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Investing in Index Mutual Funds: Pitfalls of Buy and Hold

Are you overwhelmed by the options when it comes to buying (and selling) mutual funds? With over 10,000 funds out there, there are more funds than stocks listed on the stock exchanges. How do we sort through this morass to find a good selection of funds, and how do we know when it’s time to sell?

One popular choice that gets a lot of attention is investing in index funds. But even this simple solution can be confusing. Do you buy just one stock index fund and one bond index fund? If you buy more than one?

Are you are investing in a portfolio of index mutual funds, where active management on your part consists of rebalancing once a year, convinced that the only thing you can control is minimizing the expense ratio of the funds you hold?

One of the big problems with buy and hold investing is the volatility
and drawdowns that will test your ability to stay in the markets just as it’s reaching its lows.

Did those low expense funds help a lot during the 2000-2004 bear market or the 2007-08 drop?

If you’ve read this far, it’s probably because you suspect that there is a better answer than simply buying and holding low expense mutual funds or index funds.
But you aren’t sure where to start.

As an alternative to index investing, take a look at our course for the beginning investor. We go over topics like:

  • How to identify which mutual funds to buy, and
  • Just as importantly when to sell them.
  • We will also go into how reduce risk by choosing the right funds to diversify, and how to tell if they are diversified.
  • We will take a look at market timing, and what timing can work with mutual funds.
  • And for the ultimate in risk control, we will cover hedging techniques. This will be true hedges, that actually reduce risk, not the hot shot strategies that has many “hedge funds” in over their heads.

The next time you’re listening to the news, and you see or hear that the “market is at a 6 year high!” or some other great news like that, just realize what that really means. if you had bought and held an index fund 6 years ago (or whatever the time period is that is being reported), you would have been just as well off putting that money in a mattress, and behind putting it in a money market fund.

Looking at the markets recent performance, realize that not only have the returns been unimpressive, but the drawdowns (the amount the account net worth has come down from it’s peak value) have been breathtaking.

Since June of 1999, both the S&P 500 and the Nasdaq 100 have actually had a negative return. And also take a look at the maximum drawdown from their highest point. The S&P 500 index is bad enough at almost 50%, but if you look a the NASDAQ you will see almost 80%, from above 5000 back down to 1500. That is hard to come back from (and in fact it has not come close yet). So much for patience with buy and hold bringing you back.

Well, if buying and holding index funds are not the answer, how we expect to consistently beat the markets? Where do we want to invest our hard earned money? Next we will look at the opportunities using mutual funds for beating the stock market averages.

P.S.

If you aren’t convinced that you can do better than buy and holding index mutual funds, then I would at least ask you to read what I consider the best book I’ve seen on the topic of asset allocation using index funds

The Intelligent Asset Allocator.

And if you don’t have time for books, you can get The Intelligent Asset Allocator on CD as well.

Or if you have zero tolerance for math, the same author has published The Four Pillars of Investing: Lessons for Building a Winning Portfolio.

If you insist on index investing, at least do it well.

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