Chapter 23

Ten Fund-Investing Fears to Conquer

In This Chapter

arrow Avoiding the tendency to predict (and the anxiety that comes with it)

arrow Learning to relax and watch your investments grow over time

Experiencing the worries that I identify in this chapter is a sign that you’re a normal person. But these concerns are also something I want you to overcome. When you do, you’re well on your way to avoiding common painful and costly fund-investing blunders and oversights.

Investing with Little Money

You have to start somewhere. People with less to invest actually benefit more from mutual funds than investors with heftier balances (although those investors benefit a lot as well). With just several hundred or a few thousand dollars to invest, you can’t diversify well or avoid commissions that gobble a significant percentage of what you have to invest when you buy individual securities. By investing in mutual funds, you can invest efficiently.

If you invest money for the longer term, especially inside retirement accounts, start with a hybrid fund or a fund of funds. Some of these funds have low minimum initial investment requirements of $1,000, and they’ll go even lower — $50 — if you sign up for an automatic investment plan that regularly makes electronic withdrawals from your bank account. (See the examples in Chapter 15.) Invest just $1,000 today in good mutual funds and add just $50 per month. With funds that average a 10 percent annual return, in 20 years you’ll have about $44,000! Invest over 40 years, and you’ll have about $336,000. If you can manage $100 per month rather than $50, you’ll have about $82,000 in 20 years and $628,000 in 40 years!

Investing in Uninsured Funds

Lack of insurance (think FDIC on bank accounts) isn’t what makes funds risky. Mutual fund risks are driven by the price changes of the securities, such as bonds and stocks, that they invest in. Unlike banks and insurance companies, mutual funds can’t go bankrupt (see Chapter 2). Funds that invest in municipal bonds may have insurance against the default of the bonds. Otherwise, insurance isn’t necessary or available for funds.

Don’t overlook other not-so-obvious types of risk. Bank accounts don’t carry the price risk, or volatility that bond and stock mutual funds do. However, bank accounts are exposed to the risk that the value of your money may not grow fast enough to keep ahead of inflation and taxes.

tip.eps If you don’t like significant volatility, even with money you’ve earmarked for long-term purposes, invest more of your money in balanced or hybrid funds. These funds tend to mask the volatility of their individual stock and bond components because they’re all mixed together (see Chapter 13).

Rising Interest Rates

After a lengthy period of declining and stable interest rates, speculation inevitably surfaces about when interest rates will rise. This spooks not only some bond investors but also stock investors. Rates rarely rise when they’re widely expected to and even when they do rise, it’s nearly impossible to know how significantly rates will increase and what, if any, impact that will have on the bond and stock markets.

remember.eps The financial markets tend to lead these sorts of economic changes. The stock market, for example, often peaks six months to a year before the economy does. Conversely, stock prices usually head back up in advance and in anticipation of an actual economic recovery. Interest rates and bond prices typically have the same kind of interaction. For example, by the time everyone’s talking about the damage to the bond market from rising interest rates, the bond market has usually hit bottom.

Missing High Returns from Stocks

Perhaps you’ve read about how investment legends like Peter Lynch and Warren Buffett make wise stock picks, so you figure that if you do what they do, you can, too. (After all, numerous books out there say that you can.) Nothing personal, but it isn’t going to happen. You’re probably a part-time amateur, at best. If you enjoy playing pickup basketball games, it’d be fun, if somewhat humbling, to play against greats like Kobe Bryant and Lebron James. But I assume that you’d play these stars for the fun of it instead of in an expectation or vain hope of beating them. Buying individual stocks is the same — don’t do it thinking that you’ll beat the better mutual fund managers.

warning_bomb.eps Don’t fool yourself into thinking that you’re an expert just because you know more than most people about a particular industry or company. Many others have this knowledge, and if you have truly inside information that a company is about to be acquired, for example, and you invest your money based on this insider knowledge, you can end up with a large fine or jail sentence or both. (See Chapter 4 for a thorough discussion about investing in stocks of your own choosing.)

