Kimmunications

We don't have enough time to buy and hold

Market commentator and analyst Barry Ritholtz has recently posted on his blog about the big divide between the pundits and the public over the state of our economy. Or, as he puts it, “the disconnect between reality and the Pervasive Pollyannas of Prosperity.” Most of the analysts you see on CNBC, he says, are touting the strength of the economy, or at least its potential to turn around soon. The public, he says, sees the situation very differently – they’re expecting more rough seas ahead.

Barry says the pundits have just gotten ridiculous:

How absurd has the Panglossian cheerleading become? On my pal Larry Kudlow's show last night, several of Candide's descendants talked about how great stocks are if you hold them for 30 years. That's right, the holding period for equities according to this crowd is three decades. Of course, this means every pullback is a buying opportunity. Words such as these can only be spoken by someone who has never worked on a trading desk or managed assets professionally -- or if they did, they lost most of their clients' money.

Barry illustrates very clearly here the problem with the strategy of buy-and-hold. It’s true that the U.S. stock market has returned on average 10-12% annually over long periods of time. To take advantage of the long-term growth, you’d need to buy when the market is down. To a buy-and-hold investor, the current market downturn is a perfect buying opportunity.

But investing isn't just about knowing when to buy. The problem with buy-and-hold isn’t the “buy” part. It’s the “hold.” To get the long-term 10-12% return, you potentially have to hold for a really, really long time.

The Wall Street Journal is calling this “The Lost Decade.” From Dec. 31, 1999 to December 31, 2007, the return of the U.S. stock market was practically zero (1469.25 in 1999; 1468.36 in 2007). Here we are in the middle of 2008, and the S&P is below 1300. For us to get back to the 10-12% average, we would have to experience a very long period of above-average returns. The question is, how long? Nobody knows. It could take 10, 20 years or longer. History tells us there have been 20-year periods in the past where the average return of the stock market was less than 2%.

If you’re in your 50s, your retirement time horizon may be 40 years (10 years pre-retirement; 30 years in retirement). 20 years is a long time to wait for the market to even itself out.

That’s why buy and hold doesn’t work for most of us. We don’t have time for it!

This is precisely why I am a cash-flow investor. My goal is to exchange the long-term 10-12% annual returns of the stock market for something more tangible in the short-term. If I focus on generating cash in the short run, the ups and downs of the market over time don't tend to bother me as much.

I admit, investing in the stock market this way is a bit of a paradigm shift. You have to think of your stocks not as an appreciating asset, but as a means to an end. Once you view your stocks this way, it’s a little easier to endure the market slowdowns. 

SOURCES:

1. Ritholtz, Barry. "Persuasive Pollyannas of Prosperity," The Big Picture, 02 July 2008. http://bigpicture.typepad.com/comments/2008/07/more-on-the-pub.html

2. Browning, E.S. "Stocks Tarnished By 'Lost Decade'," The Wall Street Journal. (accessed 02 July 2008)

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 888-6SNIDER to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal. Click here for performance statistics of the Snider Investment Method and a discussion of yield vs. total return.

Financial Advisor Double Whammy

Academics are slowly peeling back the curtains on the financial services industry to expose some serious shortcomings. One groundbreaking study, which I've referenced before, found that commissioned financial advisors don't bring any appreciable value to investors. It found that the mutual funds recommended by traditional advisors severely underperform the market as a whole.

No real surprise there, since the vast majority of the funds are expensive, actively-managed funds that typically pay the advisor fat commissions.

Now there's a study that shows that clients of commissioned financial advisors severely underperform within those same investments. In other words, not only does the mutual fund underperform the market, the investor underperforms the fund!

The reason, according to the authors, is that clients of traditional (commissioned) financial advisors are more likely than self-directed investors to try to time the market:

Our results sound a warning to fund investors who are considering whether to attempt market timing, either on their own initiative or through their broker's advice. On average, active investing leads to underperformance relative to a passive dollar invested in the fund. In addition, the use of an investment professional to trade shares is correlated with even worse investment timing performance.

The study, "Investor Timing and Fund Distribution Channels," is written by Mercer Bullard of the University of Mississippi, Geoff Friesen of the University of Nebraska-Lincoln, and Travis Sapp of Iowa State University. The authors studied 6,164 funds between 1991 and 2004.

Investors in load funds lagged the performance of the funds by 1.82% on average annually. Those invested in legal no-load funds (funds with no commission and a low 12b-1 fee) lagged their funds' performance by 1.91%. And those involved in Class B fund shares underperformed by 2.28%. The only investors who didn't underperform were those in pure no-load index funds.

This study shows that traditional financial advisors are no better than anybody else when it comes to timing the market. And they don't seem to do anything to curb the behavior of their clients who think market-timing is possible:

One potential explanation is that brokers seek to justify their compensation not only by helping their clients pick funds, but also by demonstrating their active monitoring through market timing advice. If this is the case, the evidence suggests that this advice, on average, is less than helpful. Another possible explanation is the well-documented psychological tendency of investors to overweight recent performance. Although investment professionals presumably are more aware of, and less, susceptible to, a short-term performance bias, their clients might be more susceptible to this bias than self-directed investors. … A third explanation is that some brokers may be able to appeal to their unsophisticated clients' short-term performance bias in order to increase sales compensation. Thus, brokered shares may show evidence of (bad) timing because of client pressure, the broker's financial incentives, or both. [emphasis added]

The authors were especially critical of advisors who put their clients in Class B shares.

Why do Class B shareholders fare so much worse? One reason might relate to questionable conduct by brokers. Class B shares often are an inferior choice for investors and have been the subject of a number of enforcement actions alleging misleading sales practices. Sales of Class B shares can provide higher compensation to a broker than other shares and therefore present an economic incentive to steer clients toward these shares.
…
It is possible that a broker who recommends Class B shares in order to maximize compensation may also tend to emphasize recent returns in order to allure investors. More prudent advice would instead tend to emphasize long-term performance, but on this count Class B shares fare poorly.

I think the biggest takeaway from this study is this: Ask yourself if your advisor is providing any value. Did you hire them because of their expertise? Their access to better investments? Their potential to keep you from making dumb mistakes? If they aren't providing any value, why are you still paying them?

SOURCES:
1. Bergstresser, Daniel, John Chalmers, and Peter Tufano, 2006, Assissing the costs and benefits of brokers in the mutual fund industry, Working paper.
2. Bullard, Mercer, Friesen, Geoffrey C. and Sapp, Travis, "Investor Timing and Fund Distribution Channels" (December 2007). Available at SSRN: http://ssrn.com/abstract=1070545

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 888-6SNIDER to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Financial Advisor Red Flags - Part 2

Last week, I listed six red flags to watch out for when dealing with a financial advisor or broker. To recap, they were:

1. Invoking a dead relative in an effort to keep your account
2. Recommending variable annuities when they're not appropriate -- such as in an IRA
3. Recommending you move money out of your 401(k) or stop contributing. Also: recommending that you borrow from your 401(k)
4. Constructing a portfolio for you with an expected annual return of less than 10%
5. Recommending only mutual funds, especially those that are only available through his/her company
6. Accepting a commission from products they sell

The post was getting long, so I stopped there. This week, I'd like to continue where we left off with more red flags, some of which were suggested by readers like you. Again, these are in no particular order.

7.  Suggesting that you borrow from your home equity to invest

I am not an advocate of taking a loan for the specific purpose of investing. This includes taking out a home equity loan to play the arbitrage game many salesmen are suggesting these days.

An arbitrage is when you try to take advantage of a price or interest rate differential between two markets. For example, you take out a home equity loan at, say, 6 percent and invest the money in a mutual fund with an expected return of 10 percent.  If successful, you would profit from the 4 percent spread between the loan and the mutual fund.

Salesmen will claim that this strategy is low-risk or even risk-free, but it isn't. What happens if the mutual fund doesn't return 10 percent? What if it returns only 5 percent? Or if it loses money? Compound interest works against you and you stand to lose a lot more than you bargained for.

Also, you can't forget about the fees, commissions and taxes involved in such a strategy. Even if there's a positive spread, these can severely cut into your returns. For me, it doesn't seem worth it.

8. Assuring you that an investment cannot lose money.

An employee of mine showed me a postcard she received from a financial advisor near her neighborhood. He advertised a historical annual return of almost 15 percent with "no known history of loss." The implication is that he can deliver high returns with no risk. Sounds like the perfect investment, right?
RED FLAG! There is no such thing as a risk-free return above what is guaranteed by the U.S. government. It's a basic principle of economics: reward is the profit for risk. As an investor, your job is to manage the trade-offs between risk and reward. A risk-free investment such as a bond will give you about 4-5 percent. If you want more than that -- and most of us do -- you have to be willing to take on a little more risk.

9. Claiming he/she can turn a small amount into a large amount

I heard an advisor on the radio the other day claim he could get his clients a 500 percent return with very little risk. He suggested that he could get that return through a combination of techniques, including investing in real estate.

Is he saying that real estate is low risk? Millions of homeowners, particularly along the West Coast, would disagree! Since the recent housing bubble burst, home prices across the country have been declining steadily. In the top 10 metropolitan areas, home prices declined more than 13 percent since last year, according to the Case-Shiller Home Price Index. Different markets are performing differently, but nowhere are prices ratcheting higher right now. Common sense tells me this claim of a risk-free 500 percent return is simply bogus.

Another financial advisor-type is claiming that he can show you how to turn $10,000 into $3 million in just a couple of years and that he has a 30-year track record to prove it. I did a little math… if he started with $10,000 30 years ago and did what he says, he'd have billions of dollars by now. I haven't seen his name on the Forbes list of the world's richest people, so something tells me his claim doesn't hold water, either.

When someone makes outrageous claims like these, they're playing to your greed. Just remember that with higher returns comes much bigger risk, and if it sounds too good to be true, it probably is.

