By DAVID MOON, Moon Capital Management
A friend cornered me in my office
building last week. 'David, I know that small stocks are more risky, but I've
been reading Morningstar and TheStreet.com. They tell me that small stocks do
well when the economy starts to do better, but they do a lot worse when the
overall economy starts doing poorly. Do you think I ought to be selling my small
cap funds right now and buying large cap stocks?'
weren't for the fact that we were having this conversation in the men's room, I
would have tried to shake some sense into him.
repeatedly demonstrate a few predictable statistics about investing. The stock
market returns about 10 percent a year. The average stock mutual fund returns
about 9 percent a year. The average mutual fund investor earns about 3 percent a
difference between the average return on stocks and mutual funds is easy to
understand; it is the expense ratio of the average fund. But it may be a bit
more difficult to understand how investors can buy assets that return an average
of 9 percent a year, yet only earn 3 percent annually.
to the other 6 percentage points of return?
Some of it
goes to taxes. But a bunch of it vanishes when investors switch back and forth
between small cap stock funds and large cap funds or energy stocks or funds that
invest in mid-cap southeastern US ethical growth stocks.
chase the hot sector of the day, many of them invariably buy high and sell low.
Their emotions guarantee it.
January, every national magazine and newspaper publishes a list of the best
performing mutual funds from the previous year. About the same time, 401(k) plan
participants receive their year-end statements. These two incidents prompt a
great number of people to review their investment choices ' and a vast number of
them will move some of their money into the best performing funds from the
Look at the
money flow in and out of funds for the first quarter of each year. The funds
receiving the most money are the ones with the best short-term performance. That
is, investors buy high.
get disappointed at the end of the current year, they dump the most recently
purchased funds ' the ones they bought only after the big increase. Then they
buy the new winners. That is, they sell low.
Sell low. It's an old investment joke, but for many investors, it isn't a joke;
it's a description of their portfolio management process.
several fallacies in the logic of my aforementioned bathroom buddy. For example,
when it comes to risk, size doesn't matter. The market capitalization or
revenues of a company do not determine its riskiness.
dangerous assumptions in his logic, however, is that he could make broad
predictions about the economy, and then switch among stock segments, generating
above market returns. It is, instead, a predictable way to guarantee leaving
those six percentage points on the table.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).