Monday, August 29, 2011

Buy and Hold is Dead! (but is it really?)

Don't look now, the but Buy and Hold investment strategy is dead. Again. So says hedge fund manager Simon Baker, the CEO of Baker Ave. Many have said so in the past, and many will doubtless say it so in the future, Baker is just the most recent.

I don't know about you, but every time I hear some expert make this proclamation, my mind flashes back to that scene in Monty Python's Holy Grail. You know the one where the guy is walking through the plague ridden streets of some England village calling, "Bring out your dead!" and one hapless old man being carried to the dead cart claims, "I'm not dead!"....

Well, that old man is Buy & Hold.

Mr. Baker argues that buy & hold is a "relic of a bygone era when the economy was stable and consistent growth was the norm."

With all due respect to Mr. Baker, I would argue that his definition of Buy & Hold is much closer to Buy & Neglect. It's a common misunderstanding of buy and hold that many people have. Buy and hold does not mean, buy shares of stock or mutual funds and forget about them for 30 years.

The point is that most people cannot time the market, and doing so is a fool's game. Besides, the data shows that buying and holding works pretty well when the investor continues to buy on the down turn.

To his credit, Baker is not arguing that individual investors should try to time the market, just time the major crashes. ;-)

His point seems to be that buy and hold does not work in times of high market volatility, but I think for most investors it's fine as long as they continue buying. After all, that's dollar cost averaging and it's one of the pillars of saving for retirement.

I think the heart of his argument is risk. He says that it's a risky market these days, and guys like Jack Bogle don't want to consider risk. But what is risk? To a certain extent, risk is a function of time and in the short term, risk is very high. But in the long term, risk is much lower and that's where this whole argument breaks down.

It's apples to oranges in terms of investing for the long term vs. trading for the short term.

Here's the video interview with Simon Baker so you can hear it straight from him:

Thursday, August 25, 2011

Buy and Hold (and Buy Some More) is King in Crisis.

Ever since the crash of 2008 we've heard stories of investors withdrawing all of their money from stocks and putting it in ultra safe investments like cash and treasuries. We've also heard numerous proclamations that "buy and hold is dead". Here's a story that shows buy and hold is not only not dead, but by far the best course of action for your retirement planning...

First, the disclaimer and caveat: Staying the course/buy and hold and buy some more is the preferred course of action with proper diversification and time to recover from the volatility. In other words, don't just sit there if you're 5 years from retirement and 90% in stocks. But then again, if that's your 401(k) at that point in your life, then you've got serious problems anyway. See a professional retirement planner ASAP!

Now for the rest of the 401(k) population, US NEWS & World Report has a piece detailing how 401(k) Savers Who Stuck With Stocks Saw Gains

I've gone the extra mile to compile the data presented in that article into a chart to really hammer home the contrast.

Click for larger view.

The study (by Fidelity investments) compared the average return of 401(k) accounts from September 2008 to June 2011 across 5 possible actions taken after the big plunge of 2008:

  1. Do nothing. (stay the course)
  2. Pull everything out of stocks and put it all in a "safe" investment, like cash
  3. Pull everything out of stocks, and then pile back in once the market began its bull run
  4. Left everything as it was, and stopped contributing new money
  5. Left everything as it was and increased contributions

As you can see, the winner by far is not only holding onto your stocks, but adding to them on the way down. This is because you're essentially buying those new shares on sale and magnifying your gains when the market swings up again.

Note: leaving the market and getting back in is nearly the same as staying and not buying new shares. This makes sense since you're essentially riding the market down and then back up and most people cannot time the optimal time to get out and back in.

Incidentally, these results mirror my own experience. During the crash I left my allocations untouched, and increased my contributions by 5%. The result was that my overall account balance had recovered within a year of the market crash.

Wednesday, August 24, 2011

3 Factors Driving Gold (and When They Might End).

There is no disputing that gold is hot these days, but why? What's caused the meteoric rise in the price of gold in recent years, and will it end soon?

According to Rich Ilczyszyn, MF Global's Senior Market Strategist, the 3 things driving demand for gold are:

  1. The European debt crisis.
  2. Federal reserve policy.
  3. Bull market fever.

Regarding the flight to safety, Ilczyszyn says:

"Gold isn't a safe haven, it's a currency. In other words, as far as gold bulls are concerned, gold is anti-everything collapsing in the Western world."

When this will end is anybody's guess, but I would think that a sign from Washington D.C. that they were getting serious about America's debt crisis might be a turning point. If the dollar suddenly gained strength and the U.S. financial house were on the road to order there would again be a competing currency to gold. Eventually this would weaken the sentiment that gold is the only viable currency of the future.