10. Claiming he/she can successfully and consistently time the market.

Some advisors love to claim that they can tell you when to get out of the market and when to get back in. They'll tell you they have the tools and the research staffs that nobody else has. What they won't tell you is that all the evidence says it can't be done successfully over the long term. Read my recent post on market timers.

11. Attempting to sell you on a fast-moving trend

A former criminal judge told me about numerous schemes that crossed his bench over the years. One of them involved an advisor who sold fractional shares of oil and gas royalties.

"They will lure an investor in with a higher-than-normal return, playing on your greed. Then they come back again several months later and want you to buy more of that share for an even higher return. The house of cards will ultimately fail, leaving the investor with nothing."
A guy called me up not too long ago and offered to sell me fractional shares in something like this, saying that because of rapidly rising energy prices, now is the time to invest. I told him, "If you're calling me, trying to get me to pitch your oil deals to my clients, this tells me that this is the top of the oil rush, not the bottom."

The more people who are calling you and taking out ads regarding a fast-moving trend, it probably means it's time to get out, not get in. To make money, you have to buy when everyone else is irrationally selling and sell when everyone else is irrationally buying. When the sales pitches are fast and furious, alarm bells should go off.

12.  Offering you professional services for free.

One reader told me he was suspicious when his CPA offered to do his taxes for free. What kind of a CPA does that? In this reader's case, it was because the accountant wanted him to open an investment account through him. The investment account would probably generate more in commissions and fees than he would charge for doing a tax return.

This isn't necessarily wrong, but it is something to be aware of. Look, people in the financial services business -- or any business, for that matter -- always get paid. None of us does this for free. As a customer, you need to know how they get paid. Would you rather pay them up front and know what you're paying for, or would you rather take your chances with hidden fees and commissions? Look for transparency in pricing.

There are, of course, many more red flags to watch out for. Keep emailing me your suggestions, and I'll keep adding to the list.

SOURCES:
1. Glink, Ilyce. "Homeowners react to falling real estate values." The Boston Globe, May 13, 2008 (accessed May 15, 2008).
2. "The World's Billionaires." Forbes, March 5, 2008 (accessed May 15, 2008)

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Investing Like Yale

In times when the market is going every which way, it can be comforting -- and rewarding -- to follow a rigid system. This video from Investment News shows how large university endowment funds follow a system to get better results. It also features an interview with a big-name fund manager who also follows a system.

Key quote: "We've found over the years that the numbers are more reliable than opinions, and that includes my own opinion." - Steve Leuthold, The Leuthold Group

Also, for those of you in the Snider Method® who are nervous about the international stocks Lattco® gives you, pay close attention to the discussion of overseas markets.

Go here to watch the video: http://link.brightcove.com/services/link/bcpid1125967528/bclid1125949998/bctid1498976295

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Market Timers Creep Out of the Woodwork

Have you ever been driving around, listening to the radio, when you hear something so offensive, so wrong, that you can't help but scream? That happened to me last Saturday afternoon. 

I was driving home from our after-show "Lunch Bunch" when I heard a financial advisor - on the same station my show comes on - tell his listeners that we should trust him because he said to get out of the market back in November. He said if everyone had done as he advised, we'd all be happier right now amid this market volatility.

Several other so-called advisors are on the airwaves warning of an impending recession. "Get your money out of the stock market now," they say.

These advisors are suggesting that they can properly time the market. And they want you to pay them a hefty premium to do it.

Why the myth persists

Why do so many think you can successfully time the market? Because we hear about the successful calls all the time. Elaine Garzarelli correctly predicted the stock market crash of 1987. Ralph Acampora became famous for predicting the dot-com bubble. We don't hear about all the market calls they made that didn't come true. But because they got it right once or twice, the media treat them as geniuses.

You're probably familiar with the phrase, "Even a stopped watch is right twice a day." It's the same for many market timers. Abby Joseph Cohen is always bullish, and when she turns out to be right, she's labeled brilliant. Roger Babson is credited with predicting the stock market crash of 1929. But he was giving doom-and-gloom speeches throughout the 1920s, even as the market reached historic highs year after year. When the crash happened, suddenly he was right.

I've even heard stories from friends in the financial services industry that the big firms keep analysts who make opposite calls, just so they can point to the one who gets it right.

The evidence

So our radio financial advisor friend correctly predicted when to get out of the market. Congratulations. But to be a successful market-timer, you can't just know when to get out. You also have to know when to get back in. And that's no easy task. There's about a one-in-ten chance of guessing it correctly, according to Vanguard's John Bogle. He tells William A. Sherden in The Fortune Sellers:

To make money, you have to make two market calls: one to get near a low point and one to get out near a high one, which means that your chance of success is about one hundred to one (one-tenth times one-tenth). And, doing it twice has a one-in-ten-thousand chance of succeeding.

…

In the 30 years in this business, I do not know anybody who has done it successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently. Indeed, my impression is that trying to do market timing is likely not only not to add value to your investment program, but to be counterproductive.

