FSO Editorials: Buying, Holding and Selling Mutual Funds by Robert B. Gordon 11/24/2003

Buying, Holding and Selling Mutual Funds
A Review for New and Seasoned Investors
by Robert B. Gordon, Sc. D.
November 24, 2003

This very old German complaint is being made by more and more of our readers who are substituting their own words. It is understandable that otherwise intelligent men and women in their forties, fifties and sixties are unhappy about their lack of currently useful investing experience. Their feeling of inadequacy can have two causes (1) Little or no personal experience in investing or (2) Too much dependence on so-called "expert" advisors with nothing but recent bull market experience.

Believe it or not, many novice investors make the learning job extremely difficult by assuming it is much harder than it really is or needs to be for most individuals. We have written dozens of articles illustrating simple portfolios to fill various needs. However, there is always room for another approach to investment learning, as we will show below. We have always steered away from using options and futures directly but we now own and suggest using two very well managed funds that can use hedges to protect gains in this bear market.

We have favored closed end funds such as ASA and CEF in the precious metals field because, unlike open end funds, they can trade both below and above their net asset value.. We have a limited experience with the new Exchange Traded Funds (ETFs) which may grow in importance depending on the outcome of the current mutual fund scandal. These are baskets of stocks which usually represent a single industry or market segment. They trade like stocks all day in the stock market and may be traded long or short and at low cost of commissions. They may make important inroads in the mutual fund industry in the future.

The best attitude to assume by anyone starting a fund portfolio is that the basic information can be obtained in a couple of months and full confidence in your decisions may take a year or two. This time estimate is based on using no load funds in a fairly simple portfolio, easy to set up and follow. In the pages that follow, we intend to suggest several very simple portfolios to set up and follow. The learning job consists in following the individual actions of each fund on the overall performance of the portfolio. You learn from the market ups and downs how to design a new portfolio to perform as you desire. You learn by observing and your expertise will grow with time. Anyone who is sufficiently motivated can do it.

Never in my wildest dreams, did I ever think about fund managers and their superiors stealing money from their investor customers. How can the top executives leave in disgrace and take with them an 80 million dollar severance package? What is our SEC chairman doing to set an example so others will never steal? I plan to write to the Chairman and hope many readers will also do so. At this writing, we do not know how many funds have violated their fiduciary obligations. We will just have to wait until the investigations are complete.

Two years ago, I wrote about the future of the mutual fund industry at the end of the bear market. I thought the number of funds would be greatly reduced by failure from massive redemptions and a forced consolidation of small funds into larger funds. Neither then or now did I think of funds being closed as a result of criminal actions, but that the redemptions would result from extremely poor performance of the mutual fund managers, not from abuse of their public trust.

In this essay I plan to write down some of the problems and successes I have had in owning literally hundreds of no-load funds over more than 50 years. When I started there was just a handful of no-load fund companies, most of them managing only a single fund. During the so-called Go-Go years of the 1960’s, new funds were formed and they grew in size until about 1966 when there was a mini-bubble involving the Nifty Fifty blue chips that could be bought and held forever. Believe it or not but that was the popular feeling until the severe bear market of 1973-74 when many funds lost up to 70% of their assets. Net redemptions from funds were very heavy and ran for 9 consecutive years until the start of the new bull market. Please note this bear market, was considerably smaller than that after the 1929 Crash or the current still young bear market. So, unless funds change their charter to hold lots of cash, we may see some funds losing nearly all of their assets in the years ahead and going out of business.

I am not at all surprised that broker’s self interest has caused them to mislead customers and put them into a fund that charges a higher load (sales commission). In fact, I have long opposed the whole idea of load funds due to their many disadvantages for uninformed investors. Most no loads today provide investors with a large amount of data on their funds, some of it helpful and much of it, like "buy and hold forever", very harmful And, now in the computer age, there is a large amount of helpful information on all types of funds by web sites like Morningstar, Quicken, Bloomberg and Yahoo.

From my early days as an investor, I looked for a time to buy and a time to sell every fund. I did not buy the Wall Street propaganda of buy and holding any stock or fund. I do not remember the exact circumstances, but I once received a letter from a fund Vice President accusing me of "market timing", probably for selling within 6 months. The proper solution for this problem is adding a modest redemption fee, like the 1.5% fee the Hussman funds charge for redemptions in less than 6 months.

