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Lost Money? Get Over It
By Stephen J. Butler Archives

The flood of letters from market timing advisors has increased its pace since the market decline began last year. If you have even a touch of bi-polar disorder you do not want to open these envelopes. They will trigger a severe bout of depression.

For example, a solicitation for an investment letter called Bob Brinker's Marketimer came this week which really makes me wish I had spent the $185 and listened to Bob. Bob, predictably, advised everyone to be 60% in cash as of January 2000.

The advertising piece points out that he was also committed to stocks throughout the '90's when many market timers were banking their fires with investments in cash. As market timers go, Bob has a huge following because he does appear to be one of the best, and there is much to learn from what he has to say about the markets and investing in general. As to his results? Who can ever know for sure. His model portfolio barely beat market averages from 1990 through August of 2000 (just 3/10th% per year better). Through August of 2001, his results improve dramatically to results that are 2.6% per year better, but his model portfolio does not include a recommendation in his newsletter that called for an investment in the QQQ (a NASDAC Index fund.) So who are we supposed to believe? The model portfolio or the letter?

Meanwhile, none of these results take into effect the cost of timing's tax impact and loss of capital from selling funds and paying taxes on gains as we move into cash periodically. Fortunately, in retirement plans, this is not an issue. However, for those timing their taxable assets, the tax costs alone makes this strategy very expensive and easy to beat with a passive investment strategy. Remember, with an index fund that rarely sells assets, there is no annual taxable event to speak of. You pay capital gains taxes eventually but only on what you take out -- much like a retirement plan. We can argue until the cows come home (as we used to say back in Vermont) about whether or not it matters WHEN you pay taxes. I, for one, want to get to retirement with the largest possible amount of money. If I have to pay more in taxes at that point, and I have more to pay because I didn't chew into my capital by paying them along the way, then I will consider that to be one of the most delightful problem-solving experiences of my career.

A review of the daily performance of the S&P 500 can be instructive. It illustrates that major annual gains occur on single days. Amazingly, just two days a year when the market is up 5% adds 10% to the annual rate of return. It is interesting to see how much of the market's increase in value is concentrated in a relatively small number of days, and sometimes these special days occur right in the middle of an otherwise downward trend.

By extension, the same is true when we look at years. In the crash of 1929-31 the market lost about 60% of its value. But in '33 through '36 it more than tripled in value. A market this volatile offers a terrific tool for those who are dollar cost averaging and investing at a methodical, monthly rate. This describes 401(k) investors who are purchasing mutual fund shares today at the lowest prices since 1998.

Stocks are the only things we tend to buy only after they get expensive. With everything else, be it cars, furniture, clothing, or other consumer goods, we struggle to find a deal. We wait until something is on sale. We load up those big carts at Costco or Sam's Warehouse and buy a year's supply of shampoo because we save so much money. Yet, when stocks become a relative bargain, like they probably are today, our natural tendency is to sit on the sidelines and wait for them to get expensive again.

Most retirement savers have managed to play it smart. Hewitt Associates, a major international employee benefits firm, reported the degree to which 401(k) investors were moving out of equities and into cash. The rate was nine times greater than normal. What the statistic did not point out was that "normal" was almost non-existent. The average 401(k) investor makes almost no investment changes at all.

Another helpful thought: daily stock prices are determined by those who are actually buying and selling on a given day. The concept is called "marked to market" and it means that the entire company is valued based upon the sale of whatever small portion is traded in the markets. If more people are selling on a given day than there are buyers, then the stock prices can drop dramatically. This can be an accident in timing more than any wholesale erosion of public confidence in the economy. It is also usually an overreaction to some event. Taking advantage of these "market inefficiencies" explains in part how Warren Buffet became so successful. (A previous column explained "marked to market" and is available at www.pensiondynamics.com under "This Week's 401(k) News.")

Mutual fund market timing newsletters are not without some merit. They're just not as valuable as their hyperbole would have us believe. After all, pure chance plays a role in the success of at least some timers with recent above-average results.

I must confess that I have learned a few things from the advertising pieces themselves. However, the danger is that this flood of advertisements will leave us feeling badly that we have done something wrong by staying in the market. Worse yet, they can prompt us to sell into the teeth of the recent declines.

It is important to remind ourselves that we sat down years ago and planned to invest for retirement over a long period of time. We agreed that common stocks were the best long-term investment, and we accepted the fact that returns would fluctuate substantially. Bearing up under this risk is the price we pay for earning an average of 10-12% over time rather than 3% in a risk-free money market fund. There is no free lunch. If there IS a market timer who will remove that risk for the cost of an annual letter, it is impossible to know, prospectively, which one of the many contenders is capable of beating market averages. Let's acknowledge our vulnerability and summon up our resolve to stay the course and stick to the basics. -end-

BUYandHOLD does not recommend any securities. The securities mentioned above are being used for illustrative purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy.