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By Christine Benz and John Rekenthaler | 02-21-2013 09:00 AM

Rekenthaler on What Hurts Fund Investors

Investors unnecessarily move between asset classes at the wrong time, effectively upending their portfolios' ideal allocations, says Morningstar's John Rekenthaler.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. I'm here at the Morningstar Ibbotson Conference, and I had the opportunity to sit down with John Rekenthaler who is a researcher for Morningstar. John discussed some fund research that showed that investors tend to do a poor job timing their purchases and sales of funds.

John, we have looked at how investors have historically timed their purchases and sales of funds, and they haven't done particularly well. I'm wondering if you can kind of summarize the latest research on that topic?

John Rekenthaler: [Morningstar director of fund research] Russ Kinnel has written a series called Mind the Gap that’s available on Morningstar.com, and I would recommend that people take a look at the Mind the Gap series in which he looks at the investor experience or investor returns on funds. Basically that measures not just the standard total return of a fund but how much money was in a fund at a given time. So the idea being, are people buying funds at the right time? Or possibly are they buying high and selling low? So it looks at the amount of assets that are in a fund as well as the fund performance, and it looks at just how well people are using funds. The answer, unfortunately, is people are not using funds that well. They tend to trail what we see as the paper returns or the standard total returns of a fund. Bottom line is, they are getting in high and they are selling low.

Benz: And you really see this across asset classes. Are there any asset classes where that performance-chasing trend tends to be especially stark, where you see investors really undermine their results with some of their poor-timing strikes?

Rekenthaler: Generally the more volatile and unpredictable the performance of a fund type is or fund category, the more this problem occurs. [Some examples of these asset classes are] sector funds, volatile equity funds, and emerging-markets funds. And some of new alternative funds, as well--they may not as volatile but they are unpredictable, people don’t know what to expect of them.

The best success tends to be in what we call solution-based funds--so allocation funds, target-date funds in particular because the asset flows are so steady in the target-date funds. People tend to do pretty well in those. So one takeaway from Kinnel's work is unless you as an investor have kind of a special and strong personality or as an advisor you are working with somebody who is like that, you're probably better off in a broader solution-based fund than brick-by-brick assembling the individual bits because the temptation becomes too strong at the end of a year or at the end of a three-year period to look at the individual bits and get upset of the ones that performed the worst and clear them out. What you are doing is you tend to be clearing out of not your worst fund but your lowest-performing asset class which then is maybe your best-performing asset class next time around but you don’t have it any more.

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