I am not an expert on the many ways a "load" can be charged to an investor. All of them have the disadvantage of penalizing the investor for selling the fund, even years after purchase. As a result of the current "market timing" investigation, many funds, if not all, will probably add a short time redemption fee which will increase the incentive to buy ETFs instead of funds. I have also heard that there may be pressure on funds to offer real time pricing through the day as in stocks and ETFs which is within the ability of modern computers. That would further complicate the fund business and make them more competitive with stocks and ETFs.

Today, the mutual fund industry is in turmoil but I do not hesitate to suggest those funds which I expect will do well in the severe bear market that lies ahead. These good performers in major fund companies should be survivors of any crisis in the overall fund industry. I expect that fund classes which do poorly, like the S&P500 index funds, may eventually disappear from the market scene. However, regardless of what happens in the near or distant future, I expect that my readers will be able to maintain their portfolio objective by finding a suitable replacement for any fund that becomes unavailable.

As older readers well know, our recent bear market portfolios have used a fairly limited number of asset classes believed to deserve a special place in meeting the objective of continuing gains in the bear market. It is unfortunate but true that even our largest no load fund companies do not have all the suggested asset classes. For the information of our readers, we have compiled the list below for certain important asset classes. Although not all inclusive, it contains ample variety for us to assemble a number of teaching portfolios that we hope many readers will use to develop and improve their investing capabilities.

Stable Asset Classes
1. U. S. Treasury Bonds, short to intermediate maturity.
2. Foreign Government Bonds, short to intermediate maturity.
3. Total Return Income Fund with up to 30% hedge protection.
4. Strategic Growth Fund with up to100% hedge protection
Volatile Asset Classes
5. Short Fund, inverse stocks, fully managed
6. RYJUX Short Fund, inverse 30 year Treasury bond
7. Diversified Precious Metals stock Fund.
8. Diversified Energy stock Fund
9. Diversified Health stock Fund
10. Diversified Real Estate (REIT) stock Fund

The table below is a summary of the funds which are currently available among 9 leading no-load fund companies. It may be incomplete and I would be happy to have readers send me any additions to this table

Fund Category
Fund Company	1	2	3	4	5	6	7	8	9	10
American Century	X	X					X		X	X
Fidelity							X	X	X	X
Hussman			X	X
Loomis Sayles		X
Prudent Bear		X			X
Rydex					X	X	X	X	X
Scudder		X					X		X	X
T. R. Price	X	X						X	X	X
Vanguard	X							X	X	X

Some of the above fund families have brokerage services that sell stocks and other mutual funds to their customers. It may be possible to buy all ten of the fund types from one company. I personally deal with two on-line discount brokers who charge either no or very low fees to buy and sell mutual funds. This makes it easy to follow performance on a single monthly statement. Although it takes $25,000 to open an account at Rydex, I can buy any fund for $2500 at my brokers, with just $1,000 for a tax free account.

It is not surprising that our largest fund companies do not offer many funds suited for a bear market. Instead, they offer the same old funds from bull market days. They chose to offer funds that would compete with other fund companies products, rather than concentrating on what investors would really need for future success. You can always be sure that, as any for-profit business, they put their own success ahead of that of their customers. However, the current very low cash position of nearly all funds spells redemption trouble ahead as this vicious bear market develops. Our ten choices will be free of this drain on their assets due to their expected excellent performance in the bear market ahead.

It should be noted that the two Hussman funds are unique, because of their protective hedges which are instituted as needed to prevent any loss, the two Prudent bear funds are unique due to their 16-20% holding in precious metals and RYJUX, the Rydex short bond fund is unique as the only fund of its type. There are also several bond ETFs that can be sold short to protect long bond positions but we will use RYJUX.

We get many e-mails from men and women who have been dependent on a broker or advisor whose bullish help is no longer effective in this market climate. Their assets may be too low to reach the minimum of for-fee advisors who could do a better job. Some of these people have never made an independent decision to buy or sell anything and need suggestions on how to start acquiring experience with little or no risk. Some of them are not only super cautious but need to have step by step advice on entering the market and profiting from a good learning experience.

Let’s build several portfolios from our list of asset classes from which investors can select one or more for use as they see fit.

