Should I wait until the market comes back?

The question I am asked most frequently these days is, "Should I wait for the market to go back up before I sell the investment I am in and move it into something more appropriate?" As you can imagine, this question generally revolves around selling out of a traditional portfolio to move it into a Snider Method portfolio -- but the answer holds true regardless of the investment.

There is absolutely no reason to wait until the market goes back up to exchange one asset you are holding, in hopes of capital appreciation, for another similar asset. Let me give you an example to illustrate this point:

Suppose you started out with an investment in a diversified portfolio of mutual funds that have a cost basis of $200,000. The market has dropped 50% and your mutual funds have likewise dropped in value. So today, they are worth $100,000. If the market goes up 10% from here, you'll earn 10% of $100,000, or $10,000. At this point, the $200,000 you paid for the mutual funds is irrelevant. The market doesn't know how much you paid for those funds and it doesn't care.

Now imagine you sold those mutual funds for $100,000 in cash. You use that $100,000 to purchase $100,000 worth of a different investment. If the new investment goes up 10%, you will earn 10% of $100,000, or the same $10,000 you would have earned in the previous investment. So long as you are switching to an investment which has a similar potential for gains, nothing is lost by switching. You earn the exact same dollars, given the same returns, as you would have in the original investment.

Let me repeat that -- you are not locking in losses so long as you are exchanging one capital appreciation asset for another that has a similar opportunity for profit.

This is not the case with cash flow investments. The key characteristics of cash flow investments are: 1) Cash flow is money that comes to you while you own an asset; and 2) The cash flow is generally (though not always) tied to the face value of the assets or the amount invested, not the market value.

Suppose you have bought $200,000 worth of actual bonds paying 5%, a cash flow investment. The cash flow from these bonds is $10,000 a year, which is why you bought them. Imagine the value of the bonds fell by 50% and are now worth $100,000. If you sell the bonds for $100,000 and use the $100,000 to buy a different cash flow asset, paying the same 5%, the maximum cash flow from that investment is now $5000. You have just permanently reduced the income potential of the portfolio by half, unless you can find an investment with a yield high enough to make up for the loss of principal.

If you are like many of the people I speak with, you may have this concept of exchange confused with the advice that says never sell when the market is down. Sell is different than exchange. Sell means selling out of the assets to move into something which is much more conservative and has less potential for gain -- like cash -- in which case, you definitely are locking in losses.

So, to make it easy, the rules are:

1. If you are exchanging a capital appreciation asset, for another capital appreciation asset with similar potential for gains, nothing is lost.

2. If you are exchanging a capital appreciation asset for a cash flow asset with yield potential similar to the capital appreciation potential, nothing is lost by switching.

3. If you sell a capital appreciation investment to move it to something with a much lower potential for gain - like cash equivalents or U.S. Treasuries - you are locking in losses and crippling your portfolio.

4. If you sell a cash flow investment  - like a bond or a Snider Method position - for less than it's cost basis, you are permanently reducing the income potential of the portfolio.

My final caution is to be clear about why you are selling an investment. All investments, by definition, are cyclical. Selling because an investment is currently underperforming its long-term average is never a good decision. No investment can be above average all the time. Again, by definition, average means that sometimes it is below and sometimes above. This is not Lake Wobegon where all the children are above average.

Remember that investing is a probability game. The key to successful investing is to select investments, which given their probabilities and characteristics, are the closest match for your investment objective, time horizon and risk tolerance. Then sit back and be patient.

On the other hand, what many of you are realizing, is that you are not in investments properly matched to your investment objective or your time horizon. Your objective is retirement income and you're investing in capital appreciation investments. When that is the case, the time to switch is the moment you realize you are in the wrong investment.

If you would like to learn more about how cash flow investing might be able to help you meet your objectives, I would invite you to attend one of our free, online Investor Briefings. You can find the details on our corporate website at snideradvisors.com.

The opinions expressed should not be construed as financial, legal, tax or other advice and are provided for informational purposes only. All investments involve risk including possible loss of principal. Investment objectives, risks and other information are contained in the Snider Investment Method Owner's Manual; read and consider them carefully before investing. More information can be found on our website or by calling 1-888-6SNIDER. Past performance is not indicative of future results.

