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Buy and Hold, Except Mutual Funds Don't

Watching all of this stock market volatilty every day has to get you wondering about who is doing all this trading. Of course, mutual funds always tell investors to buy and hold; yet when you look at how they behave, they simply don't do it.

Mutual fund managers on average turnover their portfolios at rate of between 80% to 100% a year, which means they basically sell all of the securities in the portfolio every year. And in these markets, you can be pretty sure that the average turnover ratio is going to climb even higher. So although their marketing material encourages investors to buy and hold, the managers certainly don't practice what they preach.

What they really mean is buy and hold their mutual fund, while they trade your retirement savings like crazy. And as they buy and sell during these volatile days, they may well be recognizing lots of losses in your portfolio, as opposed to simply owning a good collection of companies and riding out this cycle.

If you're tired of all these ups and downs, as an investor you should consider taking affirmative steps to avoid participating in the trading. That means reviewing the funds you own and looking at their turnover ratio. In general, if you've got turnover of more than 25% in a portfolio, you've got a fund with a lot of trading. And you have to wonder, if these managers aren't confident enough to hold most of their stocks for at least a year, why should you be confident holding their mutual fund?

  • Now, fund companies will tell you that turnover of as much as 50% is considered low, because of course that is below the average. But ask yourself if selling half of what you own every year sounds like low turnover? Of course not. What they consider low is still way too high. The entire industry is far too focused on short term gains in the stock market. In general, fund managers don't implement the advice they give to mutual fund investors, which is to sit tight and not panic. The professionals seem to be panicking.
There are good mutual fund managers out there with low turnover, but sadly they are in the minority. Most funds trade a lot. But you may well find some good funds in your 401(k) menu with low turnover, or you can also focus on owning some index funds, which generally follow a buy and hold approach. Index funds often have turnover below 10%. There are far more index funds available today than ever before. You can choose from all sorts of different buy and hold strategies that span from the traditional S&P 500 type approach to index funds that focus on companies that pay healthy dividends.
  • Of course, you have to do the research on what you're buying so you understand how the fund is structured and the overall risks. Turnover is just one factor to consider, but it's an important one.
The vast weight of the evidence in the financial markets is that buying and holding a portfolio of high quality stocks has the highest probability of producing competitive returns over the long term. I expect that will continue to be true into the future.

Bottom line. If you don't want to participate in all this trading, make sure your investments are reflecting your buy and hold philosophy.

Above material does not constitute investment advice nor does it constitute a complete discussion of the issues identified. Consult your individual financial advisor prior to making any financial decisions. Past performance is no guarantee of future returns, and all investing involves the risk of loss.
Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my new book Your Money Ratios: 8 Simple Tools For Financial Security, available in bookstores and at The Wall Street Journal called the book "one of the best finance books to cross our desks this year." WSJ 12/19/09.

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