                                            30% U.S. Treasury Short Term Bond Fund
                                            40% Foreign Government Bond Fund
                                            30% Total Return Hedged Income Fund
                                           100%

This simple portfolio holds just 3 unusually safe funds to build confidence for a non-expert investor. Comparing the performance of the first two bond funds will be very instructive on tracking the value of the U.S. dollar versus foreign currencies. The third fund is very conservative because it employs a variety of income producing bonds and stocks which can be protected against bear market losses, if any, by use of up to 30% of an appropriate short hedge. The scholarly weekly reports of this very bright fund manager, available on the fund web page, will provide a great education which I highly recommend. Regardless of age or health, the owner of this portfolio will not suffer any anxiety or sleepless nights. Start with a modest amount of assets and build the size of the portfolio slowly as you gain full confidence in its conservative performance.

                                              30% U.S. Treasury Short Term Bond Fund
                                              30% Foreign Government Bond Fund
                                              30% Total Return Hedged Bond Fund
                                              10% RYJUX - Short Long Bonds
                                            100%

Perhaps this portfolio is misnamed because we use the very same 3 funds as above plus a10% position in a fund that is short the long bond market. This asset class will be more volatile but its overall effect in a period of rising interest rates should be very positive. In other words, this portfolio may very well out gain Portfolio 1 .If in doubt, start both portfolios and let market experience be your guide for longer market exposure. Or, if you like, start a little contest with your wife to see who wins.

Balanced Portfolio # 3
                                              25% Foreign Government Bond Fund
                                              25% Total Return Hedged Bond Fund
                                              25% Strategic Growth Hedged Stock Fund
                                              13% Energy Stock Fund
                                              12% Prudent Bear Short Stock Fund
                                            100%

This balanced portfolio holds 50% bonds and 50% stocks and will provide an interesting learning experience while not being too hard on the investor’s nerves. Three fourths of the portfolio will almost certainly show a rising price while the last 25% will exhibit price volatility. The diversified energy fund and the Prudent Bear short fund will probably be either gaining or losing but the overall effect will probably be positive. It is almost impossible to pick the right percentages of these assets at the start, so I recommend that the initial percents be considered for change during the second year, based on their actual performance in the first year. Making this correction and seeing the results should provide a wealth of learning experience. That is exactly how you gain confidence in managing your own money. Every single corrective action you make helps you do better the next time.

                                              10% U. S. Treasury Bonds, short to intermediate
                                              10% Foreign Government Bonds, short to intermediate
                                              10% Total Return Income with up to 30% hedge protection
                                              10% Strategic Growth with up to 100% hedge
                                              10% Short Fund, inverse stocks
                                              10% RYJUX Short Fund, inverse bonds
                                              10% Precious metals stock fund
                                              10% Energy stock Fund
                                              10% Health stock Fund
                                              10% Real Estate (REIT) stock Fund
                                            100%

Unlike our first 3 suggestions which are aimed at (1) increasing your wealth and (2) adding to your ability and confidence in managing money, portfolio #4 is aimed solely at educating the investor. The classroom is the real stock market and there is just one student, the investor. The curriculum is to study the very different market action of ten quite unique asset classes. We have deliberately used equal amounts so that, at the end of a year, one glance will show the winners and losers. In a tax free account, it will cost ten thousand dollars to build this portfolio. For the maximum amount of learning, it should be continued for at least a year, or for the length of a major bull/bear market cycle.

With the real world performance in hand, one can then calculate the annual returns of various portfolios. This information can be very valuable. The next step for the student investor would be to discard the weakest 2 or 3 assets and to determine the best percentages for the remaining classes. The final and most important step is then to build and follow the new portfolio. That is how I learned and there is no question but you will too. You do not really learn by reading books about how other investors made money. In designing the portfolio, it is very important to get the proper balance between growth and safety, for example consider the following hypothetical portfolio:

                                              25% U. S. Treasury Bonds, short to intermediate .
                                              25% Foreign Government Bonds, short to intermediate.
                                              15% Strategic Growth Fund, up to 100% hedge
                                              15% Short Fund, inverse stocks
                                              10% RYJUX Short Fund, inverse bonds
                                              10% Precious Metals Fund
                                             100%

From the studies made in the first test year, we would know that this portfolio would have a very high probability of success. See the many other portfolio examples in our essays over recent months. Note that we almost always start with at least 50% of very stable bonds. But in the section on Rebalancing, below, we discuss transferring profits from volatile classes to the stable bonds. So, over the years, using periodic rebalancing, all the asset classes grow and retain their desired percentage in the portfolio.

Please go back and review the first three portfolios. Note that they use 3, 4, and 5 of the 10 asset classes. They are learning portfolios designed to make money in this bear market. But since this market is volatile and unpredictable, no guarantees are possible. With respect to portfolio #4, you could transfer the assets to one or more of the other learning portfolios at the end of the initial testing period.

