There is no one protecting most of the money in mutual funds against market loss. Surprised? Sadly, it’s true. Read on to understand how we can make such a claim.
After very long bull market that started in the 1980s and went for years and years, investors began to believe the market will always quickly make up any mutual fund losses. Maybe investors forgot the importance of protecting your nest egg against loss and began to believe money in the stock market only goes up in value.
For almost 30 years, we never experienced a devastating bear market. During the years, most of the investment world (seemingly) decided to disarm themselves of the very weapons that are effective at protecting the money in mutual funds. It is, in short, a lost art.
Here is a roundup of the major players in the investment world and whether they are actively protecting the money in their care against market loss:
- Mutual Fund Managers don’t have the responsibility (by prospectus) of guarding your investments from severe declines or bear markets – only for investing the money into stocks and/or bonds according to the investment philosophy of the fund. When you receive an annual bonus, even if you lose money, you have no real incentive to protect investors’ money, as long as you beat the index you follow. Many Mutual Fund Managers are paid a bonus only when they perform better than an index – even if that means they lost less than the index lost. If your fund and the index fund you are supposed to track are both down, no problem, as long as your fund loses less investment value!
- Index Mutual Funds? There is no one making any investment decisions because there is no active manager in an index mutual fund. The stocks are picked merely by size and because of their inclusion in a broad index. The job of an index mutual fund manager is not to protect you against losses. Their job is to be fully invested at all times in the stocks that represent their index. During the past five years, as more money has been channeled into index mutual funds, the price of the largest stocks in these index funds has been driven artificially high. This has increased the amount of risk associated with these mutual funds.In a bear market, you will be 100% invested in declining stocks. Is that what you want? Probably not, but most investors don’t know this.
- Financial Planners -Do they protect the investments in mutual funds? Largely AWOL. They have bought into a buy-and-hold philosophy that doesn’t believe “protecting the money” is their job. Their job is to place the money into good mutual funds according to a computer generated asset allocation program, and then hope for the best. Even worse, about 80% of Financial Planners are compensated by commissions, which creates a conflict of interest when choosing a place to invest the money.
- Money Managers are following the Efficient Frontier / Market Hypothesis / Portfolio Optimization methods of optimizing asset allocations over great periods of time with no plan for protecting the investments in mutual funds. Their plan for dealing with volatility and bear markets is to be invested over long periods of time and hope that someday, a rising market will make it all work out fine. Again, no defensive weapons at their disposal.
Why it Matters
Without a plan to protect your money, you may deplete your investments in retirement before a long enough period of time has passed for your “efficient portfolio” to recover. For example, in the 1970’s protracted bear market, if you had owned Fidelity Magellan, you would have lost over 70% of your investment over two years. If you were also withdrawing money for living expenses, you would have depleted your portfolio before it ever recovered.
You would think that after a decade of spinning their wheels during a severe bear market, the financial world would stop and reevaluate. Unfortunately not.
This is why we are committed to great portfolio design that never forgets Rule #1: Don’t Take Large Losses.
