bad timing

An examination of historical flows to U.S. stock mutual funds and the performance of the U.S. stock market reveals that, on average, individual investors have done a poor job of market timing. In general, they tended to increase their exposure to stocks just prior to a sell-off, and reduce their holdings ahead of a period of stellar appreciation (See the chart above). For example, investors allocated a record $219 billion in net new money to stock mutual funds during the 12-month period ending October 31, 2000, which preceded a decline of 27% for the S&P 500® Index throughout the following year. Another example of poor timing took place soon thereafter. After three straight years of stock market declines, flows turned negative (redemptions exceeded sales) during the 12-month period to February 28, 2003. However, from that point on throughout the next year, the S&P 500 rallied 35%. In other words, most investors were selling out of equity funds prior to a significant rebound and at exactly the time when they would have benefited the most by owning a higher percentage of stocks.

The effect of taxes

According to the brokerage Charles Schwab, an investor who sells a stock with a short-term gain (a stock held less than 366 days) must find a new stock that outperforms the sold stock by 21.2% just to offset the taxes. In contrast, selling a stock with a long-term gain requires that a replacement stock outperform by only 8.1%. Although taxes should never be the primary driver of your investment decisions, if at all possible, hold your winning stocks for at least 366 days -- and preferably much longer!


[9/26/07] The trading secrets of the super-rich.

Twenty Years Ago

Twenty years ago, on October 19, 1987, the day that would soon become known as “Black Monday,” the Dow Jones Industrial Average (DJIA)plunged 508 points––or 22.61%. By any measure, it was the worst single day in U.S. stock market history.

Of course, the markets eventually bounced back, building ever-increasing strength over the 1990s and hitting a fever pitch before the dot-com bubble burst in the spring of 2000. What followed was a disastrous bear market, in which investors experienced three years of consecutive, double-digit losses. At the time, a common joke was to say that your 401(k) had shriveled into a 201(k).

But the numbers help put things into perspective: The DJIA today trades above 13000. On the day of the crash in 1987, the Dow opened at 2246. Just imagine the gains you would have forfeited had you given up on stocks back in 1987.

The stock market is a mighty resilient beast. Remember September 11, 2001? The Dow lost 7.7% when it reopened on September 17. Six months later, it was up 10.47%. The day President Kennedy was shot, the Dow fell nearly 3%. Six months later, it had rebounded by 15.37%. The Cuban missile crisis in 1962…the North Korean invasion of South Korea in 1950…the Japanese attack on Pearl Harbor in 1941. All these incidents brought immediate havoc to the market. And yet the market came back every time.

Gates and Buffett still top the Forbes 400

A billion dollars just doesn't go as far as it used to. For the first time, it takes more than $1 billion to earn a spot on Forbes magazine's list of the 400 richest Americans. The minimum net worth for inclusion in this year's rankings released Thursday was $1.3 billion, up $300 million from last year.

The new threshold meant 82 of America's billionaires didn't make the cut.

Collectively, the people who made the rankings released Thursday are worth $1.54 trillion, compared with $1.25 trillion last year.

The very top of the list was unchanged: Microsoft Corp. founder Bill Gates led the list for the 14th straight year [actually 13], this time with a net worth estimated at $59 billion. He was followed by Warren Buffett of Berkshire Hathaway Inc. in second place with an estimated $52 billion and casino mogul Sheldon Adelson, No. 3 with an estimated worth of $28 billion.

Larry Ellison of Oracle Corp. maintained his ranking at No. 4, with an estimated net worth of $26 billion.

But the list showed some notable changes.

Joining the top 10 of the country's richest for the first time were Google Inc. founders Sergey Brin and Larry Page, who tied for fifth place. The 34-year-old moguls' wealth has quadrupled since 2004 to an estimated $18.5 billion this year, while their company's stock value has surged 500 percent.

Fortune's foresight

Perfect foresight is impossible in the complicated and dynamic world of investing. Even the best investors typically turn out to be wrong – meaning they don’t beat a risk-free rate of return – on 30-40 per cent of the investments they make. That’s perfectly fine – if your winners on average also go up more than your losers go down, you can build an outstanding record over time.

The fallibility of investment foresight came to mind recently when I revisited a feature article in Fortune magazine that appeared in the summer of 2000 under the ambitious headline “10 Stocks to Last the Decade”. As the table (below) indicates, a portfolio of this august group has tumbled 39 per cent since the article ran, versus a meagre, but positive, 3.5 per cent gain for the broader market as measured by the Russell 3000 index.

