Equities: Oct to July stats

[John G]

For the past 10 months, the media has run multiple stories about investment risk and being in "safe" investments. "Do you know where your money is?" The pundits (with the possible exception or Rukeyser) have made a lot of "tut tut" type remarks emphasizing being in cash, investing in "solid" companies, "conservative" investments, and there was all that stuff about dividends and taxation. A scan of Money, Worth, Kiplinger and other financials mags would show an overall negative tone.

What has actually happened? Lets look at the statistics for Oct 9 through the last Friday in July the approximate returns have been:

S&P500 up 28%

DOW up 29%

Russel 2000 up 31%

Nazdaq up 58%.

Any my point is?

Did anyone tell you that last October was a turning point in the market? Did they tell you the best single performing segment would be the top 100 Nazdaq stocks (like Intel, Microsoft, Cisco, Dell, etc)? I think it was quite the contrary, too much doom and gloom. Where were all those supposedly smart people telling the public that it was a good time to invest in equities?

My point is that markets run in cycles. It is near impossible to time "the market", to know when to jump in and when to leave. Equity (aka stock) investing has a lot of short term risk and volatility, but over the long haul has historically provided excellant results. Some folks wait for "proof" and invest after the market climbs and panic when the market swoons - the results are ugly.

In Dec 4 on this message board I said:

"While the stock market has been down for 2+ years, investors in bonds have done very well. CDs have more or less kept pace with inflation. All of this is highly irrelevant to the long term performance of various asset classes in the future. You should not make investment decisions based upon the instant snapshot of market conditions. Neither you nor I can have any certainty where real estate or stock market values will be 1 year later, but we should have a good sense for 20 years down the road. The long term annual rate of return in the stock market is in the 9-12 % with the low end being a balanced portfolio with some bonds and the upper end being a mix biased towards growth. Some people beat that range, some don't."

The experienced investor has a better chance of understanding these cycles and for the most part ignoring them. I hope by posting this message, which is a little off topic, it will help less experienced investors to understand the market dynamics and make better decisions.

[dh003i]

In light of the above comment, the following books may be of interest.

References on investing wisely irrelevant of the business cycle

• The Intelligent Investor, by Benjamin Graham. A trying book to read, because it is written dryly, but excellent analysis. It often talks about the mis-investments made by individuals who try to time the business cycle:

  The one principal that applies to nearly all these so-called "technical approaches" is that one should buy because a stock or the market has gone up and one should sell because it has declined. This is the exact opposite of sound business sense everywhere else, and it is most unlikely that it can lead to lasting success in Wall Street. In our own stock-market experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus "following the market." We do not hesitate to declare that this approach is as fallacious as it is popular.

  
  The best way to avoid this folly is to use dollar-cost averaging, which means that -- no matter what -- you invest a certain amount monthly in stocks or stock mutual funds. This approach averages out the highs and lows of the business cycle. Profit from other people's folly, don't participate in it. Of course, using dollar-cost averaging you won't buy as much as you could when the market was at a low, but who can time the market well enough to predict when it's really at a low? (see above quote, apply it's logic in the reverse).
  
• , by Phillip Fischer. Doesn't really cover the business cycle specifically; but you can't mention The Intelligent Investor without mentioning it's complement. This is also another one you won't read in one sitting.
  
• , by Peter Lynch. A pretty easy book to read, for the more common person. There is also an interesting summary of Lynch' investment style online, based on his books.
  
• The Perils of Market Timing, from Fool.com. Punchline: Two of the most successful investors that are still among the living, Lynch and Buffet, say that market timing is humbug.
  

References discussing the business cycle.

These books are economics-focused, rather than investment focused. They focus on the macroeconomics of the economy. Almost all of these focus on the relation between the business cycle, monetary instability, and inflation. None of these books will allow you to tell when a crash is going to happen. No respectable investor or economist claims to accurately forecast when a crash will happen.

They will, however, help you understand that market crashes are unavoidable, and why that is so. A main point in many of these books is that during boom periods, hypsters will often declare such harmful humbug as, "we're in a new economic period, where there will be ever-lasting growth with no depressions". They said it during the 20s booms and during the 90s boom. This is kind of fallicious "it is now, thus it will be forever" thinking is part of what leads to the paranoid attitude among speculators which prevents them from speculating during a bear-market.

[*]On The Manipulation of Money and Credit, by Ludwig von Mises.

[*]The Panic of 1819: Reactions and Policies, by Murray Rothbard. A dissertation on the Panic of 1819.

[*]The Austrian Theory of Trade Cycle, compiled by Richard Ebeling. A collection of essays on the cycle.

[*]Where we are and where we are headed (mp3).

[*]The mechanics of the business cycle (mp3).

[*]The sociology of panics and crashes in American history (mp3).

[GBurns]

It seems to me that there are an awful lot of theories about how or how not to invest, What bothers me is that none of these authors or "gurus" seem to have made any reasonable money whether from their own "advice" or from any other "technique". The money seems to be made from the book sales and speaking engagements instead.

All I ask of all these people is "Show me the Money" that they or anyone else made following the advice.

