Some Bad Advice from the Gurus

Here are some of the things they will tell you about mutual funds.

Buy and Hold – Do not try to time the market, and just stick with some good funds.

This is utter nonsense. Yet it is the approach recommended by William O'Neil and many others. You can see what happened to the people who stuck with Brandywine. It is not possible to time the market perfectly, but it is possible to do better than you would do if you just stayed in all the time. It is also possible to jump on the hot funds and sectors, ride that wave while it lasts, and then move to the next wave.

Sometimes, however, you get excellent advice from somebody in the financial press. Cramer's Column, The Quaint Notion of Buy-and-Hold Investing pretty much says it all for the buy-and-hold strategy, at least as it applies to individual stocks. A short excerpt:

Let's say I bought Philip Morris (NYSE:MO - news) at the beginning of the year. Hey, dog of the Dow, great company. (Let's for the moment forget that I will smack anybody in my family who uses its main product, and I haven't hit anyone since Adam Stagliano in 11th grade.)

I would now be down 36%. In the world of the quaint, 20th-century notions of "long-term investing," I would be labeled a patient, conservative investor. I would be "considered." I would be thoughtful. I would have done my homework, because the P/E is low, the yield is great and the management, well, what can you say, they've been killing people for decades and getting away with it by sponsoring the arts!

Well, he picks an easy target, of course, since they sell addictive drugs which kill, but oddly enough I did have a friend of mine recently tell me how Philip Morris was the cornerstone of his portfolio. Yuck!

June 30 addition to this topic: From the Motley Fool Canslim Message Board. Enough said

Only buy funds with low expense ratios.

On the face of it, this is good advice. You do not want to pay too much for these guys to manage your money. But the bottom line is fund performance, and the fees are factored into the performance. When you compare the charts of two funds, all you care about is which one is doing better. The fees are irrelevant, since they are already in the chart. Is there a correlation between low expense ratios and fund performance? I don’t know or care, and in any case it would not be a 100% correlation.

Only buy funds that trade infrequently.

Again, all you care about is the fund performance. There may or may not be a correlation between frequency of trades and fund performance, but as with expense ratios, it would not be a 100% correlation.

If you trade frequently, you will have to pay taxes, and the taxes will wipe out your gains.

This could be true. If not trading at all gives you 15%, and trading frequently gives you only 16%, then the taxes (unless you are trading your IRA) will get to you. On the other hand, if you double the return of “buy and hold”, as is likely (see the Fundbuster results), you will certainly come out ahead. Many people are so afraid of paying taxes that they fail to make the returns that they should. Also, some people are so afraid of paper work that they avoid trading at all.

Get real, guys and girls! Nothing is free, but if you just keep records of your trades as you go along, you will find that it is not much trouble to do your taxes in April.

Diversify

Well, what does this really mean? A small cap fund, and a mid cap fund, and a large cap fund, and a technology fund, and a health care fund and a financial services fund … ? Wrong! Buy good funds, and sell them when something else gets better.

Be Patient - Give the Fund Time

Yes, fund managers are right that frequent trading of funds does add to the expense of running the fund. There is a simple way of preventing frequent trading, of course: just be a top performer all of the time. Now here, quoted from a Washington Post article, is the absolute height of arrogance:

Many mutual fund managers look back longingly on the good old days when investors stayed put. "Twenty years ago, the average holding period was seven, eight, even 10 years. Now three years is considered a long holding period. We consider that an insanely short period of time from which to judge a fund's performance," said Brian Mattes, a spokesman for the Vanguard Group of mutual funds.

To try to coax back that kind of patient behavior in investors in its Health Care fund, Vanguard imposes a 1 percent exit fee on "short-term" investors. In this case, "short-term" is defined as cashing out in less than five years.

Five years, of course, predates the rise of the Internet, the surge in online trading, the Asian economic crisis, the Russian economic collapse, day traders and a host of other events that have reshaped financial markets and reshuffled investment winners and losers.

Gimme a break, Brian baby. Only an idiot holds a dog of a fund for even 1 month while "judging its performance". I cannot imagine every doing business with Vanguard. Or to put it another way, quoting from the same article:

"In many ways, the mutual funds are victims of their own success, or at least of their own advertising," Steele [a Rydex Vice President] said. "Mutual fund executives all do it. When they do well, they post their returns - best fund in its category. So what they are trying to do is to lure that flighty investor who gravitates to the high performer. If you live by that sword, you're going to die by that sword."

A Discount Broker Does not Push and Particular Fund

Well not always, at least according to this article. It says, in part, "The Charles Schwab Web site boldly promises financial services 'without sales pressure or conflict of interest.' But the discount broker is promoting a new Hambrecht & Quist mutual fund to financial advisers and its own customers in exchange for a cash payment. Such an arrangement, which Schwab says has been made in the past with other mutual fund firms, gives the untested fund extra visibility among the more than 1,650 funds in Schwab's OneSource, the Web's largest mutual fund supermarket. ..." So I suggest that you shun any free advice or promotions from these guys.

And sometimes, they lie with statistics

This link takes you to a Motley Fool article on how Merrill Lynch Chairman and CEO David H. Kamonski uses "statistics the way a drunk uses a lamppost -- for support, rather than illumination." This article is so good I wish I could just completely reproduce it here, but there are those copyright laws.

And do they learn from experience?

From this article we can see that LTCM (the hedge fund that caused a financial crisis in 1998) is now almost out of business.  No mention of what sort of losses their investors are going to realize.  But here is what bothers me:

"[New York Federal Reserve President William McDonough] said the fund, headed by former Wall Street maven John Meriwether and based in Greenwich,
Connecticut, had repaid most of the bailout money. People close to the situation have said Meriwether already is talking to wealthy individuals and other firms seeking fresh cash to start a new fund."

OK, I know there is a sucker born every minute, but can't they learn from experience?  And how can "wealthy individuals" manage to stay wealthy when they continue to have such poor judgment? If I remember correctly, Merrill Lynch Chairman and CEO David H. Kamonski was one of the ones who invested in LTCM.  Will he do it again?  Will he recommend it to other "wealthy individuals"? What does that say about the quality of financial advice from Merril
l Lynch?

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