Shorter holding times troubling


Last month, I got a letter from a man who bought his first mutual funds in April. The funds, including sales charges paid to a financial adviser, were showing a loss.

The investor was wondering if he should sell.

Any regular reader of this column knows that a few months is not enough time to decide if you like the look of a fund's statements, let alone the information on those documents. It's clearly not enough time to judge a fund and bail out.

Yet the letter writer preparing to jump is hardly alone.

The trading of mutual funds - either by investors trying to time and beat the market, or by folks who simply give up on funds too quickly - is accelerating at an alarming pace.

The Bogle Financial Markets Research Center, the think tank created by Vanguard Group founder Jack Bogle, uses industry data to show that the person who buys a fund today will hold it, on average, for just over two years. That's down from an average holding period of three years in the late 1990s and more than 12 years in the 1950s and 1960s.

The situation is troubling because there are real people behind those statistics, and those investors are ignoring the roadblocks that have previously kept them in mutual funds for at least a little while.

The upfront sales charge, for example, normally is an encouragement to hold a fund; if you pay the freight to own the fund, you probably don't want to throw those dollars away by leaving the fund quickly.

Taxes often discourage selling, but quick turnarounds typically don't have huge tax impacts and are more paperwork hassle than deterrent.

A growing number of funds have installed short-term redemption fees, charges of up to 2 percent that investors pay when they don't stay around in a fund for a specified period, usually anywhere from three months to two years. These charges get cycled back into the fund to defray the costs associated with a fast-trading investor.

Yet those fees are not enough to make investors stay put. Firms that have instituted short-term redemption fees report that the move has barely affected the flow of money rushing into a fund when it's hot and leaving when things cool.

Fund companies, most notably industry leader Fidelity Investments, have tried to increase redemption fees and further deter hot-money trading, only to be rebuffed by the Securities and Exchange Commission.

Heightened trading in funds clearly is the result of unrealistic expectations, where investors are ready to sell at the first sign of decline or whenever the fund lags its benchmark for a quarter.

Fund managers are frightened by the pace of trading in and out of funds because it makes their job tougher. That's particularly true in small funds, where this month's big influx of cash might just be going to work when half of it gets sucked back out in next month's you-didn't-beat-the-market-last-week redemption wave.

As an individual investor, shrinking holding periods should concern you in two ways:

1) You may want to avoid funds that attract "hot money." If a fund has had huge performance numbers and the manager shows up on television, you can expect a rush of cash from performance-chasers. Much of that money will be gone just as quickly.

Total net assets is a detail that fund companies usually share. If you are going after a high-flying fund with the intent of staying put, and don't want to see performance eroded by hot money, call the management company. Ask how the fund has grown and what has happened to inflows since returns heated up.

You may want to avoid funds experiencing big performance-related increases in inflows.

2) You could be part of the trend.

Unless you bought a fund trying to capitalize on a short-term market move, you are part of the problem if you have sold something you owned for fewer than 18 months.

Before that minimum time has elapsed, you haven't seen enough to know if a fund has let you down. Selling out quickly allows your second guesses to overcome your first ones; unless you've become a whole lot smarter, that's not a good move.

Never buy a fund that you can't commit to for at least two years. If you can't stay put that long, you either need the money short-term, the fund is too risky to inspire confidence or you haven't done enough homework.

Noted Morningstar President Don Phillips said at his firm's recent investment conference: "We'd all benefit from stepping back and giving our fund managers more time. ... In the long run, you aren't likely to add much value to your portfolio by trading your funds."

Charles A. Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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