Managing a Mutual Fund Portfolio

Last week, I talked about how to build a mutual fund portfolio in three simple steps. This week, I want to talk about how to manage a mutual fund portfolio. Let’s walk through four common strategies:

  1. The Wing it Strategy. This is the most common mutual fund strategy. Basically, if your portfolio does not have a plan or a structure, then it is likely that you are employing a wing it strategy to manage your portfolio. Take the test, if you are adding money to your portfolio today, how do you decide what to invest in? Are you one that searches for a new investment because you do not like the ones you already have? A little of this and a little of that? If you already have a plan or structure, then adding money to the portfolio should be really easy. In my opinion, this strategy will have the least success because there is little to no consistency.
  2. Market Timing Strategy. The market timing strategy implies the ability to get into and out of sectors or assets or markets at the right time. The ability to market time means that you will forever buy low and sell high. Unfortunately few investors buy low and sell high because investor behavior is usually driven by emotions instead of logic. The reality is most investors tend to do exactly the opposite – buy high and sell low. This leads me to believe that market timing does not work in practice. No one can accurately predict the future with any consistency.
  3. Buy and Hold Strategy. This is by far the most commonly preached investment strategy. The reason it is most commonly preached is that statistical probabilities are on your side. Markets generally go up 75% of the time and down 25% of the time. If you employ a buy and hold strategy and weather through the ups and downs of the market, you will make money 75% of the time. If you are to be more successful with other strategies to manage your portfolio, you must be right more than 75% of the time to be ahead. The other issue that makes this strategy most popular is it is easy to employ. This does not make it better or worse. It is just easy to buy and hold.
  4. Re-Balancing strategy. Re-balancing is somewhat of a middle ground between market timing and buy and hold. With this strategy, you will re-visit your portfolio mix from time to time and make some readjustments. Let’s walk through an oversimplified example using real performance figures.

    Let’s say that at the end of 1996, you start with a portfolio of four mutual funds and split the portfolio into equal weightings of 25% each.

    Allocation ($)Allocation (%)
    Fund A$25,00025.0%
    Fund B$25,00025.0%
    Fund C$25,00025.0%
    Fund D$25,00025.0%
    $100,000100.0%

    After the first year of investing, the portfolio is no longer an equal 25% weighting because some funds performed better than others.

    1 yr. returnend balanceAllocation
    Fund A13.60%$28,400.0026.28%
    Fund B6.80%$26,700.0024.71%
    Fund C8.50%$27,125.0025.10%
    Fund D3.40%$25,850.0023.92%
    $108,075.00
    The reality is that after the first year, most investors are inclined to dump the loser (Fund D) for more of the winner (Fund A). However, the right strategy is to do the opposite to practice sell high, buy low. Re-balancing simply means that you sell some of the funds that did the best to buy some of the funds that did the worst. Your heart will go against this logic but it is the right thing to do because the one constant in investing is that everything goes in cycles In year 4, Fund A has become the loser and Fund D has become the winner.
    1 year return
    Fund A
    -16.0%
    Fund B
    22.3%
    Fund C
    9.6%
    Fund D
    15.2%

    Re-balancing this portfolio year after year means that you would have taken the profit when fund A was doing well to buy Fund D when it was down. In fact, if you had re-balanced this portfolio at the end of every year for 5 years, you would be further ahead as a result of re-balancing.

It’s all about discipline

The key to portfolio management is to have a discipline that you adhere to. The most successful money mangers in the world are successful because they have a discipline to manage money. Believe it or not it has less to do with discipline and more to do with the fact that they have a plan. Warren Buffet said it best “To invest successfully over a lifetime does not require a stratospheric I.Q., unusual business insight, or inside information. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace.For more information you can follow him on Twitter @JimYih or visit his other websites JimYih.com and Clearpoint Benefit Solutions.

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