The role of luck in a financially secure retirement

A new type of mutual fund was introduced in late 2007 by the fund industry called managed-payout funds. The goal of these funds is to give retirees a steady stream of income. At the time, they were touted as being an easy way for investors to get regular income payouts, professional money management and relatively low fees. Early players in the managed-payout fund arena were Fidelity, Vanguard, John Hancock, and Charles Schwab.
 
These funds demonstrate something known as the “sequencing of return problem” for retirees. If a retiree experiences losses early in their retirement, principal is quickly depleted and the amount of time until the retirement portfolio runs out of money is reduced.
 
Like the new retiree, these funds are being decimated by the stock market plunge. Right out of the gate, these funds are unable to meet their obligations to retirees and are basically returning principal.
 
"The plight of managed payout funds dramatizes boldly, what can happen to investors if they experience a serious market downturn early on, when they are starting to draw down their payments in retirement," said Dan Culloton, a fund analyst at Morningstar.
 
The Sequencing of Return Problem
 
When you are in growth mode, sequence of returns doesn't matter. Regardless of whether a portfolio experiences weak or strong returns early on, the ending market value will be the same.
 
Let's look at an example:
 
Assume we have two portfolios, X and Y. Each starts with $500,000. Neither is taking withdrawals. Portfolio X experiences early losses. Portfolio Y experiences early gains. As you can see from the chart below, there is no difference in the ending value.

This is not the case once you begin taking distributions. As you can see from the chart below, Portfolio X experiences losses early on and runs out of money in less than 20 years. Portfolio Y has strong early returns and is still going strong at age 100.

Even though both averaged 6.5% return, the difference in the two outcomes is massive!

This demonstrates the tragic flaw in a traditional capital appreciation portfolio when your investment objective is income replacement. There is just too much dependence on luck. You are basically betting on a random sequence of numbers over 30 years and the consequences if your bet doesn’t pay off, are catastrophic.
 
How cash flow solves the sequencing of return problem
 
Capital appreciation is when you buy something in hopes it will go up in price. When it does, you sell it for more than you paid for it, and the profit is called capital appreciation.
 
Cash flow is money that comes to you while you still own the asset. Examples of cash flow would be rent, royalties, interest, dividends, and option premiums. The key characteristic of cash flow is that you do not have to sell the asset in order to make money.
 
Another important characteristic of cash flow investments is cash flow is typically tied to the amount invested rather than the market value. Take a bond, for example. The yield is a percentage of the face value. A $1000 bond paying 6% will pay $60 in cash flow whether the bond is worth $900 or $1100.
 
Cash flow is the blindingly obvious solution to the sequencing of returns problem, among others. Imagine your monthly expenses are $9000 a month and your portfolio generates $12,000 a month in cash flow. So long as the $12,000 is not connected to the market value of the portfolio, the sequencing of return problem goes away. Your portfolio withdrawals would be unaffected by the sequence of return.
 
Why does Wall Street continue to try to shove the same old square pegs in increasingly round holes, as evidenced by the dismal failure of the managed payout funds? As Robert Frey, an adviser in Bozeman Montana, says, "These funds are dogs." It's time for the capital appreciation model to be put out of its misery.
 
SOURCE:
 
    1. Funds Featuring Managed Payouts Off To Rocky Start. (2009, February 11). InvestmentNews. Retrieved from http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20090201/REG/302019983/1030/MUTUALFUNDS.

No statement in this article should be construed as a recommendation to buy or sell a security or to provide investment advice unless specifically stated as such.  All investments involve risk including possible loss of principal.  Complete information can be found on our website or by calling 1-888-6SNIDER. Some information for this article has been gathered from external sources.  We believe they are reliable, but Kim Snider and Snider Advisors assume no responsibility for the accuracy of this information.

The mother of all reverse compounding problems

The only proven way to achieve a passive double-digit yield to replace your income is to own businesses – either directly or indirectly through common stock ownership. But this creates a challenge.