In my archive for the past two years, I have presented several dozens of portfolio examples for my readers to consider. If you chose to read them now, you would find a subtle change in the portfolio design over that time period. The reason is that I have been fully invested at all times and my own learning experience increases daily. This is my principal avocation and, since my wife went into our Care Center in April, I essentially spend most waking hours pursuing it.

With 63 years of market experience behind me, my discovery and use of new ideas occurs at a rapid rate. I never recommend anything in my essays that I have not studied and followed either on paper or with real money in the market.

I use my FastTrack software for making many back tests of my new ideas. This valuable software tool is quite complex and I use only a few of its features. The Windows program is available free with full 800 phone technical support. The charge of about $30 per month is for daily data on 6000 mutual funds, available on-line each evening. I use it for comparing the charts of any 6 mutual funds on my screen for periods from one month to many years. I can also put on my screen a ranked performance table over any period for an entire group of funds, eg. 30 precious metals funds. A 30 day free trial is available by phoning 800-749-1348. Give it a try.

This has to be one of the most controversial issues. On the one hand we find fund managers were buying and selling them after one day while recommending that customers hold them for most of their lives. Whether due to the fund advertising or not, many fund owners are very attached to their funds and hold them long after a decline in performance. With many thousands of funds to choose from this reluctance to sell has probably reached serious proportions but we have no useful data on the subject.

Since most investors are still very bullish four years into a great bear market, their losses can only continue to mount unless something convinces them to change. We urge any readers of this essay, who are holding funds with large losses, to sell them and take the losses before year end. Although only a tiny fraction of investors are fully aware of the dismal future for this bear market, taking losses in the next five weeks will turn out to be very wise in my opinion. The Elliott Wave theory has convinced me this bear market will last longer and prices will fall more than most investors believe to be possible.

One of the best new ideas we have developed over the past two years is our discovery of the huge advantages of periodic portfolio rebalancing. It has become a permanent and very important part of all of our recommendations over the past year. New readers should read articles published in the last 6 months. The term rebalancing has been in popular use by financial sales types who say "send us your portfolio for rebalancing". Their goal is to substitute their ideas for the investors. Our purpose in reblancing is totally different. We start with a portfolio consisting of both stable and volatile asset classes. A year later, the fund percentages may be quite different due to market action. Rebalancing the portfolio involves shifting the greater profits from volatile assets to the stable assets. In this simple process, we re-establish the original balance of asset classes and long term gains are thereby realized. Rebalancing to the original portfolio composition also can reduce future losses in the volatile components. Also, rebalancing can improve the total portfolio return over its full lifetime.

Our fellow residents in this retirement complex are still bullish and hanging onto their stocks and funds. I have long given up all hope of changing their bullish opinions. Many have their assets in tax free bonds which in my opinion may be proven very unsafe if the states can no longer pay the interest on their bonds and their insurance company fails to deliver in a crisis.

With our development of the idea of periodic rebalancing of a multi-asset class portfolio, an essential part of the plan is to rebalance every year and a day to build small long term capital gains. Of course, in a tax-free account the rebalancing is not a taxable event and can be done twice a year if the investor deems it to be advisable.

We welcome reader e-mails and especially so when they ask questions we are free to answer. Please do not ask us to name a specific fund or to compare one fund with another. We have listed the availability of certain funds in major no-load families. We may have missed a few. You can go to the web pages of the listed fund companies and see their entire fund list. Then you can go to other web sites and get past performance data and other information. Better to start now before market conditions get even worse.

Over the years ahead, the most important job for any investor is to pick the right asset classes. Do not worry about small performance differences between competing funds in the same asset class. If you can accept this fact, you will advance to at least the 95th percentile of knowledgeable investors.

New investors who have never built a portfolio and managed it to success should know one fact. They are part of a very large group in our country with money to invest who have no idea of what to do in big bear market. One could probably include in that group many financial advisors and mutual fund managers still in their bull market mode.

So my suggestion to worried readers is to get moving on one or more of my conservative learning portfolios. You may never acquire the ability to manage money if you do not start now on one of the carefully thought-out suggestions. An even better idea would be for a husband and wife to each choose a portfolio and have a friendly competition. The learning portfolios suggested above do not require much management time and, once you see them going up in this bear market, they are fun to watch. So, please share your fun with me when you reach that stage.

I greatly appreciate the flow of good wishes from our readers and hope to continue writing but at a slower pace Your letters will help keep me going.