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.

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.

Guest column: The "R" Word

I am traveling this week, so I decided to take a bit of a shortcut and run a guest column by one of my favorite writers, Nick Murray. Many people have been writing me in recent weeks about the possibility of a recession and what changes they should make to their portfolio.

We believe you never make changes to your portfolio based on what you think the market or economy will do. You only have a 50-50 chance of being right. For every economist, journalist or Chief Market Strategist who says Armageddon is coming, there is another one who says the exact opposite. Or, as the Nobel prize winning economist Paul Samuelson said, "The stock market has forecast nine of the last five recessions."

Personally, I have no opinion about whether we will go into recession or not or, if we do, how deep or long-lasting it will be. I have no control over it and I wouldn't do anything different if I knew the answer. So for me, there is no point wasting brain space on it.

Nonetheless, I thought this piece by Nick Murray might give you a different viewpoint than the one so prevalent in the press these days. Food for thought …

	The "R" Word, by Nick Murray (Originally published in Nick Murray Interactive - Vol. 8, Issue 2, February, 2008 As a measure of how utterly debased and stupid the rhetoric about the alleged imminence of a recession has been of late, nothing compares to a comment mined from an AP wire "story" that appeared in mid-January. In it, the chief market strategist for a foreign financial institution which shall be nameless – a chap who apparently has no background in economics, and/or to whom English is a second language – opined that "it's possible that the recession may only last one quarter." And you know that this is an accurate quote, because you know that neither I nor anyone else could make it up. Herewith, some rational observations about the economic phenomenon called "recession." The first, as in any rational discourse (thereby excluding all journalism on the subject), is of course a definition of the term: a method of calibrating it, which is a bit different from a method of screaming apocalyptically about it in the cadences of Chicken Little. A recession, as defined by the National Bureau of Economic Research – and therefore by anyone who has actually taken an entry-level college course in basic economics, as opposed to financial reporters who are former weather girls of either gender from a television station in Ames, Iowa – is two consecutive quarters of negative GDP growth. That is, a recession is a minimum six-month period in which the economy actually contracts. A "one-quarter recession" is therefore – like a water landing, a short-sleeve dress shirt, or a new tradition – actually an oxymoron. (A "growth recession," on the other hand, is a period of economic growth that is slower than the previous period of economic growth. Since the latter is nowhere near scary enough for use by former weather girls of either gender, journalism has adopted the term "growth recession.") The National Bureau of Economic Research will also be happy to disclose to you that there have been ten such episodes since the end of World War II. The average lasted approximately ten and a half months, and carried the economy down slightly less than two percent. (Over the last quarter century, as the economy has deepened, and our monetary tools for fighting slowdowns have improved, the time lapse between recessions has lengthened, and both their duration and depth have moderated. Indeed, since November 1982, the economy has only been in recession for 16 months out of about 300. But never mind that. It smacks too much of good news – or, as it is sometimes referred to, "truth.") A ten-month, two percent contraction on an average of every six years suggests that recessions punctuate – on average – economic expansions occupying the other 60-odd months. Forgive me, but this seems to me to be a very small price to pay for an accretion of national wealth which is ongoing, and which has produced the wealthiest society that ever existed on the earth. It is, in other words, nothing more or less than a part of the cycle, and the net effect of that cycle is the unprecedented betterment of humankind. (Why, even Americans on food stamps have 44-inch plasma TVs and are morbidly obese. Think of it: this society is so rich that even its poorest members eat too much! But I digress.) Once again: there either is or is not going to be a recession in this country. (As I write, the Chairman of the Federal Reserve is expressing to a congressional committee the Board's opinion that there is not, but what does he know?) The Fed has unequivocally declared its intention to fight such an occurrence with all the monetary weapons at its command. And both the legislative and executive branches have expressed strong interest in implementing some sort of fiscal stimulus. This is in keeping with the obvious truism that the more advance warning a recession gives you – as opposed to the last one, spawned by the sudden bursting of the tech bubble – the easier it becomes to fight it off. If there is a recession, on average the equity market – being a discounter of the future, rather than a reflector of the moment – will turn up about halfway through it, while journalism is trumpeting each new negative statistic to the skies as evidence of deepening Armageddon. Thus, the people who panicked out in fear of a looming recession will – by the time it's officially declared over – have to buy their portfolios back at higher prices than those at which they sold. With the obvious exception of the deity Himself, the stock market is the universe's ultimate ironist. And if there is a recession – and I, along with Dr. Bernanke, hereby repeat that I don't believe there will be – you may rest assured that its proximate cause will not have been oil, or subprime mortgage write-downs, or any of the usual suspects, all of which are quite adequately discounted in a 1350 S&P. It will, I'm perfectly convinced, have been journalism. I expect journalism to be alarmist, declinist, economically illiterate, repetitive, stupid and single-mindedly devoted to demonstrating that not only is the glass half-empty, but that this time it's irreparably shattered into a million pieces. But journalism's "coverage" of the economy and the markets in the last several months has been something altogether new in my 40-year career. It's made Chicken Little look like Pollyanna. And it may yet succeed in frightening the whole country into sitting down hard on its wallet. Thus, if we do have a recession, I hope journalism will have the minimal grace to report it as what it will surely be: a self-fulfilling prophecy. © 2008 Nick Murray. Reprinted with permission. Nick's lovely little book for investors, Simple Wealth, Inevitable Wealth, is available on his website www.nickmurray.com, click on "Books." We warmly recommend it.)

