What You Gain—and Lose—When You Lock Money Up for the Long Run

A money manager is proposing what he calls the Forever Fund. Investors would commit to lock their money up for 10 years at the very least. How good an idea is that?

Meb Faber, chief executive of Cambria Investment Management in El Segundo, Calif., which manages approximately $1 billion, has been talking about the concept on podcasts and Twitter. In a world of itchy-fingered traders, he wants investors to leave their money undisturbed for decades.

So far it is only a thought experiment. While I’m a fan of the idea, psychology and history suggest it is easier to imagine than to implement. Some people love locking their money up—until it goes down. Then, the mere thought of not being able to take it out freaks them out. Other versions of the idea have ultimately flopped.

Mr. Faber would offer investors both carrot and stick. The carrot would be low management fees that decline the longer you hold the fund. The stick would be redemption charges imposed on anyone who sells before the 10-year minimum—penalties put back into the fund as a kind of bonus to the loyal investors. If the money went into a market-tracking index strategy, you wouldn’t have to worry that the manager would retire or lose his “touch.”

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Such a fund would have to clear a high marketing hurdle: People can flip from liking such handcuffs to hating them, even if they shouldn’t.

In 1983, Twentieth Century Investors (now American Century Investments) set up its Giftrust fund. Investors could open an account only within an irrevocable trust they donated to someone else. That locked the money up for a minimum of 10 years (later 18 years). Investors couldn’t withdraw sooner without a court order authorizing them to break the trust.

Knowing the fund’s holders wouldn’t be able to sell in a down market, its managers could take big risks on little stocks—a strategy that paid off hugely. As of year-end 1996, Giftrust had gained 616.9% over the prior 10 years, the best record of any diversified mutual fund. Assets boomed to about $2.5 billion.

Unfortunately, returns faltered. Giftrust lost 40% in the first nine months of 2001, twice the loss of the S&P 500. Investors who might have stayed put if they’d had the option to withdraw panicked because they didn’t have it. Clamoring to get out, they inundated Missouri courts until the state enacted a law in 2005 permitting the original trusts to be broken.

Giftrust, later renamed All Cap Growth Fund, stopped taking irrevocable trust accounts in 2017.

A similar fund, Royce Trust & GiftShares, launched in 1995 with a minimum lockup of 10 years. “It avoided what happens in every mutual fund: clients bailing out at the wrong time,” says Chuck Royce, founder of Royce & Associates, the fund’s manager.

Royce GiftShares performed well early on, earning 23.7% annually through the end of 2000. Then cheap small stocks lagged—and so-called 529 college-saving plans, which also are customized for long-term savers, proliferated. The fund dwindled to $74 million; this June 30, Royce finally merged it into Pennsylvania Mutual, a much larger portfolio.

Another wrinkle: Individual investors might not need handcuffs. They probably aren’t as impatient as many professionals believe.

Investors in the U.S. seem nowadays to be among the twitchiest on earth, according to data from the World Bank. The portfolio turnover ratio—the total value of shares traded relative to average market capitalization—was 133% in 2017, the latest figure. That equates to a holding period of only nine months. Back in the 1970s, U.S. investors held stocks for roughly five years at a time.

Average turnover rates can be misleading, however. Even if most investors seldom or hardly ever trade, a minority of traders may be buying and selling as if their underpants were on fire. When you average the patient and the fidgety together, it looks as if everyone is more active than the typical person is.

In fact, many individual investors are sitting bulls: They buy, hold and sit stock-still.

Only 21% of investors in 401(k)s made a trade in 2018, according to record-keeper Alight Solutions. A 1988 study reported that 72% of retirement savers had never changed their allocation of assets. Another study, covering 1.2 million 401(k) savers, found that 80% didn’t trade even once in 2003 and 2004. Meanwhile, taking money out is painful: Early withdrawals are generally subject to a 10% tax penalty.

Almost anything that helps people become more patient in a myopic world is good. Several factors combine to lock investors into their 401(k)s without making them feel like prisoners: the distant beckoning glow of retirement, the looming tax penalty, the potential to borrow from their balances, and the flexibility both to diversify and to move money within the plan without having to take it out.

The key to getting people to lock up their money for the long run is giving them the feeling they are free to crack the safe anytime they want.

Write to Jason Zweig at intelligentinvestor@wsj.com

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