Investment Newsletter #10 (Sept. 21, 1999)
Tom Madell. Copyright 1999
Can a $4,000 Exchange Result in a $28,000 Loss?
The purpose of this newsletter article is to illustrate something that may shock you. It's about how selling or exchanging even relatively modest amounts of money from a mutual fund account can wind up costing you dearly in the future. In order to explain how this can happen, I will give you, as I have in my past newsletters, a real example based on my own actual mutual fund data.
Back in 1987, I opened an account in the Janus Fund. This is the flagship fund of the now "hot" fund family that is currently being widely touted as the best performing family fund group. Back then, it was not very widely known, and as I recall, there were only about 3 or so funds within the family group.
During the first 9 months I owned the fund, I invested nearly $6,000 in the fund. But these were the days that led up to the '87 crash and shortly thereafter. After the crash, being a new investor and knowing a lot less than I do today, I like many others, was fairly spooked and mainly trying to get back to even. So during '88, I exchanged $4,000 out of the fund in two installments.
But here is a question that all serious long-term mutual fund investors might want to consider. Given this fund's subsequent excellent performance between '88 and now, how much do you think having pulled out just $4,000 might have actually cost me in lost growth potential?
To find out the answer, let's look at how this fund, rated 5 Stars by Morningstar, has performed since the last of these above two sales which occurred on Nov. 9, 1988. As computed by the Quicken program, my average annual return for this account comes to 21.35% from that date through Sept. 18, 1999.
According to the Rule of 72 which I discussed in Newsletter 4, if you divide 72 by the 21.35 annual return, you get approximately the number of years it takes for the investment to double, in this case a little less than 3.5 years.
So, now we are ready to look at what would have happened to the $4,000 had it remained in my Janus Fund account to the present time as opposed to being exchanged out:
Date Potential Amount
Nov. '88 $4,000 (exchanged amount)
May '92 $8,000 (amount doubled)
Nov. '95 $16,000 (doubled again)
May '99 $32,000 (doubled again)
What this dramatically shows is that even though at the time I thought I was making relatively small, prudent portfolio moves, the consequences of my decisions were magnified 8 times over the next 10 1/2 years. As a result, by exchanging $4,000 from the fund, I very well might have reduced my current stake in the fund by a whopping $32,000! Since I still had access to the $4,000 elsewhere, the net loss of potential growth within this fund account can be estimated to be approximately $28,000.
Fortunately, this did not turn out to be as horrific an outcome as it might have. Let's look at what I did right. Since 1988, I have never sold any other shares of this fund. And I made additional occasional purchases of $3800 down through the years. Here then is a summary of my overall investment performance for the Janus Fund:
Investment period: 9/21/88 - current
Total invested: 9,671.75
Total redemptions: 4,000.00
_________
Net cost: 5,671.75 (Investments minus redemptions)
Current value: 31,169.70 (through Sept. 18, 1999)
Current profit: $25,497.95 (Current value minus cost)
Investment performance: 19.96% annualized
(Total return)
True, if I had not sold the $4,000 worth of shares back in '88, I would currently have approximately $63,169.70 (31,169.70 + 32,000) in this fund's account, or nearly double my current balance. However, here was another saving grace: More than half of the original $4,000 sold was exchanged into another Janus family fund, Janus Venture. (This fund is unfortunately closed to new investors.) From the day of that exchange through the present, my average annual return for Janus Venture has been 18.40%, also calculated using Quicken. So, I did nearly as well on the money I switched as if I had left it in the original fund. But for the rest of the money switched back in '88 that did not go into another stock fund, we can assume the very significant loss of growth potential referred to above.
Conclusion
The reason for examining your past transactions in detail is to determine whether the majority of your actions turned out to be the correct ones as measured at a significantly later date. No one can expect to come out right all or even most of the time. However, by examining your previous patterns, you should be able to learn from your mistakes and do a better job in the future.
For me, the lessons from the above example are clear. Unless there is a truly compelling reason, you should probably not redeem mutual fund shares unless you really need the money. And when making an exchange from a stock fund, it usually makes the most sense to go from one stock fund to another one, rather than from a stock fund to a non-stock investment such as bonds or cash. I suggest that the above situation also illustrates that you should not redeem shares either because of heightened fears or the usually illusory notion that you can correctly time the market. See Newsletters #2 and #6 for further thoughts on the selling of shares.
Of course, the future could be different. There may be times when a timely exchange or outright sale from a fund, especially one that is underperforming its most relevant benchmarks, will prove to be a wise decision. But for the truly long-term investor with an investment horizon of 7 to 10 years or longer, the odds are very much against you coming out ahead by reducing the overall size of your invested assets.