Bogle's impressions are supported by several studies, one of which is from Dalbar. Their Quantitative Analysis of Investor Behavior has, for many years, shown how investors shoot themselves in the foot trying to chase returns. In other words, impulsive investors. But market timers do even worse, according to their 2004 study:

Although the S&P 500 on average grew by 13 percent over that 20-year sample, Market timers actually lost money.

And these financial advisors are suggesting that timing the market is a good thing?

By getting out of the market, as these advisors suggest, you may avoid losing some capital in the short term. But you're almost assured of missing out on the gains when the market starts going back up. According to a study from SEI Investments, the majority of a bull market's gains come in its first few days and weeks. If you wait until you see the market turn, you've already missed a golden opportunity.

From The Wall Street Journal:

SEI looked at the dozen bear markets since World War II. If you held stocks at the market bottom, you made an average 32.5% over the next 12 months. But what if you bought one week after the bottom? Your gain was trimmed to an average 24.3%. Meanwhile, if you didn't buy until three months after the market bottom, your gain was just 14.8%

So what do we do?

I have no idea whether we're headed for a recession or a prolonged bear market. I don't have a crystal ball, and I'm not in the business of predicting the future direction of the stock market. What I do know is that the stock market is the best place for long-term growth over time, just not all the time. Trying to time the market is a fool's errand.

Any advisor who tells you otherwise is either lying or sadly misguided.

SOURCES:

1. Dalbar Inc., Quantitative Analysis of Investor Behavior, 2004.

2. "It's Time to Prepare Yourself for an (Inevitable?) Bull Market." Getting Going, The Wall Street Journal, Oct. 23, 2002. http://online.wsj.com/article/SB1035309775900025391.html?mod=googlewsj (accessed April 30, 2008)

3. Sherden, William A. The Fortune Sellers: The Big Business of Buying and Selling Predictions. New York: John Wiley & Sons Inc., 1998.

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

The Wall Street Journal's Disservice to Investors

A couple of people emailed me about the story that appeared on page one of the Tuesday, August 14, 2007 edition of the Wall Street Journal headlined "Over Their Heads: Small Investors, Too, Get Nailed by Arcane Trades." This headline would have been pretty "scary" and confusing to investors with little or no knowledge of options, futures or exchange-traded funds.

 

The article tells the story of various investors who have tried to use short selling, market neutral funds, commodities, and foreign investments to protect their portfolios against declining stock prices. The gist of the article is about how these measures have failed and their investors "burned".

 

Let's look at the sub-text of this article and see how it is great for selling newspapers but sends the absolute wrong message to investors. The article implies:

 

1. It is possible to avoid falling portfolio values when market prices fall.

 

2. We should look at the individual pieces of the portfolio and how they are performing rather than the portfolio as a whole.

 

3. When something goes down in value, sell it; when it goes up, buy it.

 

4. Options and futures are inherently risky, as implied by the heading, "Exotic Instruments" on the chart of optionsXpress' option trading volume.

 

Shame on you Wall Street Journal! This is a blatant case of, "If it bleeds, it leads!" You aren't educating investors with a story like this. These messages are going to cause people to lose money because they got the wrong message from a "reputable" paper like the WSJ.

 

Here is what you should have told us:

 

1. Globalization has lead to increasing linkage between investments. Investments that once moved independent of one another now move in the same direction, at the same time. Trying to avoid losses in portfolio value will inevitably lead to disappointment. Instead, learn how to make your money work, even when portfolio values are falling.

 

2. A portfolio is a group of investments, which when taken as a whole, are designed to achieve the investment objective, over time. There is no such thing as a perfect investment. Hold any investment long enough and there will be times that you hate it. Other times you will love it. What you want to do is have enough performing well, at any one time, to make up for the ones that are performing poorly and as a whole, achieve your objective.

 

3. Buy and sell decisions within your portfolio should have nothing to do with the short-term performance of the individual investments. If the combination of investments are properly matched to your investment objective, risk tolerance and time frame, your investments should only change when one of these parameters change.

 

4. Options and futures are not inherently good or bad, safe or risky. They are just a tool. It is the way people choose to use them that is safe or risky, smart or dumb. When used incorrectly, knives can be dangerous too, but I don't try to cut a side of beef with a spoon! Derivatives are some of the most flexible investment tools available to individual investors. Using them to create cash flow and manage risk is smart. Using them to place a highly leveraged bet on the future direction of wheat is dumb!

 

Unfortunately, most people are taught the dumb way - or know someone who is taught the dumb way. I feel badly for the people in the article but I think it is a symptom of a larger problem. The problem is investors are being driven less and less by sound investment principles and more and more by fear and greed. As someone in the article mentioned, investors often know just enough to shoot themselves in the foot.

 

I believe in self-directing your own investments. Managing your own portfolio reduces cost, eliminates conflict-of interest and puts control over your financial future where it belongs - in your hands. However, this article also points out the value of having an experienced financial coach - someone who can look at what you are doing, see the mistakes you might be making, and give the appropriate guidance.

