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Fashionable Mutual Funds Mix Strategy

1. Introduction
2. Popular 401K investors delusions
3. Fashionable mutual funds mix
4. Follow the leader
5. Naive siegelism
6. "Financial alchemist" strategy
7. Stable value only or "Depression might start tomorrow" strategy.
8. Bonds-based strategy
9. "Gold always shines bright"  and "Commodities rulez" strategies
10. Lifecycle strategies
11. Economic cycle based market timing
12. Combination of lifetime strategies with market timing.
13. Conclusions
14. Webliography
15. Old News

The name says it all. It's pretty much the selection of mutual funds that are most fashionable today. Classic example of 'fashionable stock mix" were technology overloaded 401K portfolios of pre 2001 days.  Another example was wide usage of Vanguard PRIMECAP which was one of the most popular mutual funds before dot-com bubble burst.  Right now foreign and emerging market stocks are often part of fashionable mix (often in 50/50 mix). People put all their money into high dividend paying stocks (and recently that used to mean by and large financial stocks) also probably can be put in this category despite the fact that the fundamental idea is sound but was distorted by subprime mess.

Commodities (typically oil or gold) overloaded portfolios probably also can probably be considered to be a fashion if bought in 2007 when they became a fashion. But that are rarely possible for 401K investors: few 401K investors have access to corresponding funds and ITFs.

The worst thing about this strategy is "panic" timing of the market as "fashionable mix" can abruptly change with change of the market conditions (dot-com bubble burst).  That often means selling and buying shares at least favorable prices which almost guarantee future underperformance of the portfolio.  As John Waggonner mentioned in one of his USA Today columns:

CAUSE AND EFFECT

How the S&P 500 has fared in the 12 months following the largest outflows from stock funds, since 1984:   Net outflow as a % of total assets S&P 500 gain 12 mos. later October 1987 -4.1% 18.8% July 2002 -1.9% 10.0% November 1988 -1.6% 27.3% August 1988 -1.6% 28.4% August 1990 -1.2% 26.1% Sources: Investment Company Institute, USA TODAY research

 

If you were one of the many mutual fund investors who bravely faced the August stock market declines, took your money and bravely fled, well, you're not alone. Investors yanked more money out of stock funds than they put in in August — the first time that's happened since June 2006.

The stock market, naturally, rallied sharply in September. Experts point to this phenomenon to show that mutual fund investors, en masse, tend to have remarkably bad timing at pinpointing market bottoms. They may have a point.

Wall Streeters, who consider themselves the smart money, are fond of pointing out the foibles of the general investing public. Joseph Kennedy, father of President John F. Kennedy, supposedly decided to sell his stocks before the 1929 stock market crash because even his shoeshine boy was offering stock tips. If even shoeshine boys are playing the market, he figured, it was time to head for the exit.

Over the years, Wall Streeters have found different ways to watch what the dumb money is doing. In theory, if you buy this reasoning, you'll make good money doing the opposite of what the public is doing. "Keep track of the masses," the saying went, "for they soon turn to asses."

Which brings us to mutual funds, which are the investment of choice for the average investor. The public has nearly $7 trillion invested in stock funds — $6.4 trillion invested in traditional stock funds and $479 billion in exchange traded stock funds. In total, mutual fund assets equal about one-third of the $19.6 trillion U.S. stock market. (Many funds invest in international stocks, so the amount of fund assets as a percentage of the U.S. market is somewhat lower than a third.)

In theory, you can glean some useful information about the stock market from the behavior of mutual fund investors. Because funds are a large source of new money for the stock market, you would assume that inflows should drive the market higher, and outflows should drive the market lower.

While going with the crowd is not altogether bad strategy abrupt withdrawals are and one simple way to improve the returns for this strategy might be limiting one time withdrawals or additions to, say, $1000 a week.

Last modified: October 29, 2008