Kim Snider Financial Communications 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 are subject to risk, including possible loss of principal. Individual results may vary. Individual performance depends on individual savings, investment time frame and market conditions. Diversification does not ensure a profit or protect against loss in a declining market.

The Performance Paradox - Greed - (Part 2)

Last week I wrote about what I call the Performance Paradox. The Performance Paradox is: The more you want or need it, the more you try to get it, and the more you micromanage it, the worse it will be.

 

There are two sides to the Performance Paradox. One is fear, which I discussed last week. The other is greed. Let's see how these two work together to decimate investor performance.

 

John is a 45 year old employee of a defense contractor here in town. His company offers a 401(k), which he maxes out each year. John characterized the performance of his 401(k) as "awful" and his performance as the manager of his 401(k) as "mediocre at best."

 

"Why do you say your 401(k) is awful?", I asked.

 

"I keep hearing how the Dow is at an all-time record high but my 401(k) is nowhere near an all-time high. I must be doing something wrong."

 

"How do you decide what funds to pick within your 401(k)?"

 

"I pick the one with best track record over the last couple of years?"

 

"Only one?"

 

"Yes. I go for the one going up the most. But as soon as I get in them it seems like they stop going up."

 

"So then what do you do?", I asked.

 

"I sell them."

 

"And then how do you pick the next one?", as if I didn't know the answer.

 

"The same way."

 

It didn't take a lot of detective work to spot the cause of his sub-par returns. His portfolio decision-making was being driven by greed. Of course, this process for picking investments flies in the face of what we know to be true - namely that markets are cyclical. Trees don't grow to the sky and all investments go through periods where they do well and others where they do not so well.

 

So take a mutual fund that has out-performed the market in each of the last three years. People start to notice. The fund manager gets written up in Barron's. The fund makes a bunch of lists in magazines like Smart Money and Forbes, with titles like "The 10 Funds You Must Own This Year Unless You Want to Be Poor and Stupid" and money comes pouring into the fund from people like John.

 

This is great news for the fund company - big cash inflows - exactly what they hope for. They make a lot of money and the fund manager gets a multi-million dollar bonus.

 

But it is bad news for the new investors like John. It’s a death knell. Big inflows are a contrarian indicator. They almost always signal the end of the run.

 

What John does not consider is it is absolutely impossible for the above average performance to continue indefinitely. The aggregate return of investors is the stock market return less transaction costs. There is no persistence in stock market returns. The funds which do well in any given period are typically the worst performer in subsequent periods. In short, the results are basically random.

 

So driven by greed, John buys the hot fund. When it fails to meet his unrealistic expectations, as it inevitably will, he sells it. What has he just done? Bought at the top and sold at the bottom. If you look at the fund's performance on Morningstar it will seem to have done quite well. Look at John's performance and it won't be anything close.

 

This pattern is well documented in an annual study by Dalbar called the Quantitative Analysis of Investor Behavior or QAIB for short. What the QAIB tells us is that in any rolling 20 year period the average investor underperforms their investment by a significant margin because of a persistent pattern of buying high and selling low.

 

This pattern can be driven by greed, as in John's case, or by fear, as I wrote about last week. Either way, the result is the same.

 

What is the answer?

 

The one thing I know for sure about investing is to make money over the long run you have to stay put. Successful investing requires discipline and patience. As I said last week, investing in the stock market is a winning strategy over time, just not all the time.