 

We have taught 3009 investors how to:

 

• Manage their emotions
• Preserve capital
• Get growth even as markets decline
• To generate enough portfolio income to do what they want, when they want, without worrying about market ups and downs.

 

If you have over $25K to invest, register today for our free introductory class, Personal Investing 101: An introduction to cash-flow investing and the Snider Investment Method™.

 

SOURCE:

 

1. Eleanor Laise, et al. "Over Their Heads: Small Investors, Too, Get Nailed by Arcane Trades." Wall Street Journal 14 August 2007; A1

http://online.wsj.com/article/SB118705636964396823.html (Subscription required)

 

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

The Courageous Investor

Mike was a caller on my radio show Saturday afternoon. Four or five years ago, he had gotten very aggressive in his allocations in his 401(k). Now that the market had been going up for awhile, he was nervous and wanted to know should he change his allocations to something more conservative?

 

What Mike was suggesting is called market timing and it is doomed to failure. Stock picking and market timing are by-products of an obsession with day-to-day performance which is a sure way to get the opposite result.

 

One of the lessons I teach is that most of us are getting the cart before the horse. We pick our investments based on their performance and hope they will meet our objectives.

 

The path to successful investing lies in doing it the other way around. First, you must decide what your objectives are. What is your money's higher purpose? Why are you putting it to work? What do you want it to help you achieve?

 

This is not about numbers. Your objective isn't an 8% return or $1 million dollars in the bank. This is about what you are able to do. This is about being able to do what you want, when you want, without worrying how you are going to pay for it. And most likely, it isn't just one thing. It may be several.

 

I have one client in his mid-50's, his peak earning years, who took two years off to do missionary work in Africa. I have another client who left his job to take care of his two sons full time. Now he is getting his teaching certificate so he can be on the same schedule as his boys as they grow older.

 

Maybe your goals are a little bit more mundane. You just want to have enough money to be able to quit working some time before you die. That's OK. But I would encourage you to allow yourself to get creative and think big. What really lights your fire? What is the one thing you secretly want to do if you had enough money and enough courage? That one thing is your money's higher purpose.

 

	"In the long run, you only hit what you aim at." - Henry David Thoreau   "Aim at heaven and you will get earth thrown in. Aim at earth and you get neither." - C.S. Lewis

 

The cool thing about approaching money this way - even if you don't hit what you aim at - if you aim high enough, even a miss will put you in a pretty good position. So why not aim high?

 

Once you understand your money's higher purpose, then you have two other factors to consider before you can even begin to think about which investments to put your money to work in. You must also consider where you fall on the risk/reward continuum and your temperament.

 

Investments stretch along a risk-reward continuum, from those that produce a guaranteed return to those that offer the chance, but not the promise, of a return. Generally, the higher the return, the higher the risk, although it should be noted that risk can take many different forms. It is not always the loss of capital. That is where your temperament comes in.

 

What sort of investor are you? Are you patient or impatient? Do you stick with an idea that makes sense or do you change philosophy every time what you are doing begins to feel the slightest bit uncomfortable? How hands on are you? How much time do you want to spend managing your investments? These are all questions of temperament.

 

Only when you are crystal clear on these three things can you begin to choose the investment philosophy that is best suited to your specific needs. And yet, when I ask a room full of investors how many can tell me what their money's higher purpose is, only 1 in 10 typically raise their hand.

 

When you get clear about these things before choosing an investment, questions like Mike's go away. Investment strategies and specific investment vehicles are chosen based on their ability to achieve your objectives with the appropriate amount of risk and no more, while be mindful of the fact that your investment strategy must fit your temperament.

 

When you take this top-down approach, your investments - in other words, your money's place of employment - should only change when your money's higher purpose changes. And that, I shouldn't need to tell you, should occur very infrequently.

 

	"Courage is never to let your actions be influenced by your fears." - Arthur Koestler

 

An investor who takes this approach is a courageous investor. A courageous investor never changes course based on fits of fear or greed. The beauty is, the level of commitment to the investment approach matches the level of commitment to the objective. Provided you are committed to your money's highest purpose, the rest becomes a moot point.

 

In the new movie release, Georgia Rule, Lindsay Lohan's character, Rachel, has an exchange with Simon (Dermot Mulroney) about the difference between right and wrong and a lie and the truth. She turns to him and asks sarcastically, "How does it feel to be so sure of yourself?" Without missing a beat, he shrugs his shoulder and replies with complete sincerity, "Yeah, it's pretty good."

 

That is the feeling you get when your investments are based on a higher purpose instead of something facile like growth, income or capital preservation or base like a millions of dollars or 50% return. Wouldn't you like to feel that sure of yourself on a topic that makes some of the smartest people feel so uncertain?

 

Learn more about how to put your money to work consistent with its highest purpose in my upcoming class, "The Family CFO's Guide to Investing." I am offering this class in June only - once in Frisco, once in Fort Worth and once in Dallas. The best part is, like this article, it is free. Check the dates and get registered at kimsnider.com.

