Funds Behaving Badly

Revolutionary technology! Hot-shot startups! Super-high yield! Funds offering exposure to these goodies are making the rounds, all trying to tempt investors with visions of smokin' returns and the Next Big Thing. Exciting? A word of caution-this all smacks of heat-chasing, one of the biggest pitfalls investors face as bull markets age and human nature makes us greedy. Flashy tactics might seem splashy, but in our experience, gimmicks and sound long-term strategies don't mix. This is a time to stay grounded and focused on your long-term goals.

Consider the gimmicks in question, and you'll see a theme. One glitzy new ETF will track companies that develop, use and invest in "disruptive" technologies like robotics, 3-D printing, nanotechnology and bioinformatics (analyzing body chemistry and genetics)-all on the theory that exposure to "technology of the future" is the ticket to sky-high returns. That's a popular view these days, but it betrays a fundamental behavioral error: viewing investing as a get-rich-quick trick. There actually isn't much evidence "disruptive technologies" offer superior returns over time. In short bursts? Sure. But a lot of it ends up being a flash in the pan (see: Bubble, Dot-com). Plus, a strategy that banks on this will likely be over-concentrated in Tech and Health Care. The fund in question has about 60% in those two sectors alone. Great if they surge, but there is a giant opportunity cost-and risk of loss-if they don't.

Elsewhere some mutual funds are taking a different approach to chasing the Next Big Thing: buying shares in private tech startups, banking on a big IPO payout. Think of it as the mutual fund equivalent of investors searching high and low[i] for "the next Dell" in the late 1990s-more swinging-for-the-fences, get-rich-quick thinking. Now, on the one hand, these are traditional mutual funds and generally more diversified than the pure disruptive technology-chasers. On the other, they're tying up pretty significant sums in illiquid investments that may or may not pay out one day. That's an odd mismatch with mutual funds' traditional purpose of offering instant, highly liquid diversification. It's also an odd mismatch with the goals of most folks who own mutual funds in their retirement accounts. Most people simply do not need to double down on some speculative startup. But it's a powerful marketing gimmick[ii], and many investors might not consider the tricky details and potential drawbacks here.[iii]

Investing is a marathon, not a sprint. The focus should be more on finishing-reaching your goal-than being speedy. It's boring, but true. Staking your financial future on one single trend or event isn't investing-it's speculating. Speculating always looks like the road to riches, but it's often the road to ruin. Investing is a longer-term endeavor, which requires staying disciplined and immune to quick-rich gimmicks, not being blinded by greed. This will only get harder from here. We're in a maturing bull market, and greed is perking up. But your goal as an investor is not to predict the next hot fad. This is a loser's game, which a lot of investors learned after 2000's tech bubble burst. Many others are likely still smarting from gold and silver's slide in recent years. A big bull market seems to have a way of making folks gradually forget such lessons. However, a more disciplined, diversified approach that isn't swinging for the fences is the most likely path to reaching your retirement goals.

Greed isn't unique to stock investors. Most folks might not seek quick riches in fixed income, but they do chase yield-and yield-chasing "unconstrained" bond funds are gaining popularity, as recently reported in Fortune magazine. Unlike traditional bond funds, which stick to a set benchmark (e.g., long-term government and/or corporate, US Treasurys, etc.) unconstrained funds go literally all over the map to find whatever yields the most. Like Russia and habitual defaulters Greece and Argentina. There is nothing inherently wrong with these funds. For fixed-income investors with certain goals, they're probably fine. But, as noted in the article, for many individual investors, they run counter to bonds' typical purpose, which is to decrease an equity portfolio's expected short-term volatility and help with cash flow. Super-high yields might sound nice for cash flow purposes, but high-yielding bonds are inherently more volatile-and the higher default risk accompanying many of them (ahem, Greece) is probably inconsistent with many folks' goals.

We realize this probably makes us sound like fuddy-duddies, but sometimes it pays to be a boring stick in the mud. We know from experience that the longer bull markets last, the more greed creeps in. We're not suggesting greed is running amok today-with so many still nervously watching for a crash, this seems more like the earliest movers. But it will escalate. Folks grow envious of friends and neighbors bragging about their big wins, and they want to get in on the action. Bond investors get tired of ultra-low first-world yields and want a bigger payout. It's all normal human behavior! Keeping this greed in check and staying disciplined might not seem fun in the very near term, but for most folks, it's the right long-term move.

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