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Destructive Investing Tendencies

Bill Mann, Motley Fool Asset Management
December 29, 2013

The following commentary was originally posted on, the website of Motley Fool Asset Management, LLC.

"Knowledge is knowing that a tomato is a fruit. Wisdom is not putting it in fruit salad."
-- Miles Kington

Dear Fellow Fool Funds Shareholder:

A few days ago I got a call from a Bloomberg reporter wanting to talk with me about the stock market news of the day. She asked me about things like the Twitter IPO, and the fact that the S&P 500 and the Dow Jones Industrial Average keep hitting new highs, and what I was hearing about the upcoming jobs report, and whether I thought the markets could continue running through the end of the year.

So much of the business side of running an asset-management company is about getting your name out there that I can see exactly why trying to come up with credible answers for these questions might seem like a good use of psychic energy for a lot of people. It's Bloomberg, after all.

The thing is, I had nothing. These questions are almost wholly uninteresting to me, and on the balance I think that people who spend 10 minutes per year thinking about such things have wasted at least nine of those minutes. So for many of the questions my answers were, essentially, "that sort of consideration is irrelevant to our process."

I felt bad for the reporter, who was extremely nice, and professional, and self-evidently very, very smart. We eventually had a good conversation about other things that had nothing to do with whether I foresaw a short-term reversal (I don't). But I couldn't help wondering, as I have in the past, whether people's tendencies to focus on these kinds of things (hot IPOs, short-term trends, macroeconomic reports that have almost no bearing on how many burritos Chipotle will sell) are destructive to their investing returns over the only time frame that matters -- the long term.

Is overtrading destructive?
We've written several times about studies showing that investors who trade the most have the poorest returns. (See "The Behavior of Individual Investors" by Brad Barber and Terrance Odean for a prime example.) We've also talked a lot about studies demonstrating that the average holder of a mutual fund generates substantially lower returns than the fund itself over time, through buying and selling at the wrong times. A Wall Street Journal article from December 2009 offers a stark example: The CGM Focus Fund was the best-performing fund from January 2000 to the end of 2009, with a 10-year average return of 18%. While investors in the CGM Fund might have been congratulated for their wisdom, it's unlikely most of them felt like celebrating. According to a Morningstar "dollar-weighted" study, on average investors in the CGM Focus Fund lost 11% per year.

How is this possible? Easy -- investors allowed short-term results to determine how they invested. They poured money in after CGM Focus had generated market-beating gains, and they yanked it out after the fund had plunged. Ken Heebner, the talented manager of the fund, is known as a swing-for-the-fences kind of guy, so these swings tended to be dramatic. Most dramatic was the fund's 80% rise in 2007, after which people flocked in, investing $2.4 billion, only to catch its equally spectacular 48% drop in 2008.

Do you love investing?
This may seem like an odd question for a fund manager to ask. After all, mutual funds are, by their very design, made for people who don't like to invest and would prefer to have a professional do it. This is why The Motley Fool's decision to launch a company to get into the mutual fund business struck so many people as being odd. "Aren't you the 'do-it-yo