 

And as always, feel free to leave your thoughts and comments below.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Jim Cramer on Market Manipulation

I suspect many of you have seen this video because several people emailed me the link. If you invest money in the stock market and you haven't seen it yet, you MUST.

 

It is approximately ten minutes in length and it is the most candid conversation I have ever seen recorded about the manipulation of stock prices. I have heard these conversations over dinner but never in front of a microphone or video camera.

 

 

UPDATE (3/23/2007): YouTube has taken down the video but you can still view it on TheSteet.com. Thanks James for tracking that down.

 

Amateur investors want to believe that stock prices are a function of the fundamental value and future prospects of a company. They are not - at least not in the short run.

 

Amateur investors believe the news they read on the companies they own and think it means something. It does not.

 

Amateur investors desperately want to believe you can look at historical price, fundamentals and news and figure out which way a stock is going to go.

 

If this video doesn't fundamentally disabuse you of this notion, I don't know what will. And this is just talking about one tactic used by one group - hedge funds. There are many others, like window dressing and marking the close, all going on simultaneously.

 

Amateur investors, meaning people like you and me who do not run billions of dollars of institutional money, have only two choices. The first is to try to play the trading game against the pros. I am here to tell you it can't be done profitably over long periods of time - no matter how many seminars you take, newsletters you subscribe to, or pieces of software you buy.

 

The movement in prices is random. There is no ability to predict what is going to happen next. If you don't have the financial ability to move the price, you don't have a chance as a trader over the long run.

 

The other option is to take the VERY long view. You buy companies that you would be happy to own for many, many years because over the long run, the market machinations don't matter. While you own them you generate income from them, let them sit, whatever. If your investment premise is correct, and you are buying financially sound companies with good long-term prospects, the long time horizon cancels the noise and leaves you with nothing but signal.

 

The hard part, of course, is that while you own the stock, you have to train your brain to ignore the noise. It is easy to let our emotions take over and assign some meaning to the short term movements in price. But a reaction based on noise is, by definition, going to result in a poor decision.

 

	TAKEAWAYS:   1. The stock price does not reflect the fundamental value of a company in the short run.   2. News has no predictive value either.   3. Unless you have the ability to move markets, your only rational choice is to take a long-term approach to investing and ignore what happens in the short run.

 

I would love to hear your thoughts on this topic. Specifically, what are your takeaways from it? Does this change your approach to investing in any way? Does it clear things up or muddy the waters? Leave your thoughts and comments below.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Don't second guess

Ignoring the temptation to second guess investment decisions improves results. Here is an example.

 

The stock-picking newsletter, Closed-End Country Fund Report, stopped issuing new recommendations in mid-2004. But because the editor said he might resume publishing at some point in the future, Hulbert's Financial Digest left its last picks active in their database. For those of you unfamiliar with Hulbert's, it is a service of Dow Jones that has tracked newsletter performance since the mid-1970s.

 

A funny thing happened. The dormant newsletter's picks have gained 139% since it stopped publishing, it was one of the top performers of 2006 and it has the best five year performance among all newsletters tracked by Hulbert.

 

There are important lessons here for individual investors. Amateurs and professionals alike are affected by fear and greed. When you decide to change course, in mid-stream, it is rarely a logical decision. More likely you are being driven by fear or greed. Fear and greed make terrible portfolio managers.

 

Mark Hulbert, the found of Hulbert's Financial Digest (and a previous guest on my radio show) does an exercise to prove this point. Each year, he takes the picks of newsletter writers at the beginning of the year and figures out the return if they had stuck with those picks rather than fine-tuning throughout the year. In every year, the newsletter writers would have done better by going with their original game plan.

 

In 2006, for example, the average newsletter portfolio gained 11.35%. Had they stuck with their picks from the beginning of the year, their results would have been 12.15%. When you factor in the tax consequences of the transactions, the results would have been even more favorable if they had gone with their original plan.

 

Similar exercises have been done for mutual fund managers and individual investors with similar results. Time and time again, study after study says fear and greed cause us to buy high and sell low. We become convinced that we could do better elsewhere and we get the exact opposite result.

 

An article by Mark Hulbert on MarketWatch recognizes the difficulty we all face:

 

None of these results denies that doing nothing can be psychologically difficult. Holding a stock that is falling takes courage, just as it can seem irresistible to jump on a stock that has already risen.

 

If it was easy, we would all make a lot more money and they would have to take very few coaching calls at Chronim Advisors. I don't think anyone, especially me, is suggesting you completely ignore your portfolio. That can be equally bad. But you have to strike a middle ground.

 

But what these results do suggest is that we should place a large burden of proof on making a change in our portfolios. Unless the arguments in favor of such a change are particularly compelling, we probably should simply do nothing.

 

The most important thing you can do as an investor is to be consistent. In other words, you must make investment decisions when you are sane - when you have not put any money at risk - and stick with them when you become clinically insane - which is the moment you invest a dollar in a security. From that point on, you are not competent to make logical decisions.