The chart [at left] shows each of the bear market declines since the end of World War One. We are in the tenth decade and there have been twenty bear market drops of 20% or more –about one every five years. If you want to get even more specific, it is about sixteen months out of every sixty that we spend in bear markets. Of the twenty bear markets since WWI, eight of them have had a drop of more than 40% in the S&P.

It is absolutely true stocks go up over the long run. But your time horizon isn’t the long run when your objective is income replacement. You have bills to pay each and every month. When you are living off your portfolio, in order to pay those bills each month, you must sell some of the stocks and bonds in the portfolio. Based on historical market data, those sales will be at a loss a large percentage of the time. These regular losses create the mother of all reverse compounding problems.

You know about the power of compounding right? Which would you rather have? A million dollars or a penny doubled every day for thirty days?

Miraculously, a penny doubled thirty times is $5,368,709.12. But the bad news is it works the opposite in reverse. If you sell assets at a loss, you get reverse compounding. If you have a $100K stock portfolio and it loses 50% of its value, how much does it have to go up to get back to $100K? 100%! It has to double. That is reverse compounding.

The challenge is approximately one out every five years in the stock market is a down year. You have to sell off assets every year in order to eat. So, in order to live off the portfolio, you are going to have to sell stuff at a loss on a fairly regular basis. If those losses occur in the wrong order, it dramatically increases the chances of what academics call retirement ruin – a nice euphemism for running out of money before you run out of breath. This is known as the “sequencing of returns problem.”

Take, for example, the 17 year period from 1987 to 2003. The average return was 13.47%. Assume a portfolio of 100,000 taking $10,000 a year adjusted for inflation by 4% over those 17 years. Depending on the sequence of returns which produce the 13.5% average, the ending portfolio balance could be as high as $76K or as low as negative $187K! That is a big swing and obviously meaningful to your situation late in life.

Lesson Four: To avoid the sequencing of returns problem and negative compounding, an investor must avoid permanent losses of capital at all costs. Permanent losses of capital occur when assets are sold at a loss.

The preceding is an excerpt from my newest special report: How to not just survive, but thrive, in turbulent financial markets. Feel free to download the report and share it with anyone you think would benefit from the information.

---

Disclaimer: 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. This article is not a complete discussion of the benefits and risks of the Snider Investment Method®. For a complete discussion, read the Snider Investment Method® Owner's Manual, available by calling 866-9-SNIDER (866-976-4337). Please read and consider carefully before investing. All investments are subject to risk, including possible loss of principal.

Great Historical Perspective on Recent Market Action

Here is a really useful histogram of the annual return of the S&P 500 going back to 1825. I found it on the web in a number of places. All attribute the chart to Value Square Asset Management but I am afraid I have been unable to find the original source document. (Click on the chart to get the full size version).

This is our fifth bear market in twenty years. Contrary to public opinion, business cycles have existed since businesses have existed and they will continue to cycle between boom and bust in spite of government's best efforts to control or eliminate them. If that is true, then ipso facto, capital appreciation investing cannot work.

Just follow through the logic with me. I need double digit returns to pay myself, pay Uncle Sam and keep up with inflation in retirement. Owning businesses, either directly or indirectly through the stock market is the only proven way to get double digit returns over long periods of time. But about every five years, the business cycle takes the market down with it. If I have to sell in order to create income to live and with capital appreciation, I have to sell in order to realize profits, which means in order to pay my bills I have to sell at a loss, capital appreciation cannot work. Let me repeat. It cannot work.

And yet, that is what we continue to be sold. It is as absolutely as simple as that and it doesn’t take a rocket scientist, Harvard MBA or Ph.D. in finance to see that is true. The problem is quite simply that our world has changed dramatically in the very short time since the 1980’s and our investments haven’t. It is time to change our paradigm. I don’t know how to put it any more simply than that.
_________

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. This article is not a complete discussion of the benefits and risks of the Snider Investment Method®. For a complete discussion, read the Snider Investment Method® Owner's Manual, available by calling 888-6SNIDER. Please read and consider carefully before investing. All investments, including the Snider Investment Method® are subject to risk, including possible loss of principal. Income is objective and not a guarantee. Dollar cost averaging does not guarantee you will not experience capital losses.

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)

---

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.