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Buy high, sell low--not

Tess' conversation with Jason Zweig of the Wall Street Journal about Sheepish Bulls is a timely reminder just how poorly most of us are at investing. How bad? Consider this calculation by Steven Leuthold, a long time money manager and market historian.

Leuthold looked back at the bull market of 1984 through 2000. The stock market sported an average annual return of 16.3%. (Ah, those were the days.)

Now, guess what the average equity mutual fund investor realized during the greatest bull market in U.S. history? Maybe 15% after subtracting fees? How about 14%? 10%?

A yearly gain of 5.3%. Mutual fund equity investors pocketed a return less than Treasury bills, he figured. Now, that hurts.

What accounts for the miserly performance? Part of the problem is the high cost of actively managed mutual funds. We aren't the rational thinking machines calculating the odds described in finance textbooks, either. Emotions, fads, and mental biases affect our investing decisions.

We can't seem to resist the urge to chase past performance, piling into the latest hot mutual fund or speculative sector just as the game is ending. We buy when stocks are rising and the economy strong and sell when stocks are falling and the economy weak. Buy high and sell low is a recipe for mediocre long-term returns.

What about the last decade? It was a terrible decade with an average annual total return for U.S. equity mutual funds of 1.59%, according to Morningstar. That's nothing. But Morningstar says mutual fund investors did even worse, managing to eke out a 0.22% gain. That's a rounding error off of zero.

Here's one takeaway from data like this: Stocks are risky, really risky. Since the 1870s the U.S. stock market has gone through 17 bear markets with declines greater than 20 percent.

Two of the three biggest declines in the stock market over this time period were in the past decade. That's why I like to look at a chart like this one created at dshort.com. Whenever the bulls run... the bears eventually show up.

About the author

Chris Farrell is the economics editor of Marketplace Money.
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As far as I can tell, mutual funds don't do anything to protect their value and go up and down with the market. Seems just as easy to make up my own mutual funds and sell some things when they're high and buy some when they're low.

What I do is to have 3 stock funds and a short term bond fund (similar to a money market fund). For the past few years, I have been rebalancing about every 2 or 3 months. The company that manages my 401K has an easy to use reblance option. When the bottom hit in 2009, I was not lucky enuf to rebance on the exact day, but it worked out for me.

I thought Jason's suggestion to move money into stocks in chunks (say over 6 or 10 months) was important.

I sit here listening to the segment with Jason Zewig about Buy High Sell Low and those investors that got out of the market. One thing I did during the down market was not open my 401k statement because I knew I would react to the market emotionally and do something I would later regret. Instead I left my allocations where they were and now I am glad I did. Isn't this what the experts tell us to do? "Ride out the downturn, you're in this for the long haul." Even though I knew I was going to retire in 2010, I have a pension so I knew I wouldn't need my 401k funds for some time. I try to catch your show every Saturday on my local NPR station WCPN Cleveland. Thanks for some great financial news. Keep up the good work!

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