 

The investor who moves in and out of various investments because the one they are in now doesn't feel good or because they think the grass is greener somewhere else will always get the opposite of their intended result. That is the Performance Paradox.

 

Next week, we'll talk about the antidote. Stay tuned.

 

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 Performance Paradox - Fear - (Part 1)

When the markets re-opened on September 17, 2001, the Dow was down, at one point, 850 points and the S&P lost 5% of its value. I remember remarking to my husband (boyfriend at the time) that I felt as if I was moving through Jell-O. Much of what we thought we knew about our world had just gone out the window. No one knew what was coming next. Would there be more attacks? Was this just the beginning? And even if there weren't, how would the economy withstand such an unprecedented disruption?

 

That week, a number of our clients called us. Some just wanted to talk. Others wanted to know what to do. Should they continue with the Snider Investment Method as if nothing has happened? Should they sell their Snider Method positions? Should they liquidate their other stock market holdings?

 

Our response, as it always is, was to stay the course. There was no reason to alter the strategy or do anything different. After all, our investment objectives, tolerance for risk or time horizon did not change when those airplanes slammed into the World Trade Center. I put together a 60 second radio spot that aired on local radio before the markets reopened which told people we would be buyers of stock when the markets reopened.

 

Many people, clients and otherwise, thought we were nuts. Some called to say they were dumping their portfolios. We advised strongly against it, but it was their money. They could do what they wanted.

 

Those who dumped their portfolios did so out of fear and are classic examples of one side of what I have come to call the Performance Paradox. The Performance Paradox is that the more we react to the short term performance of our portfolio, either out of fear or greed, the worse our long-term performance will be.

 

The person who invests from a base of fear, in other words is so afraid of market losses or is so obsessed with short term performance, that he sells every time an investment goes down creates a pattern of turning temporary losses in value into permanent losses of capital. Do this over and over again and you will continually turn winners into losers.

 

What is the answer?

 

To be a successful investor, you must be an optimist. You must recognize and internalize that we live in the greatest, most transparent economy in the world. There will be downturns and tough times - no question. All of us have a tendency, especially as we get older, to think the world is going to hell in a hand basket.

 

And yet, we also know that ten years after any economic disruption - whether it be the Great Depression, the 1987 crash, the currency crisis of the late 1990s, September 11th or whatever - we can look back and we will not wish we had sold. Instead we will wish we had invested everything we had at the time.

 

This is not to say that investing is risk-free and that even the most optimistic among us won't go through periods of doubt. By definition, we will experience severe declines periodically in the future. Investing in the stock market is a winning strategy, most of the time, but not all the time. And those down years can be hard to ignore.

 

If we could accurately predict when those down years would occur, this discussion would be moot. We would simply get in ahead of market upturns and get out ahead of the downturns. But of course, no one can accurately predict when the downturns will come or how long they will last. As Nobel Laureate Paul Samuelson said, "The stock market has forecast nine of the last five recessions."

 

What we can predict is, if you are an optimist who takes a long term view of the market, you will prosper over the years because you will have found a proven strategy for success. The investor who takes the opposite approach - who is bound up in fear and as a result monitors his portfolio constantly and reacts out of fear to short term declines in value, will not be successful over the long run.

 

This is the Performance Paradox. The more you want or need it, the more you try to get it, and the more you micromanage it, the worse it will be.

 

So which are you? Do you take an optimistic long-term view of the market? Or do you try to micromanage the short term performance of your portfolio?

 

Next week, I'll look at the flip side of the Performance Paradox - greed. Then we'll talk about the antidote. Stay tuned.

 

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.

It's All In How You Look At It

Look at the ballerina below. Is she turning clock-wise or counter-clockwise?

I see her turning clockwise, which is supposed to mean I am more right brain. Most people will see her turning counter-clockwise, which means you are more left-brain. But the cool thing is you can change which way she turns.

 

Focus on her turning the other way. Sometimes I have to look off the screen to get her to change. Sometimes it is really hard. Can you do it?

 

It just goes to show it is all in how you look at it. I had a caller on my radio show on Saturday who said he had pulled all of his money out of the stock market because he was afraid of terrorism. In other words, he was afraid of the risk. I, on the other hand, always have all of my money IN the stock market (by way of the Snider Investment Method™) because I too am afraid. Only I am afraid of running out of money.

 

Some people focus on short term risks that cause temporary market declines and opt for cash or bonds to manage risk. I focus on longer term risks like inflation and longevity and opt for generating cash flow from stocks to manage risk. Both of us see the same set of facts but interpret them differently.

