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Columns: Boomer Bucks
Barbara Mlotek Whelehan Expert: Barbara Mlotek Whelehan
Boomer Bucks
Buy-and-hold investors do better in the long run
Boomer Bucks

Investors their own worst enemy
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"These 'invisible costs' include brokerage commissions, bid-ask spreads, price impact and timing costs," Kadlec says. Unlike fund fees, which are widely reported, these trading costs are very difficult to assess and are generally not reported, he says.

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Kadlec and co-authors Roger Edelen and Richard Evans, the latter two from the Carroll School of Management at Boston College, studied 1,700 domestic equity funds from 1995 to 2006. They discovered that trading costs have a greater impact than expense ratio on fund performance, "because there's much more variation." On average, says Kadlec, every dollar spent on trading costs translates into a 42 cent reduction in fund value. So while funds recover about half their trading costs, "the other half is a deadweight drag on fund performance."

The study looks at various types of trades among different types of funds, and goes into "excruciatingly boring details," Kadlec admits. He's right, so I'll spare you and get right to the punch line.

Says Kadlec, "You might conclude that all trading is detrimental to shareholder wealth, but that's not the case if you look deeper into this issue. The impact of trading on performance depends critically on who is trading and why. Large trades are particularly costly to performance ... By contrast, when funds trade in small quantities for discretionary purposes, the relationship between fund performance and trading costs is actually positive. Those funds actually more than recover their costs and add value."

It's not going to be easy to figure out which funds have the highest trading costs because turnover apparently isn't a good measure. But if you look at a fund's prospectus and quarterly reports, you can learn about the fund's investment strategy and style. If you're in a growth fund whose managers follow an earnings momentum strategy, it's a good bet that the fund will incur much higher trading costs than a fund with a buy-and-hold strategy.

The winning-est strategy
Buy-and-hold is arguably the best strategy for fund investors to have. A study in the June issue of T. Rowe Price Investor Magazine reveals the advantages of that strategy over market timing. 

In a hypothetical example based on actual returns between June 30, 1990, and June 30, 2006, two people invest $100,000. Both portfolios were identically allocated in the beginning: 60 percent to large-cap stocks, 20 percent to small caps, 15 percent to international developed markets and 5 percent to emerging markets stocks -- all indexes which investors can't invest directly in, though they can invest in index funds with low costs.

The wimpy market timer bailed any time an asset class fell 10 percent within a month and invested that money in cash. Then when the asset class gained 10 percent within a month, the wimp summoned the courage to get back in.

Meanwhile, the buy-and-hold investor stuck with the same portfolio through bull and bear markets.

Guess who won? The market timer had average annual returns of 8 percent, and his portfolio grew to $342,600. The buy-and-hold investor's annualized return was 10.3 percent, and his portfolio grew to $480,000.

Moral of the story: The markets may cause motion sickness at times. Just take some ginger and remember that over the long term, they inevitably will rebound.

Bankrate.com's corrections policy-- Posted: Aug. 29, 2007
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