Marketplace: Last-Minute Stock Trades Could Cost You

By buying a few of the year's hottest stocks and dumping some losers, your portfolio manager might suddenly looks like a genius. But Marketplace's Steve Tripoli talks with Madeleine Brand about how such trades made in this last week of the year end up costing consumers in taxes and transaction fees.

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MADELEINE BRAND, host:

Back now with DAY TO DAY, and a year-end note of caution for investors.

Check your mutual fund statements. Chances are the people who manage your funds have recently adjusted the stocks to make it look like they made wise choices this past year. Steve Tripoli from MARKETPLACE joins us now. And Steve, I understand this practice is so widespread that there's even a term for it. It's called window dressing.

STEVE TRIPOLI: That's right, Madeleine, shameful as it is that they admit it, it's been going on for a long time. It's kind of a perfect footnote to this year of the business world putting its own interest ahead of investors, like all those backdated stock options we keep hearing about.

So what happens, as you mentioned, is portfolio managers buy the year's top stocks and sell the losers around now. They do it at the end of every quarter, but investors tend to focus on year-end more closely. Thomas Russo at Gardner, Russo & Gardner in Pennsylvania says this harms most investors several ways.

First of all, it generates transaction fees and taxes, but it's also bad investment strategy. He says that's because it generates transactions that only continue long-running trends.

Mr. THOMAS RUSSO (Gardner, Russo & Gardner): And usually, when you find yourself at the tail end of a trend, which is what window dressing typically accomplishes, you're likely going to be paying higher prices for those well-recognized success stories and selling your generally perceived losers at a price that's probably not adequately recognizing their remaining value.

TRIPOLI: So they're buying high and selling low, basic bad investing.

BRAND: Right, but aren't they supposed to be looking out for our needs, and aren't they supposed to be professional enough to know not to do that?

TRIPOLI: Yes.

(Soundbite of laughter)

TRIPOLI: But, you know, what's going on is that job preservation trumps your interest and mine. You know, these managers can't afford to be exposed as not beating the market averages, which most of them don't do over time. That would be bad for their jobs. And if you saw their real investments over the course of the year, you might wisely decide to take your money elsewhere. So to heck with you and me.

BRAND: Well, is there anything that we can do about this?

TRIPOLI: Well, fortunately, there's an easy answer, plus some not-so-easy ones. The not-so-easy ones are that we can all watch the trading activity in our portfolios and mutual funds more closely. That's more work for us. Or maybe we can ask regulators to change the way managers report their holdings.

BRAND: Is there an easier fix?

TRIPOLI: Yeah, and the easier fix also has the advantage of being widely recommended by unbiased financial advisers for a lot of other reasons, too. Just buy a bunch of low-cost index mutual funds. These are funds that - they hold a basket of investments that mimic the S&P 500 or the Wilshire 5000 or foreign indexes or bond indexes, whatever. And the beauty is there's not much trading. These are what's called passively managed funds. They just hold the stocks in the index, so window-dressing and most trading is eliminated.

And you know what's really ironic, Madeleine, these index funds beat the large majority of active managers most of the time, anyway. So if investors can train themselves to settle for the broad market's returns and to stop trying to find some unknowable magician who can beat the markets, they'll end up ahead in lots of ways.

And you know, rather ironically, that leads to our program on MARKETPLACE later today. We'll be discussing how it's been a record year on Wall Street for investment bankers' bonus checks, and we'll find out how some bankers plan to spend their checks.

BRAND: Well, let's hope it just trickles down to the likes of you and me.

TRIPOLI: Unlikely.

BRAND: Thank you, Steve.

TRIPOLI: Take care.

BRAND: Steve Tripoli of public radio's daily business show MARKETPLACE, produced by American Public Media.

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