History Repeats Itself

Consider an example we will call Fund X.

Always volatile, this fast-trading fund grabbed investors' attention in 2007, when it generated an 80% return on the strength of its natural resources bets as well as well-placed short positions in certain mortgage-related companies. Predictably, a flood of investor assets whooshed in that year and in early 2008, just in time to see the fund lose half of its value. Through 2008, the fund's 10-year total return was still extremely impressive, at roughly 18% on an annualized basis. But due to poorly timed purchases and sales, the typical investor in the fund actually incurred a 20% loss over that time frame.

It will cost you to be fickle

Although few funds have cash-flow stories as dramatic as this, investment research firm Morningstar's studies have found that investors across all fund types—both stocks and bonds—have paid a price for being fickle.

The damage is greater on the stock-fund side, especially with volatile sector and region-specific funds, in which volatility and temptation are highest. In the natural resources category, for example, Morningstar data show that an investor who bought and held an average-performing fund in the category would have pocketed a very robust annualized total return of 14% in the 10-year period through 2010. But due to poorly timed purchases and sales, actual investors in natural resources funds gained a less impressive 8.7%. Investors in the Latin America and Pacific Asia ex-Japan categories have left even more money on the table due to poor timing decisions. Not surprisingly, both groups have logged periods of exhilarating performance as well as periodic sell-offs. It's easy to get caught up in the excitement of a go-go fund's performance. Don't-don't.

The lesson?

Clearly, emotion has a way of interfering with reason. That's why dollar-cost averaging can be such a good idea. Sure, it's possible to make more money with a lump-sum investment. But it's also possible to make less.