 

The way to circumvent that is to make all the decisions up front and never on the fly. Now you might be thinking to yourself, but what if new information becomes available that I didn't have in the first place?

 

Remember, 99% of what you hear is noise, not signal. Pros may be able to distinguish between noise and signal but you can't. The probabilities will work in your favor if you can teach yourself to ignore it.

 

Throughout the history of financial markets, the investors that have done best are those that can manage their portfolio, and their emotions, with unflinching discipline. If you listen to noise, change course mid-stream, and constantly second guess your investment decisions, you will probably not be very successful as an investor.

 

But the good news is this is a learned skill. If managing your portfolio well is a priority for you - and who can afford for it not to be given our need to fund a thirty year retirement - moving from a fly by the seat of your pants mentality to a disciplined approach will make a big difference.

 

SOURCE: (Direct quotes are highlighted)

 

1. Mark Hulbert, "The Value of Doing Nothing"; MarketWatch.com; 19 Jan 2007

http://snipurl.com/mktw_nothing

 

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Illusory Correlations

An article by Mark T. Finn and Johnathan Finn, published in John Mauldin's Outside the Box E-Letter points out one of the more difficult aspects of economic decision-making - that is that we are constantly fooled by randomness:

 

Consider a classic experiment done in 1948 by B.F. Skinner. Paul Slovic describes the experiment as follows:

 

Skinner found that hungry birds, given food at brief random intervals, developed very idiosyncratic, repetitive actions. The precise form of this behavior varied from bird to bird, and Skinner referred to these actions as superstitions. What happened to these birds can be described in terms of the concept of positive reinforcement. The delivery of food increased the likelihood of whatever form of behavior happened to precede it. Food was then presented again. Because the reinforced behavior was occurring at an increased rate, it was more likely to be reinforced again. The second reinforcement caused a further increase in the rate of this particular behavior which improved its chances of being reinforced again, and so on. After a short while the birds were found to be turning rapidly counter clockwise about the cage, hopping from side to side, making odd head movements, etc. Because such behaviors are reinforced less than 100 percent of the time during learning, they persist even when reinforcement stops altogether. Animals trained in this way have been known to make many as 10,000 attempts to obtain a reward that was no longer forthcoming.

 

(Psychological Study of Human Judgment: Implications for Investment Decision Making, Paul Slovic, The Journal of Finance, Vol. 27, No. 4, Sep., 1972)

 

With only partial tongue in cheek we would point out a strong similarity between Skinner's experiment and investing in the stock market. There is the fertile ground of overwhelming data from which illusory correlations can be drawn. The outcome is expected to be positive (an increase in wealth). That expected positive outcome is associated with positive reinforcement (good performance) that is at least intermittent if not random. There are few statistically valid analyses provided as systematic feedback that would refute an illusory correlation.

 

I see this time and time again among investors. Imagine I bought 10 different stocks and all the stocks whose company name begin with A go up in price while the others all go down. The heuristics, or logical shortcuts in our brain's operating system cause us to leap to an illusory correlation between the company name and rising stock prices. Consequently, I start buying more stocks that begin with A. A random distribution of returns in a rising market would suggest, incorrectly, that stocks beginning with A go up more often than not. With an ever-increasing percentage of stocks in my portfolio beginning with A, I cannot see that stocks that begin with other letters go up in equal percentages.

 

You may say that is ridiculous. Admittedly, I made the example extreme to illustrate the idea. But make it somewhat plausible and people do it all the time without realizing.

 

Let's take technical analysis as an example. If I buy several stocks when they rise above their 20 day moving average and I make money on them, I will create an illusory correlation between the two. As long as I can spot the pattern sometimes and make money on it, which reinforces the correlation in my mind, I will continue to look for it and bet on it. It doesn't matter that the pattern often fails to hold true. I will continue to believe in the correlation.

 

The problem is that to make the correlation in our minds is very easy. It only requires a tenuous association between an event and a reward. But to disprove the correlation is hard. Few people are going to sit down and calculate the correlation coefficient between price and the 20 day moving average!

 

One other thing I find interesting is the link between these behaviors and addictions. What makes something really addicting is when we receive intermittent variable reinforcement.

 

"The interesting thing that Skinner discovered about intermittent reinforcement and maybe one of Skinner's most important discoveries was that behavior that is reinforced intermittently is much more difficult to extinguish than behavior that is reinforced continuously."

 

A slot machine is a perfect example. We put money in and occasionally money comes out - not always and the amount varies. This is intermittent variable reinforcement. It is this characteristic that makes something really addictive.

 

Email is another example. Do you know anyone who constantly checks email? Why do they do it? Intermittent variable reinforcement. You are not sure what you will get each time, or if you will get anything at all, so you keep checking.

 

Of course, the leap from gambling to investing is not a big one. Like gambling, investors get random, or intermittent reinforcement (profits) that vary in size and frequency. Do you think it is a coincidence that most investors don't buy bonds (not variable or intermittent) even though portfolio theory says you should have a substantial percentage of your portfolio in bonds?

