Your Lying Eyes

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21 May 2010

Get Out Now, Or Wait for It to Bounce Back?

Therein lies the cruel nature of these markets. As I sit here, futures are again pointing lower. So go to cash now, and get back in later when the markets settle? Might not be a bad idea. But then you never know when someone in Europe or the administration will make some fraudulent announcement that will suddenly juice the markets up, and of course there's no way you can get back in in time. And, as we've seen this week, when the market drops, it drops like a rock.

So all the pros say "You can't play the market, so just buy into it and keep your money there." But you're going to need it someday, so if it just bounces around like this (today the S&P is at 1998 levels) what's the point? On the other hand, if you got out of the market in late 2007 and jumped back in last April, you made out great.

Low-yielding savings instruments are probably the best way to go. Our economy only grows at 1 to 2 percent a year these days anyway - why expect any better?


Blogger CFP, EA said...

As you might notice from my moniker, I'm a financial advisor. For what it's worth, here's my answer to your question/concerns.

First, it's true that trying to time or beat the market is a fool's game. The odds of success are around 0.1%. In the unbelievably unlikely event that you win that bet, the reward is fairly small; however, if you lose that bet - and you will - the punishment is huge. It's the worst bet you could ever make. The academic research on the subject overwhelmingly proves this.

Second, if you only look at the S&P 500 or the Dow, then, yes, the last decade was a waste for investors. But if you had all of your money only in the S&P or Dow for that time, well, you're a terrible investor.

Good investing involves diversification, low costs and taking the right amount of risk. For the ten years Jan. 1, 2000 to Dec. 31, 2009, if you had a portfolio comprised of 40% Treasury bonds (half in a short-term bond fund, half long-term bond fund) and 60% of your money evenly spread among large cap blend, small cap blend, large cap value, and small cap value both on the international and domestic side, you would have earned a 6.5% annual nominal (~4.0% real) rate of return. (That would have been even better if we included emerging markets.)

When you figure that over a "normal" 10-year period, we would expect to earn around 5.0% annual real return, our portfolio didn't do great, but it certainly did well enough to move us toward our goals.

I'm tired of people saying that the stock market is rigged or that the last ten years were a waste. It's simply not true if you were diversified and you rebalance your portfolio each year.

May 21, 2010 2:04 PM  
Anonymous Dano said...

In 2008 when every asset class tanked diversification wasn't enough.

The average mutual fund returned 0% over the last 10years.

Is there such a fund as what you describe for your allocation?

May 22, 2010 8:06 AM  
Blogger ziel said...

Yes, I'm sure there were a number of funds that did very well over the last 10 years, but also plenty that did poorly. Is there any evidence that the average of funds beat the market overall? Are such high-performing funds typically available to 401k contributors?

May 22, 2010 2:31 PM  
Blogger CFP, EA said...


Naturally, in late 2008 and early 2009, all risk assets (stocks, commercial real estate, commodities, high-yield bonds, etc.) collapsed. During panics, the correlation of risk assets basically equals 1.0. But even in those unusual times, not all assets fall. Long-term Treasury bond funds increase ~15% over those six months.

Diversification is about more than just having a lot of stocks, it's first and foremost about having a mix of stocks and very safe bonds (I only use Treasury bonds for my clients). Then, it's about having different types of stocks - small cap, small value, large cap and large value - on both domestic and international side. You also might throw in some real estate through a REIT mutual fund.

Of course, in the middle of a meltdown, the various types of stock offer almost no diversification, but over long periods of time, they offer tremendous diversfication. For example, for the past ten years, the S&P has earned -0.27% annual return. But the Vanguard's Small Value fund has earned 8.99%. Vanguard's International Explorer fund earned 5.05% over that period while Vanguard emerging markets funds earned 11.22%. All of them collapsed in 2008, but I'd certainly call that diversfication.

Over the next ten years, it may the S&P 500 that does well, while emerging markets does poorly. Who knows? That's why you own all of them. And you own very safe bonds for when the s&*! hits the fan.


You don't need to find funds that outperform the market. In fact, that's huge waste of money and time. You just need to get very low cost index funds that provide diversification.

Here's an easy, very low cost portfolio that will protect you and allow you to earn a great return:

20% Vanguard Short-term Treasury
20% Vanguard Long-term Treasury
10% Vanguard S&P 500
10% Vanguard Value Index
10% Vanguard Small value index
10% Vanguard REIT index
20% Vanguard International Value

If you use that portfolio and rebalance back to those percentages once a year, it's guaranteed that you will beat 80+% of professional money managers and 98% - at least - of your neighbors, family and friends. You'll also avoid getting ripped off by Wall Street.

The secret to investing is that there's no secret. No secret conspiracies or backroom deals on Wall Street. No secret strategy to beat the market.

It's patience and discipline, which is why almost nobody gets it right.

If you want to really learn how to be an investor start with the book Coffeehouse Investor and then move on to books by Larry Swedroe and William Bernstein. Otherwise, you're a small fish with a bleeding cut in a tank full of sharks.

I'd say good luck, but if you become a real investor, you won't need it. If you don't, it won't help.

May 24, 2010 4:42 PM  
Anonymous Dano said...

Thank you for the concise and specific investment advice. Hope your clients appreciate it.

May 25, 2010 8:04 AM  

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