 

Who is right? I guess it depends on how you look at it.

Kim Snider Financial Communications 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. Diversification does not ensure a profit or protect against loss of in a declining market. All investments are subject to risk, including possible loss of principal. 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.

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.

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.

 

Where Fools Rush In

Regular readers will be intimately familiar with my theme of buying when everyone else is selling and selling when everyone else is buying. This is a cornerstone of the way I invest. Another cornerstone is that no one can consistently time the market or pick stocks. That means finding a long-term investment strategy and sticking to it irrespective of short term events.

 

An article by Michael Mauboussin, Chief Investment Strategist for Legg Mason and author of the book "More Than You Know: Finding Financial Wisdom in Unconventional Places" in the December issue of Time discusses our proclivity for buying at highs and selling at lows.

 

That proclivity is best illustrated by Dalbar's Quantitative Analysis of Investor Behavior which I quote often. According to Dalbar (Mauboussin attributes it to Jack Bogle but he is quoting Dalbar) in the 20 years ending in 2005, the S&P 500 index rose 11.9% annually and the average mutual fund 9.7%, but the average investor realized only a 6.9% return. (See update at the bottom of the page for more on this.)

 

Mauboussin points to two concepts to explain our behavior. The first is recency bias. Recency bias causes us to put more empahsis on what has happened most recently and minimize, or even ignore, facts and long-term data.

 

He also suggests that we pay little attention to nagging details but instead let the stories spun by Wall Street or the financial press capture our attention. He cites the recent run-ups in real estate and energy as examples saying, "More often than not, once a sizzling sector comes to the attention of an individual investor, the opportunity is gone."

 

We are hard-wired to be poor investors. That is the gist of behavioral finance. But what you have to be aware of is that Wall Street uses that to its advantage. Quoting Mauboussin:

 

If you think the investment industry is there to protect you, think again. Many firms see a hot sector as an opportunity to gather assets. Before the tech-stock peak in 2000, the industry marketed nearly 500 technology, telecom and Internet funds. It's the same story now, only the actors have changed. In October 2004, 180 hedge funds were dedicated to energy and commodity investments. Today there are 525.

 

There's nothing new about bad timing and Wall Street's willingness to accommodate it. In fact, poor timing may be one of the most systematic and predictable errors investors make. Famed portfolio manager Bill Miller has dubbed it the "five-year psychological cycle." Investors want to own today what they should have owned five years ago. Currently, investors are pining for energy and commodities, but they should have owned them in the early 2000s, when they were cheap and unloved. Instead, investors coveted the high-flying tech and telecom stocks, which would have been smart purchases in the mid-1990s--except that investors were busy chasing bank stocks, which would have been shrewd purchases in 1990. You get the idea.

 

People not only do this with hot sectors and hot stocks, they also do it with asset classes. The time to jump in the stock market is not after it has risen 20%. And the time to sell stocks and buy bonds or go to cash isn't after it has fallen 20%.

 

This is the idea behind portfolio rebalancing, a simple but fundamental aspect of portfolio management that very few individual investors do.

 

I am curious what your thoughts are on this topic. Are you inspired to agree? Disagree? Do you have an example? Feel free to share. Comments are welcome in the comment section below.

 

UPDATE: (11/29/06) I received an email from Michael Mauboussin. I said the numbers in the second paragraph should be attributed to Dalbar, not to Jack Bogle. I was wrong. He tells me he WAS quoting Bogle, not Dalbar. Apparently they come up with different numbers. Although the message in them is the same I think. Sorry Michael for the mistake. Thanks for taking the time to set me straight on that one.

 

SOURCE:

 

1. Michael Mauboussin. "Where Fools Rush In." Time 6 November 2006, A44.

http://www.time.com/time/insidebiz/article/0,9171,1552055-1,00.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.

 

All is well with the world right?

The Dow and S&P 500 continue their push into loftier heights. Your portfolio is going up in value. So, all must be right with the world, right?

 

Well, not so fast.

 

Investors are notorious for focusing on the narrowest of time frames -- today, this week, this month, even this year. But you simply cannot look at it like that. To make decisions based on a slice in time is what causes the performance of individual investors to be so lousy, as is well-documented.

 

In keeping with our recent dead money theme, let's look at the bigger picture. The Dow may be making new highs, but I’ll bet you dollars to doughnuts your portfolio isn't. Take out your contributions since 2001 and add back your distributions. See where you are? Chances are it isn't an all-time new high.