The federal reserve announced that they will be keeping rates at record lows until at least 2013. This gives gold investors an usual sense of timing on when they might expect treasuries to become a viable investment again. Of course, the fed can always change their mind and raise rates earlier than their stated time frame.

Bull market fever is obviously at play here as well since the recent increase in margin requirements by the CME didn't cause so much as a hiccup in the price of gold. This is unusual and unexpected and may be an indication that the global gold trade is so big that the CME margin hike can't affect it.

Gold is trading at 20% above major trend support and is an increasingly volatile market, so investors and speculators alike should tread lightly on any moves as we are in somewhat uncharted territory.

Here's an interview with Ilczyszyn in which he details some of his thoughts on this topic:

Tuesday, August 23, 2011

The Myth of the Seven Percent Solution.

I was reading an interesting blog post about Unrealistic Returns In Personal Finance Writing in which the author quotes personal finance gurus like Dave Ramsey as stating the average return of stocks is 12-15%. The author's point is that 12% and above is absolutely absurd, and it's outright irresponsible for a personal finance expert to being giving such misleading and incorrect information to unsuspecting people.

Posts like that make for good comment fodder, being full of rebellious righteousness, but the truth is that it all depends on your definition of average, and what exactly you're including in that performance figure and what you mean by "stocks".

Consider that the stock market as a whole has returned an average of 12% per year before inflation from 1900-2010. This isn't too far off the standard advice I've always heard of 10%. It turns out that 10% isn't too far off 12% adjusted for average inflation of 3%.

For the record, that blogger was of the opinion that 7% is a more reasonable expected return going forward for stocks, since the recent market upheavals of 2008 and 2011. He even states that stocks have returned an average of 3% over the past decade.

Interestingly, 7% is right about where Warren Buffet sees stocks - after inflation.

But that's still about 3% lower than the 10% figure after inflation right? Not so much. You see, the other factor at play is dividends. The long term average yield of the S&P 500 is often stated as being 2-3%. Warren Buffet's figure does not include dividends. If we add this number to Warren Buffet's after-inflation-figure we get right back to the 9-10% range.

The author of the afore mentioned post made no mention of dividends, so I can only assume he was not taking them into consideration. Neither did he state whether he was considering inflation in those returns.

In short, I believe his 7% solution is really just the 10% version without dividends.

So is Dave Ramsey quoting 12-15% really irresponsible? Every time I've heard Ramsey say such things he is specifically referencing mutual funds and quoting the rate of return before inflation and taxes. I suspect the blogger above is comparing 12-15% to S&P 500 index funds, which would be a stretch. But it is quite possible to find mutual funds that provide the kind of return Ramsey suggests - especially small cap funds.

Let this be a reminder that the average rate of return can vary, especially when the meaning varies. :)

And one last thing to consider - the recent upheaval in the markets (i.e. wild, 600 point swings) makes for inefficiencies, which also makes opportunity. An actively managed mutual fund has a manager that can capitalize on these opportunities and add some points to the fund's return. And index fund cannot. If anything, that meager 3% return over the past decade should make it all the easier for a managed fund to beat the average, so it could be argued that we should expect higher returns than 7% over the next 10-15 years for some mutual funds.

Monday, August 15, 2011

A Brief (Pictorial) History of Apple... And Some Link Love.

First, the link love...

After Hours Investing was featured recently by some other denizens of the blogosphere:

  1. featured my post What's the Best Bond Index ETF - BND, AGG or LAG? in his Carnival of Wealth – The Change of Guard Edition
  2. My Wealth Builder featured the same post in The Wealth Builder Carnival #45

Thanks to both of them for the mention!

And now for something completely graphic...

I've been writing a bit recently about Apple inc. so I thought I'd share this infographic detailing the history of the company:


Thursday, August 4, 2011

Dow Drops, Yahoo! Finance Panics. (SALE!)

I caught the front page of Yahoo! Finance this afternoon and couldn't help but think that they were a little over the top. Here's the way it looked at the time:

I mean, 3%? Really? Is that headline worthy, in the middle of the day?

It turns out that the DOW finished down 4.31% for the day, which isn't peanuts but it isn't crash time. Or is it?

Well, the DOW is an index of multiple stocks so it takes more than a little bump to take it down 3 or 4% but it is only 30 stocks. It's not the entire market.

But here's the S&P 500, which is a bit bigger than 30 stocks:

I've boxed similar drops over the past 5 years. Things don't look rosy, but let's be real here. Isn't this just investors realizing that the government stimulus that's been masking the recession is ended and the veil has been lifted. The recent "boom" or Bull market was largely an illusion, or at least based on a fallacy of recovery.

I think the market is just reverting to where it should be, but that also means stocks going on sale!

Just don't back the truck up yet. ;-)