Rules of the Game: Active Management

 | Jun 24, 2013 | 10:00 AM EDT  | Comments
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Let's talk about active management.

It's not hard to find pundits warning against mutual funds, with the argument that being fully invested is good, and being in cash is bad.

I'll agree that in most cases it's not wise to sit on a pile of cash because the large equity indexes are pulling back. That's why it's a time when professional money managers rebalance and seek investment opportunities that can be acquired cheaply.

I was a trading coach for years with a large company that published materials encouraging do-it-yourself traders to pick growth stocks by timing the market. Sure, there were anecdotal success stories of those who found "big winners" and rode them higher, but these incidents invariably occurred in bull markets that were favorable to growth stocks. There was never any substantive discussion of how these exciting stock picks translated into any longer-term financial plan.

It's fun and exhilarating to identify a trading opportunity like Green Mountain Coffee Roasters (GMCR) before its price heads for the heavens. But then what? Deploy the money into another growth-stock bet? That's what the trading-system purveyors encourage you to do. After all, if you deposit it into an IRA, they lose the revenue from your desire for further trading ideas. Or should I say, your addiction to trading ideas?

There are a few problems, however, with a trading mentality vs. a longer-term investing mentality, particularly if you view trading as a quick way to ensure a fat bank account in your non-working years.

I'll readily acknowledge that about 85% of active managers fail to beat their benchmark index in any given year. That doesn't mean that I'm siding with active fund management as the only alternative to at-home stock-picking.

But it's folly to believe that the guy sitting at his computer, armed with a list of technical or fundamental "can't miss"stock traits, is better equipped to achieve some kind of financial goal. And the stock-picking financial goals are almost universally vague, consisting of something like, "Beat the S&P" or "Get huge returns!"

I know I keep harping on this fact: But neither of those goals is a retirement plan. If you are one of those who bristles at the word "retirement," because it conjures up images of rocking chairs and shuffleboard, reframe it as, "the years when I get to do what I enjoy, and won't need income from a job."

A retirement plan factors in the income streams you will need in those years, considers tax implications of withdrawing money from specific accounts and looks at the lifestyle you hope to attain during that time period.

It has absolutely nothing to do with betting on stocks or sectors. Yes, I said "betting," because that's what trading is, even if you use 37 oscillators and four different moving averages.

I understand the elation and pride in picking a stock that rockets 25% or more in some relatively short period of time. It's fun, and it makes great dinner-party chatter. Just don't kid yourself that fast gains are a ticket to retirement, because such trading is often done in vacuum, unaccompanied by any kind of comprehensive financial plan.

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