 

You have been sitting on dead money all this time. You haven't earned a single penny in over five years. And you think the new highs in the Dow and S&P are cause for celebration? I think they are an opportunity to cash out of something that hasn't worked for you and get in to something that makes more sense, like cash flow investing.

 

It is clear market timing, stock picking and even buy and hold have some fundamental flaws in a world where we often need to tap our investments because we lost our job, became disabled, or want to quit working and must fund 30 years of retirement. Cash flow investing gives you the best of both worlds -- income to act as a safety net and long-term participation in stock market gains.

 

The key to making money is buying when everyone else is selling and sell when everyone else is buying. Right now, everyone else is buying. What are you going to do?

 

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.

 

Dow components compared to all-time high

I am on a plane, en route from Dallas to Atlanta. CNN was reporting the Dow was within just a few points and inching closer to its all-time high as I was getting on the plane. By now, it may even have reached or surpassed it.

 

We know stock prices rise over long periods of time. We also know, from studies like those done every year by Dalbar, that investor returns seriously lag investment returns. For example, in the 20 year period ending in 2003, the S&P was up almost 12% per year, on average. The average investor was only up 2.7%.

 

Using the Dow as an example, it is easy to see why investor performance is so bad. The Dow made its previous all-time high on January 14, 2000. Mike Panzner has gone to the trouble of calculating the change in the current stock price of each of the Dow 30 stocks from the January 14, 2000 high to now.

 

Dow Components

 

These numbers point out two places where our brains are likely to tell us the opposite of what we need to know or do to be successful investors. The first is the trickery of averages and the second is the trickery of indexes.

 

The financial services industry uses averages a lot! You almost can't help it. It is a convenient way to summarize information. The problem with averages is that people hear them and assume they will be at least average. Most people assume they will be above average. Some of them will be right. But some won't. Someone has to be below average.

 

Everyone wants to be in the top half. If you are part of the bottom dwelling contingent, you think the investment sucks - there is something wrong with the investment or you're somehow getting gypped. Of course, If you are part of the group who is doing better than average, you think it's the cat's pajamas.

 

The danger in averages, or at least in everyone's desire to be above average, is that when you are not, you head for the exits. You bail out of the investment you are in, hoping to replace it with something better. But again, someone has to be below average. Whether you end up in the top half or the bottom half of the next investment is just luck.

 

If you end up in the bottom half again, you sell and look for something else. You are creating a pattern of buying high and selling low. If you end up in the top, then someone else is now in the bottom and they will sell low so they can go buy something else high. Every time you move from one investment to another, rather than increasing your odds of success, you mathematically increase the odds that you will underperform.

 

Crazy, huh? But true.

 

The other interesting point is made by the individual Dow components against their January 14, 2000 prices. More stocks in the Dow are lower today than are higher.

 

Contrary to the conventional wisdom, rising tides don't float all boats. The opposite is also true, falling markets don't sink all boats either. This is due to the random nature of price movements.

 

I think most people assume that if the market is going up, their stocks should go up too. I will concede that the bias is toward up in a rising market and down in a falling market. But that's about it. Stocks move in their own cycles within the movement of the index and often in the opposite direction.

 

This idea is critical to the way I invest. I believe stock prices are random. I know that even financially sound well run companies, including Intel, Microsoft, Coca-Cola and Wal-Mart, can experience five year periods of negative returns in a rising market.

 

So the Dow points out what I believe are two critical success factors for investors:

 

1. You have to resist the urge to jump ship every time an investment doesn't feel good. Chasing performance leads to worse performance. The patient investor always wins out over the impatient one.

 

2. When evaluating investment strategies, look for something that recognizes you will be impatient and makes staying in easier, even when the investment isn't up on a total return basis. For me, that means creating an income stream I can use to pay my bills and maintain a comfortable standard of living whether my stock prices are up or down. I am comfortable holding good companies for very long periods of time, so long as my standard of living is unaffected.

 

UPDATE: I wrote the majority of this post on Thursday. I didn't finish it until Sunday. So we know the Dow backed away from the all-time high. But the point remains.

 

SOURCE: Comparison of Dow components is from The Big Picture. Thanks Barry. I looked for the original source from Mike Panzner to give him a link. I couldn't find it.

 

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.

