Hugh F. Doherty, DDS, CFP
Managing a fund portfolio is a bit like organizing a fancy dinner in your home. There are only so many seats at the table. Try to squeeze too many fund managers in, and you may wind up with an uncomfortable, less-than-rewarding experience. And that is why many experts believe investors should worry less about buying and selling than about "replacing" funds in their portfolios. If you want to give a new fund a seat at your table, one of the old guys should hit the road.
You create an asset allocation that makes sense to you, then you mess it up by buying or selling. To avoid that, you probably shouldn`t buy a fund unless you are prepared to sell one you already own. And you probably don`t want to sell unless you have an idea of where and how you will reinvest the money.
The discipline of replacing, rather than simply adding to or pruning a portfolio, is practiced by many money managers. Essentially, it results in a portfolio designed to meet your goals, using only the best components you can find. While experts disagree on the "right" number of funds to own, most say between four and 10 funds should suffice. In general, each of those funds should have a role, such as buying small-company stocks, blue chips, internationals, etc. You want to find out who brings the most to the table to do that job.
Having many funds doing the same job can cut returns. If you own several growth funds, one might sell, say, Philip Morris stock when another is buying. The managers` decisions are a wash, but you pay the trading costs. Your portfolio evolves over time, and you keep learning about your investments and yourself. It`s like planting a garden. You have only so much space. Some seeds don`t sprout, and others become overgrown. And you have to do weeding and caretaking to make it all bloom.
Earned vs. unearned income
Most people become familiar with the distinctions between the two types of income during tax season, which is when the difference matters.
Earned income comes "from the sweat of the brow." It is your salary, wage, or compensation for work that requires obvious effort to deliver a service or product. Unearned or passive income does not require any physical effort; rather, it comes from putting other monies to work. This includes interest, dividends, royalties, and capital gains.
Case history on market timing
A doctor-client reports he had a varied portfolio of six growth mutual funds that he selected with the help of a computer market-timing program. In the fall, the program advised him to sell everything. He did. Three months later, it said to buy again. I bought the same funds (now at higher prices) and ended up with fewer shares, plus capital gains taxes to pay.
He asked for my opinion. My response was, "Your miserable result only reaffirms my feeling about market timing. It stinks." No one can do it reliably. Instead, pick a low-cost index fund and a few other good funds and invest for the long term. Ninety percent of all managed-stock mutual funds have underperformed the market over the past five years. I prefer the index fund. But if you can find ways to beat it with other funds, good hunting.
More about market timing
Using market timing as an investment strategy is one of the biggest mistakes you can make when you invest your hard-earned money. Market timing is defined: "getting out when you think the market is going down and getting in when you think the market is going up." Peter Lynch, Warren Buffet, and John Templeton (the three greatest minds on investing ever) say it can`t be done. Tell me why you would ever let some Wall Street stock jockey tell you it can be done.
Advice: Market timing doesn`t deliver. The actual realized returns on market timing will not beat the market. Finally, statistics on market timing have shown that if you are out of the market at the wrong time, you can miss the whole game.
Hugh F. Doherty, DDS, CFP, is a national lecturer, financial advisor to the health-care profession, and CEO of Doctor`s Financial Network. For personal financial consultations or to have Dr. Doherty speak to your study club or dental society, call (800) 544-9653.
