Market Timing and Mutual Funds

Much has been written about mutual funds over the years. On one end of the spectrum, mutual funds have been credited with the “democratization of investing” by making the stock market available to virtually everyone; on the other, they are demonized as if they were Wall Street ponzi schemes!  Much of the negative press about mutual funds is due to their complex and sometimes hefty fee structures, and much of it has to do with the “all-in costs” of owning actively managed mutual funds when transaction costs are factored. The bottom line in cost comparisons often comes down to the question: Do mutual fund managers add value?  Or are investors better-served by owning low cost passive index funds with no active management?

Many studies argue that passively-managed index funds are superior over time, typically citing statistics that say that on average, 85% of actively managed funds do not keep pace with their benchmark, much less out-perform it. Passively managed index funds simply mirror the benchmark, their returns ARE the market returns. So why do people pay sometimes hefty fees for under-performance? Obviously they aren’t looking for under-performance; investors are looking for out-performance. For someone to help them beat the market, either on the way up or perhaps to protect them from losses on the way down. Ironic, isn’t it? Investors look to mutual fund managers to help them do the one thing that Wall Street tells us cannot be done: to time the market! To pick the stocks for their mutual fund so they can outperform other mutual funds and the stock market itself, or perhaps to get the investor out in time, before a big decline in the stock market. While there are some very good stock pickers out there that might be able to out-perform in good markets (must be a pretty hard job if 85% of funds don’t beat their indexes in a given year) the structure of most mutual funds literally prevents them from providing much protection on the way down. This is because the vast majority of mutual funds must be “fully invested” at all times in their stated investment objective. So for example, a growth fund can sell their growth stocks when the market is collapsing…. But it must buy other growth stocks; they must be invested. It is like catching falling knives!

How would you like a vehicle that times the market for you automatically, and prevents losses? What’s the catch? How can you have an investment that participates in the gains of the stock market when it is going up, but has you safely on the sidelines when the market is going down? I’d call it a tradeoff, not a catch: the tradeoff is that you don’t get all of the gains when the market goes up, and you have to be willing to hold the investment for a period of time, during which you may only be able to withdraw 10% of the account in a given year without penalty. The investment is a Fixed Indexed Annuity and it has been growing in popularity since its inception almost 20 years ago. If you might be interested in an investment that can generate reasonable rates of return without risk of loss, it might have a place in your portfolio.