You Have Terrible (Mutual Fund) Timing

That’s what a study, titled “Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns,” conducted by two finance professors has concluded. Andrea Frazzini of the University of Chicago and Owen A. Lamont of Yale conducted a study that showed that mutual fund investors tend to enter a fund as it’s about to sag and dump it before it enters a “several-year” period of above-average performance. In a sense, investors have a terrible sense of timing when it comes to mutual funds.

They found that 20% of mutual funds with negative flow (more money leaving the fund than entering it) over the last three years performed 10.7% better per year than the 20% with the most positive flow. In other words, a contrarian investor would have done quite well.

There are a lot of calculations and statistics in the article, and obviously the study, and they’re all pretty compelling. My interpretation is that investors chase past performance (ignoring that little disclaimer on each fund) and it hurts them. This does make sense, imagine if a mutual fund has performed well and suddenly sees a huge inflow of money. It’s easier (and cheaper per share) to purchase 10,000 shares of a company than it is 100,000. To replicate those returns with more money is probably considerably harder.

Moral of the story? Just buy an index fund!

via New York Times, the study is available here (pdf).

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