Fund News: Good or Bad?

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There’s news about mutual fund investors. In fact, two stories have emerged in the past few days. But is the bottom line good or bad?

The Wall Street Journal, citing reports from fund companies and Morningstar Inc. (Stock Quote: MORN), says investors have begun tip-toeing back into stock funds. Many fled after the market tanked in 2008.

It’s a pretty cautious move. About $2.7 billion flowed into U.S. stock funds in January, following outflows in the previous four months. And about $8.1 billion went into international stock funds, the biggest inflow since the end of 2007.

Those figures pale next to the $28 billion that went into bond funds in January.

Meanwhile, Morningstar has reported on a new study that shows investors haven’t shaken a longstanding bad habit – buying high and selling low. They kept it up through the “aughts,” the decade that just ended.

“The grand total for the average investor in all funds in the aughts was a 1.68% annualized return, compared with 3.18% for the average fund,” Morningstar said.

In other words, an investor who stuck with the average fund through thick and thin for the entire decade would have made 3.18% a year. But the average investor actually made only 1.68% a year. That’s because investors tend to put money into a fund after it has done well, missing the biggest gains and often suffering losses as the fund retreats from its peak.

Morningstar figures the investor returns by studying cash flows in and out of individual funds.

“In U.S. equities, the average investor earned a scant 0.22% annualized, compared with 1.59% for the average fund,” Morningstar said.
While the figures sound small, they have a snowballing effect over the years. The jittery, in-and-out investor typically earns far less than the investor who holds on.

Investors’ tendency to behave badly puts the recent “fund-flow” data into perspective. People who are moving back into stocks now may well be attracted by the big gains that stocks enjoyed in 2009. But they’d have been better off bulking up on stocks at the start of 2009, or just holding steady year after year.

The affection for bond funds may not reflect well on investors, either. Presumably, many are attracted by bonds’ reputation as relatively safe holdings, and the fact that the average bond fund beat the average stock fund in the just-ended decade.

But, again, many investors may be getting into bonds too late, and setting themselves up for a fall. If interest rates rise this year, as many investors expect, bond prices could fall, dragging down bond funds. That’s because the old, low-yield bonds in those funds would be less attractive to bond traders than newer bonds with higher yields.

Study after study have shown that investors generally do best with a buy-and-hold approach, and by continuing to invest new money at a steady pace regardless of whether the markets are rising or falling. But the latest news suggests investors just haven’t got the message.

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