Sunday, June 28, 2009

Mutual Fund, Buy-Sell or Buy-Keep ?

There are mainly 2 different schools in mutual fund believers.

1. Apply Dollar Cost Averaging, (DCA) put in money consistently for a long long time. Never take it out until you die, retire or you initially planned to. Lets call this Buy-Keep technique.

2. Buy Low Sell High, when market is bad, buy more, when market is good, sell them to take profit then buy again when market is low again. This way you maximize your return, the more you roll the bigger you get. Lets call this Buy-Sell technique.
There may be some simple answers : (a) Its really a personal preference; (b) If you know DCA you use DCA, if you know the market, you use Buy-Sell techniques. But at the end of this article, there may be a distinctive answer NO MATTER if you have a preference or understand anything on DCA and the market.
DCA is boring. All it says is you save a FIX amount of money PERIODICALLY. It doesn't tell you when you can take profit, when to withdraw. It doesn't care what the market is doing now. It just say save, save save ...

The good thing about DCA is it is simple. You just need to know (1) the amount and (2) the period. And both of these parameters are 100% under your control. You decide the amount and you decide the period. Another good thing about DCA is it is usually 'cheaper' - as low as $50 or $100 for each transaction.

The good side of DCA's simplicity can also be viewed as its disadvantage. Simple may also be viewed as lack of abundance, or in this case, ignorant. Admit it, its kind of stupid to think that if I want to earn money, all I need to do is to decide the amount and period !? Having said that, DCA is not really easy to implement neither. Simple concept is NOT always Easy to execute persistently. Unfortunately This has been statistically proven.

The good stuff about Buy-Sell technique is its exciting. You may read news, find info, analyse finance data or even play with charts in order to know the up down of the market. You may even be very well verse in some particular industries that you have secretive insider knowledge. Either ways, it is exciting. You may be able to gain big profit when your decisions are right.

The unhappy moments of Buy-Sell technique is when your intrepretation of the market is wrong. Or may be you are still right, just that the market goes the other way. It could be big guys play you out, natural disaster or simply that you thought you knew but actually you didn't. On this method, you will need to spend some effort to analyse the 'timing'. You need to know when to buy and you need to know when to sell. If you spend too much time on the timing, it may be disqualified as a passive income generator afterall.

If you are reading sequentialy, there may not be any apparent answer yet. It still seems like a preference issue.

Lets look at the risk-reward of both techniques. In long run, DCA seems like to be able to cushion the risk, but it would also provide lower return. So relatively, it seems like a lower risk lower return. Buy-Sell on the other hand is very investor dependant and therefore high risk high return.

Athough a weird dude run some numbers and said that in DCA, when you lose, you lose less and when you win, you win more. But in this context, Buy-Sell technique would still provide higher return than DCA while carrying more risk. Buy-Sell technique can also claims that the longer one practise it, the more experience one will gain and therefore, the longer it is the higher chance one may win. ( hardly a truth neither )

Ok, by now can you see any distinctive answer yet ? If not, then we will have to run some numbers again ...

Says you use DCA method and put in $1,000 a month for 5 years. You would have put in $60,000 in total. If you are paying 5% charges, the total fee you have paid is $3,000 through out the 5 years period.

On the other technique, lets say you buy-sell twice a year, that would be 10 times in 5 years. Assuming the average of each transaction amount is the same as your initial capital, $60,000. The total fee you have paid would be $15,000. Equivalent to 25% of your initial capital. Comparing to 5% from DCA method, this method is disadvantage by 20%, not in practice, but in strategy.

So if out of the 10 times you buy and sell, your total lost-win ratio is 50-50, then you would most probably ended up with performing 20% lower than DCA method ( not really, read on ). In other words, in order to eliminate this potential strategy short fall, your lost-win ratio should be at least 40-60 in order to break even. ( Conceptually, not exact by numbers because other parameters are needed for full calculation ).

Another way to put it, if you earn the SAME return in both techniques and you have a net profit of $1 in DCA, Buy-Sell technique would have given you $0.80 only.

If we go back to the fundamental in mutual fund is that we pay HIGH fee for professional services. If after paying them such a HIGH fee, you turn around making your own calls. It would be equivalent to wasting all the HIGH fee you pay them at the first place, wouldn't it be ?

No doubt Buy-Sell technique is a good method but why would you ever want to pay 5-6% fee comparing to other tools that charges less than 1% and yet allow you to buy sell much easier ?

So no matter if you have a preference between Buy-Sell vs Buy-Keep, no matter if you really understand DCA, no matter if you know the market, you should NEVER apply Buy-Sell techniques in mutual fund.

If you still insist to Buy-Sell mutual fund, then please understand this formula ....

The only scenario where Buy-Sell mutual fund is NOT strategically disadvantage is when you found a particular fund that already has a large number of stocks that you planned to invest into anyway. In that case, there is a chance that the 5-6% high fee is average down by the number of stocks until it is even LOWER than the stock invetment fees.


Tony said...

To cut costs whilst still adopting the potentially more profitable buy-sell is the BUY-SWITCH.

By doing that, the effect is the same (switching is also a redemption but because you are keeping your redemption in the fund managers' money market fund, you are technically still invested with them) and yet you do not have to pay the service charge all over again when you buy back into their equities fund (switch back from Money Market fund to the Equities fund) to take advantage of your hoped for bullish market.

Mt. said...

Thanks Tony, indeed this is potentially a very good alternative.

If you want to Buy-Switch using mutual fund, do make sure you find out more info, terms and conditions, all possibilities with your fund manager. Each usually has different rules associated to it.

It is even possible to 'rip' instant profit in certain conditions, however some other managers may discourage switching.

buy switch is perfect when you have found two funds from the same manager that have opposite effect to market reaction.

Peter_APIIT said...

What u mean by number of stock x number of transaction?


Peter_APIIT said...

What is the meaning of number of stock x number of transaction?

Any example of the formula?

Mt. said...

if the cost of buying 1 stock is $10 then 10 stocks would cost $100. if these 10 stocks are also in fundA and the cost to buy fundA is $50, then its cheaper to buy fundA.

indianist said...

There are lot factors to be considered before looking for the right time to sell mutual funds without ever rushing fast to sell your mutual fund units. If anyone is aware of mutual funds and its selling methods there are top 7 factors that decides the profit of the mutual fund.

Unknown said...

I am having 100 Mutual Fund units but the share is going down, pls tell which is the right time to sell Mutual Fund units? Pls give some tips

Unknown said...

I am having 100 Mutual Fund units but the share is going down, pls tell which is the right time to sell Mutual Fund units? Pls give some tips

indianist said...

Can someone suggest me which is the right time and when to sell mutual funds that I have bought recently??