IndexFunds.com Staff

Morningstar Study Confirms Virtues of Buy-and-Hold in Bear Market

Owners of boring diversified portfolios may have found it difficult to resist dabbling in tech stocks during the dot-com craze of yesteryear. Now, having lived through the painful bear market of the last 12 months, many investors are wondering if some nifty fund rotation can stem the tide of all that red ink. Some are saying that buy-and-hold isn't all it's cracked up to be as the broad Wilshire 5000 index lost 8.36% for the year as of the end of February.

No one said it would be easy. In fact, psychologically it's most difficult to resist tinkering when the market goes to extremes, be it bull or bear.

Numerous studies have shown that the more an individual investor trades, the worse he or she does. But what about specifically in a bear market?

To find out, Morningstar fund analyst Peter Di Teresa grouped 4,880 domestic equity funds by turnover ratio and examined their performance over the last year. Why look at fund performance and not individual investor performance? Di Teresa chose to look at mutual funds because they are run by professionals who presumably have more time and resources at their disposal. Therefore they should have a better chance of weathering a down market than the average Joe or Mary.

"In a bear market, the feeling is that the pros should at least be able to avoid the big disasters through trading," said Di Teresa.

First, Di Teresa compared the performance of funds in the top third in terms of turnover ratio against the bottom third. The trigger-happy funds in the top third (1,626 funds) lost 10.5% over the last year as of 2/28/2002, while the lowest third shed 6.3%.

"The effect of high turnover gets even more pronounced when you break things down further," said Di Teresa.

This time, he took the same group of domestic stock funds and broke them up evenly by turnover into five groups. Over the same time period, the highest turnover fund group (976 funds) finished down 11.5% for the year, while the lowest turnover group lost 5.8%.

The results of this cut-and-dry study indirectly expose the dangers of trying to time the market with mutual funds. So feel free to rejigger your "boring" portfolio in light of recent events in the market - just realize the pros have already tried it with theirs and apparently it doesn't seem to work that well.