Sound Money Principles
December 28, 2002

Paying attention to Wall Street analysts, television touts, and Web-based stock-pickers is hazardous to your wealth. So is actively trading mutual funds.

Let me put some numbers on that perspective: From 1984 through 2000, the average equity mutual fund investor realized an annual return of only 5.3 percent compared to an annual gain of 16.3 percent for the S&P 500. Imagine, during the greatest equity bull market in history, mutual fund investors lagged the return on default-free Treasury bills, according to Steven Leuthold, market historian, long-time manager of money, and occasional Sound Money sage.

What accounts for the miserly mutual fund return? It's partly a story of the high costs associated with actively managed funds, such steep management fees.

But the main reason for the gap in gains rests with the individual, says Leuthold. Investors are far from the rational thinking machines calculating the investment odds commonly described in the finance textbooks. Emotions, fads, and mental biases affect our investment decisions.

The big problem is the lure of running with the crowd. Investors can't seem to resist chasing past performance, piling into the latest hot mutual fund or sector just as the game is ending. Investors also tend to buy when the stock market is high and the economy strong while selling equities when the market is down and the economy faltering. But buy high and sell low is a classic recipe for poor results over the long haul. As the legendary value investor Benjamin Graham once put it, "The investor's chief problem-and even his worst enemy-is likely to be himself."

On Sound Money, we emphasize that diversification matters, that low fees are preferable to high fees, and that past returns are poor predictors of future returns. Nothing beats a buy-and-hold investment strategy with a portfolio composed of broad-based index funds. Yes, there's little excitement in such an approach. But there's the pleasure of doing better than most of the high-priced talent on Wall Street.

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