Mutual Funds Aren't Companies — They're People (October 2004)

Dominick Paoloni

My mother called recently and told me she had a Janus fund in an account I wasn't aware of. When I probed her to tell me why she was still holding it she said, "it dropped so much, I was going to wait until it came back up to sell it."

One of the most common mistakes investors make is to hold onto mutual funds that have dropped in price because they've read or heard that if you just hold on and be patient, the mutual fund's value will eventually come back. After all, the market always goes up over the long haul. If I had a dollar for every time I heard this I would be rich. The sad part is, investors end up poor with this planning misnomer.

There are several "holes in the argument" as my father always said. First, a mutual fund is not a company like IBM or McDonald's. A mutual fund does no manufacturing — it doesn't produce oil or soap. A mutual fund is not even a thing, like a corporation or a trust.

Simply stated, mutual funds are people. Even though our constitution states, "all men are created equal," in this case, the truth is, when was the last time you put on your football uniform and decided to replace Jake Plummer? When was the last time you sang like Ella Fitzgerald or drilled your son's cavity with your power tools?

Is it reasonable to assume that some mutual funds may be stronger than others? If so, we can surmise that it is an individual's ability to make critical decisions with your money on a daily basis that frankly makes a good mutual fund. For the sake of this discussion, let's call a mutual fund, "Portfolio Manager." Again, that's essentially all a mutual fund is — its living, breathing human manager.

If the portfolio manager is not making the right decisions, if they can't lose less in a down market and enhance value in an up market, if they take more risk than the return they deliver, then the portfolio manager must be replaced.

To illustrate, Janus Funds did very well in the roaring 1990s —the risk the managers took was very high and the returns were strong. But when the market turned, did the portfolio managers recognize, anticipate or reduce their risk? Did they take hedge positions within the portfolio to reduce our downside?

Portfolio managers buy and sell investments every day. And be aware that when you "buy and hold," you're holding on to a portfolio manager because he or she is down in performance, not because the value of a product or a service is. The truth is, if shares of a mutual fund drop and the manager sells the investments that made the funds plummet, you are no longer holding something you hope will go back up. They've made the wise and correct decision for you. That's their job.

So if managers aren't buying and holding various instruments within a fund if it would be detrimental, why are you? I can't stress how important it is to understand the "buy and hold" philosophy is steeped in a lie perpetrated by the big brokerage houses on Wall Street. The evidence and the facts do not and have never supported this doctrine. I remember in early 2001 when Bill Griffin of CNBC said, "The buy and hold strategy is officially dead." Wait a minute. I learned in high school that a rule like 1+1=2 is forever. "Buy and hold" doesn't work anymore? If that is the case, where is the justified outrage? Why aren't we burning all the financial publications that have pushed this agenda?

"Buy and hold" works in a Bull market, like the one we saw from 1982-2000, however, in Bear markets like 1966-1982, you would have lost your shirt.

Over the long term, if you buy an investment that goes down and hold it until it comes back up, you'd better know if you're in a Bull or a Bear market. Maybe we're better off listening to Bill Griffin and understanding that "buy and hold" is officially dead.