As for Dollar Cost averaging, I first asked in my Series 7 licensing course back in 1986 for actual factual examples that would show that it really would work, but after all these years I have never seen or heard of anyone who had real life examples. All I want is that they spend the money on an actual stock selection over the period. Like all the other theories there seem to be no real life examples.

[John G]

GBurns, Yes there are charletains among the book authors. I can't vouch for the authors mentioned above except for one, Peter Lynch. As head of the Magellan Fund for many years, Lynch made a ton of money for both himself and thousands of others... during his tenure it was one of the top 10% performing funds which is amazing because the fund was huge and it is stellar performance is hard when you are large. Lynch was first a stock picker. He only became an author later. He is currently a senior member of Fidelity Mgmt and does not manage individual funds. I remember going to an investor conference were a young firm managed to talk him into speaking for about $50,000... which he graciously assigned to one of his charities, his usual practice. I think Lynch would not be a good example of your point.

Dollar cost averaging is a fairly basic investing concept. It is no miracle solution to investing, just a practical method that many investors employ. The concept is that you invest a fixed amount in each period, such as per payroll period, quarter, or month. You can do this with individual stocks but often it is used with mutual funds. It gets folks past the point of "is now a good time to invest" and other market timing nonsense. It is also a method of making a systematic committment to invest part of your income, as opposed to remembering to occasionally send a check. When you DCA, you are also following the maxum of "pay yourself first", encouraging continous savings/investing.

From one perspective, DCA gives an investor a slight bias towards buying low and selling high because you buy more "units" or shares when the price is low and fewer when the price is high. The theory is that this will boost performance. But, in my opinion, this is not a dominant factor or even the primary reason people use DCA. Real life examples? Most employee payroll investment plans (401k, 403b, thrift, etc.) often operate as a DCA. I think the driving factor is convenience. As a teacher, my wife has participated in a 403B program for many years that puts a fixed amount of money each month in a fund, a process which is DCA by default.

Note, I am not saying DCA is a miracle solution to investing, just a practical system that gets the job done and in theory gives you a slight bias toward better performance. I think it is promoted by folks primarily to the hesitant investor. (Like the guy who recently posted about procrastinating for three years about opening a Roth)

However, in the case of IRAs and Roths, you may be better off putting the max contribution in at the first part of the year. DCA folks sometimes get a break on annual fees or minimum initial deposits with mutual funds because they provide a predictable stream on money.

[dh003i]

Like John says, Dollar Cost Averaging is no miracle solution. It does, however, help mitigate risk, and help you avoid the market-timing mentality. If you have $3,000 to invest at the beginning of the year, it may be wise to invest that (and get the profits off of it throughout the entire year). Id suggest putting it in your RothIRA in a conservative mutual fund or money-market, and then transferring 1/12 or 1/52 of it to a more aggressive long-term fund every month or week, respectively.

Youre right to be concerned about "financial gurus" who write about all kinds of brilliant strategies, but have nothing to show for themselves as far as their own investment. One thing to watch out for is anyone who says they have a "technique" that will allow you to earn above-average returns easily. It is easy to earn average returns. However, consistently earning above-average returns is more difficult than it looks. It requires a lot of hard work, some intelligence, and a little bit of luck.

Benjamin Graham and Philip Fischer were very successful investors. Warren Buffet -- who doesnt write financial books himself, but only essays -- has said of The Intelligent Investor that it is "By far the best book on investing ever written." He has also given high marks to Common Stocks and Uncommon Profits. Indeed, Buffet has said in and interview that he's . Buffet also gave a famous lecture, The Superinvestors of Graham-and-Doddsville, in which he discussed Graham’s investment approach.

You can find a brief biography of Ben Graham, the founder of value investing, from Fool.com. A noteable quote: "Between 1929 and 1956, a time period spanning the Great Depression and several major wars, Grahams investments grew an average of about 17% per year."

Finding a biography on Fisher, the founder of growth investing, was a little more difficult. Fool.com overviews Fisher. In Fishers Common Stocks and Uncommon Profits, he goes over 15 key points for good investment, all of which require substantial research to determine. His most important, and last, point is an absolute point he flatly states: If the trustworthiness of company management is questionable, investors should sell.

also has a rundown of some of the most successful investors...but be weary of the return-rates over 40%. You can copy and paste it into a spreadsheet program, sort first by tenure, second by return, and cut off anything below 10 years, as Ive done.

P.S.: You may be interested in The Essays of Warren Buffet. It's a collection of his essays on investing. You can probably find them all online separately, but it's convenient to have them in one binding for $25.

[John G]

DH, I think the posts above are well done. I highly recommend the Warren Buffet interview and Ben Graham hot links you provided. The Buffet one in particular provides some great insight into the difference between wealth and happiness - Buffet style.

I am a little amazed that just two weeks ago you were posting about "irrationalities of Wall Street", promoting value funds, claiming the DJIA outperforms the S&P500 and suggesting that folks could pick the top 20% of funds. I think readers will appreciate the more carefully expressed recent posts.

As we eventually discovered with the Beardstown ladies, above average performance is often created by selective memory, creative accounting and marketing hype. I would adde to your comment about hard work, intelligence and luck - - lots of time spent in research and analysis. Thank you for the good posts.