Investors good at picking funds, lousy at timing: Morningstar

First the good news: Morningstar Inc. research shows that investors are quite good at picking the best mutual funds in any given category. The bad news is, they tend to invest in them at the wrong time — and that’s killing returns.

“Investors know how to pick good funds, but good funds can’t overcome bad allocation,” said Russel Kinnel, director of mutual fund research.

“When we look at fund flows, we see massive evidence of bad behavior, like selling stocks to buy bonds in March 2009,” said Scott Burns, director of fund analysis for North America. Since the market bottomed March 9, 2009, the S&P 500 has returned more than 95%. Mr. Burns pointed out that if investors had just stuck to their asset allocation, they would have participated in the full run-up.

“It’s not about being contrarian; it’s about being disciplined,” he said.

Asset allocation is going to become even more important as baby boomers transition into retirement. The historical rule of thumb has been to increase fixed income to get more conservative. But with puny interest rates, the old way may not be the best way.

“Bond’s can’t do all the heavy lifting,” said Don Phillips, president of fund research.

That doesn’t necessarily mean more equities are needed, though. “Stock returns are too volatile for retirees,” Mr. Phillips said.

That means alternatives are going to have to play a bigger role in retirees’ portfolios. “Portfolios are going to have to become more complex,” Mr. Phillips said. “Alternatives give you a way to build new portfolios.”