One of the keys to sound investing is avoiding false choices. Take this tired old debate about investing in mutual funds for the long term.
Some people insist that the only proper way to invest for the long-term is through loyalty and dollar averaging. In other words, pick two or three diversified stock funds, and keep plowing your money into them, buying and holding shares through bear and bull markets.
Others disdain this buy-and-hold strategy. The shrewdest investors, they insist, are active investors. Some play the sector fund approach, moving into sector funds when their industries are hot, then rotating into cash or other sectors, when their original choices fall out of fashion, or when other sector funds look hotter.
Other active investors and shorter-term traders use funds to time the market, buying index funds, for instance, when the market appears to be in a rally phase, running to cash or buying bear-market funds when they detect a correction phase.
There are two answers to this sterile debate:
First, all three methods — buy-and-hold, sector and market timing — can work well. The key is pick the method that best suits your temperament as well as the time you have to devote to tracking your funds.
If you have the passion to trade and the time to watch the market on a daily basis, a market-timing strategy can work well for you. On the other hand, daily trading may not be your cup of tea.
Perhaps you have time watch the market once a week, and you must reserve most of your time for doing homework to weekends. But you still want to put at least part of your money to work in areas where stocks appear to be outperforming the overall market. A sector strategy may suit you.
Second, don’t get buffaloed into false choices. Just as people use funds to diversify their assets among many stocks, you also can diversify your assets among different investing strategies.
As a general rule, you probably should not try to embrace both sector and and market-timing at the same time. You could come down with the investor’s version of schizophrenia. Your would have tough time tuning your mind to the market that best suits your approach because you are trying to juggle too many styles at once.
However, there’s nothing to prevent you from combing one active approach, which will some regular commitment of your time and brainpower, with a buy-and-hold strategy, which is relatively simple to execute without a lot of time or homework on your part, once you select your buy-and-hold funds.
Jay Kaeppel, a certified technical analyst and director of research at Essex Trading Co., has successfully employed a mechanical sector-investing approach to Fidelity Select Funds. His system amounts to buying shares in the top-performing sector funds if they are in uptrends, then holding those funds as long as the trend sustains. It’s a weekly system. Kaeppel checks his positions once a week, then holds his funds or redeploys all or part of his sector-investing capital accordingly.
In 1997, his first full year using the system, Kaeppel returned 40% on his capital vs. a 31% return for the S&P 500 Index. In 1998, Kaeppel slightly underperformed the market. His money in sector funds grew by 24% that year vs. the S&P’s 27% gain. In 1999, Kaeppel delivered a 65% return trading Fidelity Select funds, trouncing the S&P’s 21% return. As of Feb. 16, 2000, Kaeppel’s sector account was up 18% vs. a 5% decline on the S&P.
Does this mean Kaeppel puts all his eggs into the sector-investing basket? No. As traders and active investors know, a hot sector can deliver out-sized returns to people who invest in funds or stocks in that area. But the flip side holds true as well. When a high-flying sector falls out of favor, punishment can come swiftly.
Kaeppel employs a price-stop strategy to boot him out of funds before a downdraft can inflict severe losses to his account. But he also puts only 25% of his capital into sector funds. He smooths out his overall risk profile by investing a separate part of his capital along dollar-averaging, buy-and-hold lines.
“There’s a lot of different things you can do,” Kaeppel said. “Basically, my approach looks at four parts. Twenty-five percent (of his fund-deployed capital) goes into growth funds. Those are pretty easy to figure out. The easiest one is ^VIGRX^. I just buy shares and hold them. Another 25% goes into into a value value fund. Vanguard has a value index fund
^VIVAX^. Again, I pretty much look at that as a buy-and-hold.”
Kaeppel avoids ideological debates that go on between partisans of different approaches.
“There’s this big debate people have about buying and holding vs. timing and another big debate about growth vs. value,” Kaeppel said. “My attitude is, why choose?”
The last chunk of his fund capital goes into the timing category. “I have couple models that give a buy signals, in which case I move part of that money into something aggressive or an index. Or when I get sell signal I could move to cash or short something.”
As mentioned earlier in this tutorial, most investors would do well to avoid trying to market-time at the same time they play sectors — at least until they have mastered one of those two approaches.