The Pitfalls of Market Timing

Jane Young, CFP, EA

Jane Young, CFP, EA

Market timing is one of the most detrimental ways an investor can negatively impact his stock market returns. History shows that investors do not effectively time the market. For the last nine years, DALBAR, Inc., a market research firm, has conducted an annual study on market returns called the Quantitative Analysis of Investor Behavior (QAIB). This study has consistently found that returns earned by the individual investor are significantly below that of the stock market indices. The 2013 QAIB report found that during the 20 year period between 1998 and 2012, the average mutual fund investor lagged the stock market indices by 3.96%. This is a significant improvement over the period between 1991 and 2010, in which the average investor lagged the mutual fund indices by 5.1%. According to Dalbar, “No matter what the state of the mutual fund industry, boom or bust: Investment results are more dependent on investor behavior than on fund performance. Mutual fund investors who hold on to their investments are more successful than those who time the market.”
The stock market is counterintuitive in that the best time to sell is usually when the market seems to be doing well, and the best time to buy is usually when the market is doing poorly. As investors, our decisions are frequently driven by emotion rather than cognitive reasoning. We frequently overreact to emotions of fear and greed which throws numberswiki.com

us onto an investment roller coaster. When the stock market goes up we start to feel more and more optimistic, and as the market rises higher we get caught up in a state of euphoria. Our sense of greed kicks in and we don’t want to miss the opportunity to make money, so we buy when the market is high. The market may stay up for a while but eventually the economic cycle changes and stock prices start to drop. Initially we rationalize that this is temporary, or just a minor correction. As the market continues to drop we become more and more concerned. Soon our sense of fear kicks in, we start to panic and we sell at the wrong time. If we don’t recognize the dangers of this emotion driven cycle we are deemed to repeat it.
In addition to our intrinsic emotional response, we are bombarded by sensationalized news and advertising campaigns to influence us to change the course of our investment strategy. Don’t get caught up in the hype about the next big investment craze. Your best course of action is to develop and follow an investment strategy that supports your tolerance for risk and investment timeframe. The stock market is volatile and is best suited for long term investing. Time is needed to absorb fluctuations in the market. Keep short term money in fixed income investments. You will be less tempted to time the market in a well-diversified portfolio specifically designed for your investment time horizon.

Understanding Mutual Fund Fees

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Jane M. Young, CFP, EA

When investing in mutual funds it is important to be aware of the associated fees.  High fees can significantly impact your total investment return.   All mutual funds have operating expenses and some have sales fees, commonly known as a load. When you invest in mutual funds you have a choice between load and no-load funds.   A mutual fund load is basically a commission charged to the investor to compensate the broker or sales person.   As the name implies, no-load funds do not charge a sales fee.

The first type of load fund is an A share fund, where you pay a front end sales charge plus a small annual 12b-1 fee.   A 12b-1 fee is a distribution fee that covers marketing, advertising and distribution costs.  The typical front-end load is around 5%, but can go as high as 8.5%.  Class A shares offer breakpoints that provide you with a discount on the sales load when you purchase larger quantities or commit to making regular purchases.  The 12b-1 fee associated with most A shares is generally about .25% annually.

The second type of load fund is a B share, where you pay an annual fee of around 1% plus a contingent deferred sales charge (CDSC), if you sell before a specified date. The CDSC usually begins with a fee of 5% that gradually decreases over five years.  After five years or so the fund converts to an A share fund.  The actual percentages and timeframes may vary between fund families.  Most mutual fund companies have stopped offering B share funds because they are usually the most expensive option for the investor and the least profitable option for the mutual fund company.

The third type of load fund is a C share that charges a level annual load, usually around 1%.  This is on-going fee that is deducted from the mutual fund assets on an annual basis.

Generally, any given mutual fund can offer more than one share class to investors.  There is no difference in the underlying fund.  The only difference is in the fees and expenses that the investor pays.

All load and no-load mutual funds charge fees associated with the operation of the fund.  The most significant of these expenses is usually the management fee which pays for the actual management of the portfolio.  Other operations related fees may include administrative expenses, transaction fees, custody expenses, legal expenses, transfer agent fees, and 12b-1 fees.

These annual fees are combined and calculated as a percentage of fund assets to arrive at the fund’s expense ratio.  The expense ratio is an annualized fee charged to all shareholders.  The expense ratio includes the fund’s operating expenses, management fees, on-going asset based loads(C shares) and 12b-1 fees.  The expense ratio does not include front-end loads and CDSCs.   According to Morningstar the average mutual fund expense ratio is .75%.