|Winning On The Zigs, Losing On The Zags
|Why small investors usually do poorly
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Updated March 13, 2016: I originally posted this article on September 29, 2003 on my "Personal Finance and Investing" topic at the long defunct Suite101.com.
The San Jose Mercury News wrote in September 2003:
"For the last 19 years the average return for the average investor was 2.6% per year, inflation was 3.1% and the S&P500 was 12.2%"The article, reposted many times over the years, explains why:
Winning On The Zigs, Losing On The Zags
By Todd Mason ,Knight Ridder, September 2003
INVESTORS WHO TRY TO TIME THE MARKET USUALLY LEARN THAT IT'S A GAME FOR PROS
Kirk's Comment: YOU DO NOT NEED TO PAY A PRO TO MANAGE YOUR MONEY! Learn to do what they do by subscribing to my newsletter. It is not as hard as they make it sound.William E. Donoghue is spoiling for a debate on the merits of market timing.
To ignore timing means "growth funds that don't grow, value funds that don't add value, and managers who don't manage,'' said Donoghue, an investment newsletter writer and money manager in Natick, Mass.
His comments come at a time when New York Attorney General Eliot Spitzer is talking tough about big investors who use market timing to trade mutual fund shares.
Timing involves placing short-term bets on the direction of the stock market, or parts of it. It represents the opposite of a long-term strategy of picking an investment and sticking with it. Fund companies serving buy-and-hold investors often ban market timers because frequent trading translates into higher expenses and taxes.
|Citing examples of alleged improprieties at four mutual funds, Spitzer's
Sept. 3 complaint rocked an industry built on leveling the playing
field for ordinary investors. |
Broad accusations aside, market timing isn't unethical or illegal if fund companies publicly embrace the practice, and many do.
Timing is getting a new look from investors after three years of stock-market losses. For example, assets grew 50 percent to $9 billion so far this year at Rydex Funds, a Rockville, Md., fund company catering to timers.
Noted economist and author Peter Bernstein chided institutional money managers earlier this year for not being more opportunistic (read: timing) in an era of stingy investment returns.
But if timing is more acceptable, is it wise? Experts say ``no.''
``The fly in the ointment is execution,'' said Jeffrey Ptak, a Morningstar mutual fund analyst. ``It requires an enormous amount of skill that the vast majority of investors don't have.''
Even the pros lack the smarts and the temperament to beat the market long term, said Mark Hulbert, who rates the performance of market strategists who write investment newsletters.
``Over long, long periods of time, 10 years or more, you're going to find that 80 percent fail and 20 percent succeed,'' said Hulbert, editor of the Hulbert Financial Digest, in Annandale, Va.
Market timers move in and out of the market frequently, betting that they can make money on the market's zigs and zags. These bets stay in place for just days, weeks or even months.
By contrast, buy-and-hold investors, measuring progress in decades, are content to reap the overall gain in the market generated by a growing economy, and increases in corporate earnings and dividends.
Buy-and-hold investors should seek out mutual funds with a low turnover rate, or percentage of its assets bought or sold in a given year. A turnover rate of 30 percent or less indicates a buy-and-hold strategy.
Spitzer is zeroing in on fund companies that say they bar timers in their disclosure documents but do something else in practice.
His complaint alleges that four fund companies, Bank One, Bank of America, Janus and Strong, struck covert deals to aid institutional investors with timing trades that were supposed to be barred.
To be sure, individual investors can be fickle as well. According to an annual survey by Dalbar Inc., a Boston financial services consultancy, the average investor holds a mutual fund for 2.5 years. "They buy a couple of weeks after the market spikes up and they sell a couple weeks after the market spikes down,'' said Heather Hopkins, a Dalbar vice president. "They make very poor decisions in timing the market.''
There is an appalling level of self-inflicted damage among investors in Dalbar's estimates of individual investment returns. The study calculates holding periods by extrapolating them from flows of money into and out of mutual funds, and applies them to historical returns.
Dalbar estimates that the average investor earned 2.57 percent a year between 1984 and 2002, or roughly a fifth of the 12.22 percent annual gain of the Standard & Poor's 500 index.
Some timers also have trouble breaking away from the crowd, said Chuck Tennes, portfolio director at Rydex, although timers do better when they focus on trends taking place over months rather than days.
``I don't often see people making money trading rapidly,'' he said. ``Where do you draw the line on timing that's foolish and damaging?''
Donoghue's strategy is to rotate among various industry groups, or market sectors, using mutual funds or exchange-traded funds, which are effectively index funds that can be bought and sold like stocks.
Hulbert, the newsletter analyst, estimates that Donoghue's subscribers would have earned 1.8 percent a year since Jan. 1, 2000, by following the three strategies in the Donoghue Plan ActionGram. In the same years, the Wilshire 5000, a broad measure of the stock market, lost 7.8 percent a year.
Meanwhile, in Morningstar's rankings of separate-account managers, the performance of Donoghue's sector-timing fund at 4.5 percent so far this year trails most of his peers. Separate accounts are a personalized form of mutual fund.
Kirk Lindstrom's Conclusion:
YOU DO NOT NEED TO PAY A PRO TO MANAGE YOUR MONEY!
Most people don't have a plan that they stick with so they chase the latest hot trend which often means they buy at the top. Then they get discouraged and sell near the bottom.
To make money, you need to find a good plan and stick to it. The simpler the plan and easier to understand, the easier it will be to follow and believe in for the long term. My Core & Explore returns by year.
Asset allocation is what any honest investment professional will recommend. "Kirk's Investment Newsletter" contains aggressive and conservative core portfolios made from Vanguard Index funds that you re-balance annually or after a major market move. I also offer low-cost alternative Fidelity index funds as well as ETFs for the core portfolios. My "Explore Portfolio" is optional for five to twenty percent of your portfolio where you try to beat the markets by using more volatile stocks to take profits when they are up and buy back shares when they are down. I am CONVINCED that having an Explore Portfolio helps you look to buy when the markets are down and then look to take profits when they are up. This helps meet or beat the returns of the pros.
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People can make electricity from the rise and fall of ocean waves. I got the idea of using the markets natural volatility from that idea. My article "Using Asset Allocation to Make Money in a Flat Market" shows how it works to make money even in a "flat market."
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