Waiting to Get a Handle on the Economy

Although I don’t advocate sticking your head in the sand, the big-picture economic issues such as interest rates, employment, corporate profits, trade agreements, and tax and budget reform are well beyond your (or, really, anyone else’s) ability to accurately forecast. Besides, investors’ expectations are already generally reflected in the prices of securities in the financial markets.

tip.eps Read about, listen to, and absorb what’s going on in the world. But don’t use this noise of the day to help make your investing decisions. You should determine your investment portfolio by considering your financial situation, your personal goals, and your plans for the future (see Chapter 10).

Buying the Best-Performing Funds

Most people want to jump on board the winning bandwagon. But the best performers all too often turn into tomorrow’s mediocre or loser funds (see Chapter 7). Look at what happened in the early 2000s to the high-flying funds that focused on technology and Internet stocks during the late 1990s. The same thing happened with the seemingly unstoppable financial companies in the late 2000s.

tip.eps The types of securities that do best inevitably change course. You may actually increase your chances of fund-investing success by minimizing exposure to recent hot performers and investing more into fund types that are currently depressed but otherwise fundamentally sound.

Waiting for an Ideal Buying Opportunity

Some stock market investors like the idea of waiting for a big drop before they start investing. This strategy seems logical, especially coming on the heels of years of advancing prices or if a major decline happened in the recent past. It also fits the philosophy of buying when prices are discounted. The problem is, how do you know when the decline is over? A 10 percent drop? How about after 20 or 30 percent? If you’re waiting for a 20 percent drop and the market only drops 15 percent before it then rises 100 percent over the coming years, you’ll miss out. If you’re waiting for a 40 percent decline, will you really have the courage to invest if that happens?

tip.eps Especially if you’re just starting to save and invest money, invest regularly so that, if prices drop, you’ll buy some at lower prices. That way, if prices don’t decline, you won’t miss out on the advance. If you have a large amount of money awaiting investment, move it gradually (dollar-cost averaging) — a portion every month or quarter over a year or two into different types of funds (see Chapter 10).

Obsessing Over Your Funds

There’s a big difference between monitoring and obsessing. You don’t need to follow the daily price changes of your mutual funds, which is an incomplete and often misleading way to discern the amount of return from your fund. In addition to share price changes, you must take into account dividend and capital gains distributions when you calculate a fund’s performance (see Chapter 17).

warning_bomb.eps Tracking and hovering over your funds increases your chances of panicking and making emotionally based decisions. The investors I know who bail out when prices are down almost always are the ones who follow prices too closely. Keep your sights on the big picture — why you bought the fund in the first place and what financial goal you’re trying to fulfill. To reduce your risk and sleep soundly at night, diversify.

Thinking You’ve Made a Bad Decision

Don’t be so hard on yourself. Invest in the funds that I recommend in this book and use good selection criteria in picking funds on your own. Then, if one of your funds goes down, the decline is — 99 times out of 100 — because the types of securities it focuses on (for example, bonds, United States stocks, or international stocks) are down.

remember.eps If, for example, your fund is down about 5 percent over the past year, find out how similar funds have done over the same time period. If the average comparable fund is down more than 5 percent, you have cause to be happy; if comparable funds are up an average of 20 percent, you have reason to worry. See Chapter 17 for some ground rules for deciding whether to dump or hold a laggard fund.

Lacking in Performance

Stop looking at fund performance top-ten lists. Most of these lists completely ignore risk. Many of these lists rank funds based on short time periods. The funds on top are constantly changing. And no one knows which ones will be on next year’s top-ten list.

remember.eps If a fund is taking so much risk that it’s in the top-ten list, then such a status also means that it’s risky enough to end up in the bottom-ten list someday. (See the examples in Chapter 7.) The categories that are used in these types of lists are also flawed, because many of the funds aren’t really comparable. Read Chapter 17 to find out appropriate ways to evaluate and track the performance of your funds.