09-27-2006: Items of interest for the Family CFO

Yet another example that no one can predict the future direction of stock prices and reading the news on those stocks will cause you to buy when you should be selling and sell when you should be buying. Take a look at the news headlines from 1995-97 about Apple. (Tip of the hat to Barry Ritholtz of The Big Picture for this one.)

 

Health insurance continues to be the x factor in the future standard of living for many Americans. The New York Times (free subscription required) says the cost of insuring a family rose 7.7% last year. That is double the cost from seven years ago. It is also double the rate of wage increases and inflation.

 

Walter Updegrave, senior editor at Money Magazine (and previous guest on my radio show) lays out some of the reasons you should avoid annuities in 3 Retirement Deals You Can Do Without. He gives the sales pitch for equity indexed annuities, IRA rollover annuities and annuity swaps. Then he does a nice job of telling you what the pitch leaves out. (Thanks to Snider Investment Method™ graduate Taylor Stevens for the heads up on this one.)

 

Paul Farrell, of MarketWatch.com, illustrates one of the fundamental problems with investing: we are human. Being human, our brains play all sorts of dastardly tricks on us. One such trick is filtering out information that doesn't support our point of view. We all do it. It is one of the reasons why I say, when it comes to investing, we are our own worst enemy. We think we are being logical when really we make decisions in a totally illogical way, most of the time.

 

If you see something you think would be of interest to other Family CFOs, please pass it on. You can email it to me: kim (at) kimsnider.com. As always, your thoughts on these or any other topics are welcome. Leave them 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.

Are Markets Random?

I ran across a post on Dr. Brett Steenbarger's blog this weekend that reminded me of an interesting experiment. I first read about this experiment in Burt Malkiel's Random Walk Down Wall Street. It demonstrates the concept of being fooled by randomness.

 

Malkiel would ask his students to draw a stock chart that was totally random. The charts would have wild swings all over the place and no discernable trend. Then he would have the students construct a chart by flipping a coin. Those charts looked like would you would see in the newspaper - complete with trends and the patterns of technical analysis.

 

This is from the post on TraderFeed:

 

It turns out that human beings are quite patterned in their efforts to produce randomness. Their random sequences have fewer runs of numbers than are found in true randomness. If we're tossing a fair coin, for example, we should get runs of five consecutive heads about 3% of the time. Interestingly, my attempt to generate a random sequence with 1's and 2's didn't even have runs of three (which should occur about 12.5% of the time). It was statistically significant at the .01 level!

 

The point is randomness doesn't look all that random. That is why it is difficult for most people to grasp the movement of stock prices are indeed random.

 

Now, you can prove this idea to yourself without being a mathematics genius. There are calculators on the web that test for randomness. You put in a series of numbers. If the analysis says there is probable or suggestive evidence against randomness, you do not have a random series. If it says no probable evidence against randomness, then you have something approaching a random set. The higher the P-Value, the more randomness there is.

 

Play with it yourself and see if your gut instinct about what is random really produces a random result. Then, go to Yahoo or Google Finance and find the closing prices of an index or stock that seems to be trending. Put those in the calculator and see what you get. Or try the coin toss. Put in a 1 for heads and a 0 for tails.

 

Let us know how your experiments turn out.

 

TIP OF THE HAT: To Brett Steenbarger for reminding me of this and providing the link to the randomness web site. I would have given him a Trackback on it, but apparently Blogger doesn't accept TrackBacks!?!

 

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.

Using Options To Manage Risk

Investors carry a lot of baggage. Much of it is erroneous information that takes on a life of its own. One of the most frequently maligned and misunderstood investments, even among financial professionals, are derivatives - namely, options and futures.

 

That is slowly changing as evidenced by this excerpt from an article in the July, 2006 edition of Financial Advisor:

 

Generally, derivatives used alone are considered to be inherently risky instruments. But when coupled with traditional assets in prudent strategies, they can actually mitigate market and other risks. Industry regulatory bodies have recognized this truth over the past dozen years, as is evident in the language of the Uniform Prudent Investor Act (UPIA) of 1994, Section 2.b, which specifically states that for trust portfolios (which are held to fiduciary standards), investment instruments, rather than considered individually, should be considered within “the context of the portfolio as a whole.” In light of UPIA guidelines and current market concerns, the prudent use of derivatives to mitigate risk may be in order, depending on a client’s investment objectives and other factors.

 

The article focuses on using derivatives to manage risk in separately managed accounts (SMAs). Although SMAs are generally held by higher net worth individuals, the techniques are applicable to the Family CFO managing his or her portfolio as well.

 

Opti