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SPECIAL REPORT: Is 'Buy and Hold' Dead? | FUNDS AND
401(K)S : MUTUAL FUNDS' FADED GLORY

Industry Colored by a New Impatience

April 11, 1999|PAUL J. LIM

Amid wild market volatility, disappointing mutual fund returns and the rise of online brokerages, more Americans are forsaking long-term stock investing for other strategies--including active trading and a shift of capital to other, safer assets. The challenge to the 'buy-and-hold' mind-set is growing, as this three-part report explains

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In the fall of 1996, at a time of unprecedented growth in the mutual fund industry, Vanguard Group founder John Bogle warned that there was an "ominous" trend developing.

The industry's traditional emphasis on "buy and hold" investing was giving way to short-term thinking, Bogle said, as more fund companies accommodated people who wanted easy entry and exit.

The industry risked enticing investors "to use their mutual funds as vehicles for rapid switching, either for . . . market timing or for the purpose of jumping on the bandwagon of the latest hot fund," Bogle said.

How prescient.

Today, the majority of the nation's 77 million fund investors may still be buy-and-holders. But that patient strategy--made famous by the likes of Warren Buffett and Peter Lynch--while alive in the stock fund business, is not well.

Last year, investors pulled $534 billion out of stock funds, a 48% jump over stock fund redemptions in 1997, according to the Investment Company Institute. In the first two months of this year, redemptions were up 62% over last year's pace--even as major stock indexes have continued to soar.

While new money is flowing into the funds at the same time redemptions are rising, those higher redemptions have sharply depressed the net sum of new cash entering stock funds: $159 billion in 1998, down from $220 billion-plus in both 1996 and 1997.

Redemptions are surging as fund investors, for any number of reasons, are opting not to hold their funds nearly as long as they did just a few years ago.

The average holding period for stock fund investors in the late 1980s was five years, if not more, according to industry estimates. Today, many fund companies believe it is down to three years or less. Some industry experts say it may be as low as 18 months.

"Investors are becoming less patient," says Ken Gregory, editor of the No-Load Fund Analyst newsletter in Orinda, Calif. "Increasing numbers of today's mutual fund investors remind us of channel surfers who, with remote control in hand, never watch anything for more than a few minutes."

To be sure, the fund industry isn't in grave danger. With assets of nearly $6 trillion--$3 trillion of that in stock funds--the business still holds a huge share of the public's wealth.

Even so, the industry faces the potential for a worsening of the stock fund redemption wave, as the concept of buy-and-hold is pressured by three forces:

* The aging of fund shareholders. As longtime investors near retirement, more will begin to think about cashing out portions of their stock holdings, either to pay for living expenses or to move into less risky securities.

Over the last year, in fact, purchases of lower-risk bond and money market funds have zoomed even as stock fund inflows sank.

* Internal competition. There are nearly 13,000 funds to choose from, more than twice as many as five years ago. This at a time when the industry is having more difficulty attracting new customers.

Says Geoff Bobroff, an industry consultant in East Greenwich, R.I.: "We have hit a plateau in terms of reaching individual investors. We have reached the majority of households that can be cost-effectively reached."

To increase market share, then, fund companies must convince customers at competing firms to dump their existing funds.

* External competition. In an era of fast-rising individual stocks but mediocre stock fund performance overall, funds are losing business to competing outlets, such as online brokerages that allow investors to trade individual stocks on their own--and very cheaply.

Over the last three years, while the benchmark Standard & Poor's 500 index of blue-chip stocks has risen 28.1% a year, the average U.S. stock fund has gone up (I hate to say "just") 17.2% a year.

No wonder folks like Annie Bonner, 39, are being lured away from funds by the hope of making more money in individual stocks.

Three years ago, the Irvine resident began contributing to her company-sponsored 401(k) retirement plan, directing her money into three T. Rowe Price stock funds. It was her first exposure to the stock market.

Two years ago, Bonner rolled her 401(k) account into an IRA with discount broker Charles Schwab. Then she came to a realization: "If I had taken all of the money I put into mutual funds and put it into decent stocks, I would have done way better than I did through my funds."

Today, the vast majority of Bonner's retirement money has been pulled from stock funds and invested in individual stocks--including IBM, Intel and a small Southland tech firm called MiniMed.

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