Once you've built your portfolio of mutual funds, you'll need to know how to maintain it by employing a mutual fund investment strategy. Let's review four popular strategies.
The Wing-It Strategy
This is the most commonly seen mutual fund investment strategy, especially among new investors. How does it work? If you're not following a specific plan or structure that helps guide you in making your investments and maintaining your portfolio, you are likely employing a wing-it strategy.
Without a plan for investing, you might struggle to make decisions that accurately reflect your investing goals. Most experts would agree that this strategy tends to be least successful because of its lack of consistency.
On the other hand, if you have a plan or structure in place that guides your investing, then managing your portfolio should be much easier.
Market Timing Strategy
The market timing strategy implies the ability to get into and out of sectors, assets, or markets at the right time. In an ideal world, the ability to time the market means that you would always buy low and sell high.
Unfortunately, few investors do this consistently because investor behavior is typically driven by emotions instead of logic. The reality is most investors tend to do exactly the opposite of what is optimal (i.e., buy high and sell low). This leads many to believe that market timing does not work. No one can accurately predict the future with any consistency, yet there are many market-timing indicators that some investors believe give them an edge in predicting where the markets are headed.
This is by far the most widely preached investment strategy. This strategy means you'll buy your investments and hold onto them for a long time regardless of whether the markets are going up or down. Conventional wisdom says If you employ a buy-and-hold strategy and weather the ups and downs of the market, over time your gains will outweigh your losses. Billionaire and legendary investor, Warren Buffett, is on record as saying this strategy is ideal for the long-term investor.
The other reason this strategy is so popular is that it's easy to employ. This does not make it better or worse than the other options; it's simply easy to buy and then to hold.
Performance Weighting Strategy
This is somewhat of a middle ground between market timing and buy-and-hold. With this mutual fund investment strategy, you will revisit your portfolio mix from time to time and make some adjustments. Let's walk through an oversimplified example using real performance figures.
Let's say you started with an equity portfolio of $100,000 across four mutual funds, split into equal weightings of 25% each.
After the first year of investing, the portfolio is no longer weighted equally at 25% in each fund because some funds performed better than others.
The reality is that after the first year, most mutual fund investors are inclined to dump the loser (Fund D) and buy more of the winner (Fund A). That, however, is not what performance weighting is about. Performance weighting simply means that you would sell some of the funds that did the best to buy some of the funds that did the worst.
Your heart will go against this logic, but it is the right thing to do because the one constant in investing is that everything is cyclical. In year four, Fund A has become the loser and Fund D has become the winner.
Performance-weighting this portfolio year after year means you would have taken the profit when Fund A was doing well to buy Fund D when it was down. If you had re-balanced this portfolio at the end of every year for five years, you would be further ahead as a result of performance weighting. It's all about discipline.
The Bottom Line
The key to portfolio management is to have a mutual fund investment strategy that you adhere to in a disciplined fashion. The most successful money managers in the world are successful because they have the discipline to manage money, and they have a plan.
Warren Buffett perhaps said it best: "To invest successfully over a lifetime does not require a stratospheric I.Q., unusual business insight, or inside information. What is needed is a sound intellectual framework for making decisions, and the ability to keep emotions from corroding that framework."