Investors Who Make a Bad Time Worse

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IN a year when the Standard & Poor's 500-stock index has been dropping, the average mutual fund investor should do even worse than the benchmark, says Louis Harvey, president of Dalbar, a Boston research firm. The problem is that millions of investors have panicked. To avoid losses, shareholders are selling stock funds and shifting to money markets. These moves are self-defeating, Harvey says. By selling in a downturn, investors lock in losses and miss the opportunity to profit when stocks rebound. “The best strategy is to buy in a downturn when stocks are cheap,” he says.

Harvey's view should carry weight. For 20, years, he has been tracking the behavior of fund investors. All too often shareholders buy at the top of markets and sell at the bottom. The timing of investors was particularly bad in the 1990s when many novices bought high-flying technology investments after they had peaked. One of the most noteworthy disappointments came with Janus Twenty Fund. In 1997, the fund had an annual return of more than 29% and total assets of $6 billion. Noticing the big returns, investors raced into the fund, and assets climbed to more than $30 billion in 1999. The new shareholders had arrived too late, however. In 2000, stocks fell, and Janus lost 32.4%.

The inept timing explains why so many investors get poor results. During the two decades ending in 2007, the average investor in equity funds earned 4.5% annually, more than seven percentage points behind the S&P 500. Harvey stresses that investors are not doomed to repeat the bad performance. The way to beat the benchmarks is to invest steadily—and not just make big purchases at market tops. In fact, many investors automatically follow the steady approach through their 401(k) and other retirement plans. By setting money aside every month, retirement savers often buy during market dips.

Deposits into retirement plans helped produce good results in 2007. For the year, the average equity fund investor achieved returns of 7.1%, almost 2 percentage points better than the S&P 500. “People put money into IRAs early in 2007, and then they stayed invested as the market rose,” Harvey says. “This year, people are taking a look at the losses on their statements, and they immediately dump their funds.”
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