... Valuation matters. Guess what the average price/earnings ratio was of the stocks on Fortune’s list. 30x? 40x? Such ratios were for wimps in mid-2000. How about a nice round 100x? As Jeremy Siegel writes in The Future for Investors: “The long-term return on a stock depends not on the actual growth of its earnings, but on the difference between its actual earnings growth and the growth that investors expected.” That’s something to remember every time you buy a stock, especially if you’re betting on “sweeping trends”.

[via brknews]

Chuck Hughes

‘Investing with the trend’ is an important requirement for profitable stock investing for investors with a short term time horizon. Timing is everything. If you are a short term investor ‘Investing with the Trend’ should be your investing mantra. Regardless of which investment strategy you use to buy and sell stocks there is always ‘entry and exit’ timing risk for short term investors.

I like to use moving average ‘cross overs’ to define the short term price trend. For example, my Fail Safe EMA System uses 50-Day (fast) and 100-Day (slow) Exponential Moving Average (EMA) ‘cross overs’ to define a trend. A price up trend exists when a stock’s 50-Day Exponential Moving Average (EMA) line is above the 100-Day Exponential Moving Average line and the stock should be bought. A price down trend exists when the 50-Day EMA is below the 100-Day EMA and a stock should be sold. This is a simple but effective system for buying stocks when they are in a price up trend and selling stocks when they are in a price down trend.

Note: Chuck Hughes placed second in the 2006 World Cup Championship of Stock Trading, first in 2005, third 2003. Don't know how he did in the other years.

Stumbling on Value Investing

One of the Brandes Institute’s goals is to expand the investment community’s understanding of market behavior. As such, we are interested in aspects of behavioral finance.

Using excerpts and examples from Daniel Gilbert’s book, Stumbling on Happiness (New York: Knopf, 2006), this article seeks to illustrate psychological pitfalls that may prevent long-term success for investors. It also includes seven tips designed to limit the influence of potential behavioral shortcomings and help investors make more informed decisions.

in the bank or on the bank?

Is it better to put your money in the bank--or bet on the bank? Investors face this dilemma when weighing the choice between bank certificates of deposit and shares of a given bank's stock. In the discussion below, we explain why the decision boils down to how quickly an investor needs to access the funds. That is, there is no one-size-fits-all solution.

Looking Better?

To a casual observer the stock market seems almost giddy with joy. Ben Bernanke and the Fed stand ready to come in if there is trouble. President Bush is going to help sub prime borrowers which will, in turn, help ease the credit crunch. The stock market responds with a sharp rally on Friday.

But the reality is that there is a lot of fear and worry in market land. Chart 1 shows one manifestation of concern. This is the percentage of bears among market advisors and newsletter writers as reported by Investor's Intelligence. Historically whenever the percentage of bearish advisors moves above 35, it's time to start looking to buy. The percentage did get into the 40's during the 2000-2002 bear market, but during bull markets the current reading is an extreme.

It's such a reliable law. Investors get scared at bottoms and optimistic at tops, so based on this indicator, we are flirting with a bottom.

[via scalenet]

What is risk?

So what is risk? Well, risk should be viewed as the likelihood of permanent loss of capital. Betting at a casino is a good example. And it is in this context that the risk-versus-reward profile should be assessed. When you buy shares in a business for $30 apiece because you have determined through data analysis and your reasoning that the shares have an intrinsic value of $60, but then the stock tanks to $20, you have not taken on risk but mere price volatility. Of course, you should naturally go back and determine that the intrinsic value has not materially changed for the worse. If it hasn't, then your investment has really become less risky, and you should view the price volatility as an opportunity to take advantage of a better bargain.

It's this misunderstanding of risk that causes investors undue stress and results in sloppy buying and selling. Buffett used to say that you should be able to watch your investment decline by 50% and not feel pressured to sell. Mohnish Pabrai told me that a stock's price immediately tends to decline whenever he buys a stock and shoot up when he sells, yet the declines don't bother him, since he doesn't concern himself with price volatility.

5 Ways to Be a Horrible Investor

Are you one of those people frustrated with your inability to beat the stock market? Despite watching CNBC and Jim Cramer religiously, and reading The Wall Street Journal every day, you just can't seem to make it happen. Here are five ways I think that investors shoot themselves in the foot.

1. Do Little Research
   
2. Buy On Tips and Rumors
   
3. Envy
   
4. Low Conviction
   
5. Ignore Value

Uncertain Investing

"Most investors strive fruitlessly for certainty and precision, avoiding situations in which information is difficult to obtain. Yet high uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen. Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty. The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information." Margin of Safety, Seth Klarman.