your portfolio or any paper work that ever associates you with this cult organization.
Aug 26, 2014 9:01AM
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I bit the bullet before I learned what investment companies doe.  I am into American funds.  They are good funds but now I know that have a 5 1\2 percetn front load and yearly maintenance fee of about .8%.  I had to get out of it since I am so invested in it.  One definitely learns by doing.  I do most of my purchasing of stocks myself now.   It has worked out well.  Good luck finding a find that works for you.  They are out there but there are so many of them.. Who knows.
Aug 25, 2014 4:23PM
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Of the funds I have in my 401, 30% are managed, the other 70% index. All types of funds, although bond fund managers do better than stock fund managers.
Aug 26, 2014 10:35AM
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"Every day, the American bull market looks more and more like the dot-com bubble of the late 1990s. Except when it comes to valuations. The Standard & Poor’s 500 Index briefly jumped above 2,000 for the first time yesterday and the Nasdaq Composite Index is within 10 percent of a record reached in March 2000, a time when Pets.com Inc. was worth more than $150 million. Investors have seen annualized returns of 24.5 percent since March 2009, compared with 27.1 percent over an equal amount of days ending March 24, 2000, the peak of the Internet rally, according to data compiled by Bloomberg. Stocks are catching up to the pace of more than a decade ago amid record profits, near-zero interest rates and economic growth that’s expected to accelerate."
$$$
WHERE would that economic growth come from? The very next article cites the Fed as having grossly miscalculated the effect of massive job blockading and long term under and unemployment.
We will need to start building gallows for all the scholars who have been fully OFF on our "recovery". YOU? You get to stand before a tribunal until you cannot stand any longer and then...
How many idiots does it take to not get a clue about the value of free enterprise and small business and ruin an economy?
The answer is-- how many Ivy League grads are alive? Let's fix that. 
We have NO economy. None whatsoever. Our crash will decimate the nation and send the world into war over fake money. YOU never had a clue on what to do but your arrogance stood in the way of any basic solution. YOU will pay for that. 
Aug 26, 2014 6:57AM
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If you have a portfolio and haven't grasped that we are set up for crashing and cataclysmic failure, you are your own worst enemy.
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