 

I think one of the most beneficial things an investor can do is to study these sorts of behavioral issues in finance. In fact, I think it is time far better spent than studying stock charts and trading strategies. Only if we can understand our behavior and that it is far more complex than we probably realize can we hope to overcome our shortcomings as investors. For many of us, it isn't our lack of knowledge of investing that screws us up. It is our lack of knowledge about how our own brain functions.

 

What do you think? Leave your thoughts and comments below.

 

PROPS:

 

Thanks to Snider Method, alumni Dr. Andrew Lipscomb, for giving me the heads up on this article.

 

If you would like to subscribe to John Mauldin's newsletters (free and highly recommended) you can find them here.

 

SOURCE:

 

Mark T. Finn and Jonathan Finn, CFA; "A Look in the Mirror"; Mauldin's Outside the Box E-Letter; 15 Jan 2007.

http://www.investorsinsight.com/otb_va.aspx?EditionID=453

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Wall Street Analysts

An opinion piece by John Dorfman, Bloomberg News columnist, may contain the best stock tip you'll ever get - ignore stock tips.

 

The four stocks that Wall Street analysts most despised at the beginning of 2006 posted an average 21 percent return for the year.

 

The four stocks they most loved returned only 2.4 percent, which was far worse than the return of almost 16 percent on the Standard & Poor's 500 Index.

 

In short, the despised stocks walloped the favored ones. Is that a freak result?

 

No, it is not.

 

For nine years, I have been studying the annual performance of the four stocks that analysts most unanimously recommend, and the performance of four stocks on which they issue an unusually large number of ``sell'' recommendations.

 

The analysts' darlings lost 3.7 percent a year, on average. The stocks they hated declined 0.2 percent.

 

Both groups of stocks did worse than the S&P 500, which returned 7.4 percent a year, on average, during the period of the study: 1998 through 2006.

 

Investment strategists, analysts and mutual fund managers get paid millions of dollars a year to evaluate stocks. All the evidence says they fail miserably. The rate of success falls squarely within that which we would expect given the laws of chance. Why on earth do we continue to believe in stock picking or market timing?

 

In the famous words of American financier and advisor to presidents, Bernard Baruch, "It can't be done except by liars."

 

SOURCES:

 

1. John Dorfman, "Wall Street Analysts Stumble on 2006 Stock Picks"; Bloomberg.com; 9 Jan 2007

http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_dorfman&sid=a0RtSbI4S6a4

 

2. "Bernard Baruch"; Wikiquote.com; 19 Jan 2007

http://en.wikiquote.org/wiki/Bernard_Baruch

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Options Find a Place in Retirement Accounts

The traditional view of options can best be summed up in one word - risky. That has always frustrated me, mainly because it is such a persistent myth. Options can be risky, particularly when they are used to place a bet on the future direction of price. If that's what you want to do, why don't you just go to Las Vegas?

 

Increasingly though, options are being used in the way I believe they ought to be used, which is to manage risk and create portfolio income. Even more specifically, they are being used to generate portfolio income for retirement portfolios.

 

Charles Schwab did a survey of some of its options customers and were pleasantly surprised to find most of them were using options in this very conservative way. The Wall Street Journal reports:

 

The survey showed that 61% of them consider themselves to be risk takers, but only 40% think there are more gains to be made with options than with stocks and bonds, and only 31% agree that they like trying to outsmart the market with their option trades.

 

Instead, a far higher number -- 69% -- consider option trading "a great way to generate income" and perhaps most interestingly 56% say option trading is part of their retirement investment strategy.

 

That last figure is particularly interesting to Randy Frederick, director of derivatives at Charles Schwab. It wasn't long ago that option trading wasn't considered appropriate for retirement, he notes.

 

I have also noticed a trend toward much more widespread understanding and acceptance of options. In my talks I always ask how many people in the room are familiar with options. Back in 2001, I'd say only about 10% - 20% raised their hands. Today it is well over half. And they don't express nearly the amount of fear and trepidation about using them they once did. Most people now realize they are pretty mainstream and want to learn more.

 

"I can't teach you how to get rich quickly trading options," he hammers home to customers, Mr. Frederick said, but, "I can teach you how to protect what you have and get rich slowly."

 

That is really the key. Professionals know options are just a tool for achieving certain objectives. Getting rich quick isn't one of them. Highly leveraged, speculative bets using options almost never work out. But using options to manage risk and create portfolio income almost always does.

 

I'd like to thank Professor Frank Anderson, from UT-Dallas, for sending me the heads up on this article and I'd like you to weigh in with your thoughts. As always, you can leave your comments below.

 

SOURCE:

 

1. Mohammed Hadi, "Options Find Favor With Investors Seeking Strategies for Retirement." Wall Street Journal 3 Jan 2007; C2. (registration required)

http://online.wsj.com/article/SB116778575233765465-search.html

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Where Fools Rush In

Regular readers will be intimately familiar with my theme of buying