One of the things I remember most from my MBA years was doing case studies and coming up with strategy recommendations for companies. We were taught that one of the possible strategy options was the “do nothing scenario”. As eager MBAs who thought we knew better than the company itself, this was not usually the option of choice. It’s the same thing when it comes to how both clients and advisors manage mutual funds. The “do nothing scenario” is usually a non-starter.

When I was a commission-based financial planner who sold mutual funds, it was hard to resist the temptation to “do something” when clients were upset about the returns on their portfolio or on a particular fund. And I know I wasn’t the only advisor who felt that way.

In order to relieve the anxiety that goes along with a portfolio drop and the risk of potentially losing a client, the easiest thing to do is to “take action”. The advisor proves his/her worth by moving money around and the client feels that something is being done proactively to help them make money in the future. The problem is that this is often exactly the wrong thing to do.

Here’s what usually happens. The worst performing funds are sold, then recent strong performers are recommended/chosen as replacement funds. Let’s face it – it’s pretty hard to convince a client to move into a fund that has shown negative returns recently.

Unless the portfolio was badly planned upfront or there are truly valid reasons for moving out of the “dog” fund, switching funds usually amounts to “selling low” and “buying high”.  Emotionally, both client and advisor are temporarily satisfied, but this is clearly not a good strategy for making money long term. Several studies in the US and others in Australia have shown that “too much switching can result in lower returns.”

Dalbar Inc., a Boston consulting group, found that the average mutual fund investor usually gets a much lower return on their investment than the performance reported by the fund itself. Why?  Because of switches made in a chase for performance.

A better approach is to do your homework in advance of investing, come up with a game plan and then stick to it. If you want to work with an advisor, choose someone who has a very clear system for deciding when to buy, sell or hold funds. If you are acting as your own advisor, use ETFs or find a low-MER mutual fund company that has a smaller number of funds to choose from.

Having too many options makes it difficult even for professionals to make comparisons, track performance and to resist making fund switches. Spend the time upfront to create a solid, disciplined plan then, “forget-about-it”.  – Karin Mizgala

Karin Mizgala is a Vancouver-based fee-only financial planner with an MBA and a degree in psychology. She’s the President of LifeDesign Financial and co-founder of the Women’s Financial Learning Centre.