The financial media is pleased to report that the best performing mutual fund of the decade is Ken Heebner’s CGM Focus fund.

Through the end of January, 2010, the mutual fund annualized 18.03%, easily outpacing the S&P 500’s annualized return of -0.55%.

Did you miss these returns? Not to worry, because the typical investor in the CGM Focus mutual fund also missed out on the returns. Unfortunately, there is a big difference between investment returns and investor returns.

The financial media always focuses on investment returns. In other words, what did a specific investment return? In this case, the media focuses on the great track record the CGM Focus mutual fund had over the last decade.

Of course, the media rarely focuses on investor returns. In other words, how did the typical investor perform in the same investment? Luckily, Morningstar calculates dollar-weighted returns, which represents the returns real investors receive based on buying and selling.

Here are the 10-year annualized results through the end of January, 2010:

• CGM Focus: 18.03%
• Typical CGM Focus Investor’s return: -13.73%

How can this be? How did investors lose money in the best performing stock fund of the decade?

Simple. Poor investor behavior.

Most investors make buy and sell decisions based on past performance. As the financial media was happy to point out, CGM Focus returned 80% in 2007.

Believing this trend would continue, investors poured a whopping $2.6 billion into the fund in 2008.

Then, in horror, investors watched as the fund tanked -48.2%. Disappointed with the results, investors yanked more than $750 million out of the fund.

The typical CGM Focus investor missed all the gains in 2007 and captured all the losses of 2008.

Don’t fall victim to poor investor behavior and media hype. Understand there is a difference between investment returns and investor returns.

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With the dawn of a new decade arrives the financial media’s recommended investments.

Articles with attention grabbing titles such as “10 Stock Investments for the Next Ten Years” entice readers with promises of market beating returns.

But should you follow media’s investment recommendations? Consider the following articles published ten years ago.

In August, 2000, a Fortune magazine article presented “10 Stocks to Last The Decade.”

How would these ten stocks have performed if you spread your investments equally among each pick versus the market and a fully diversified portfolio*?

• Fortune’s 10 Stock Investments:  -44.21%
• S&P 500:  -7.26%
• Diversified Portfolio: +81.04%

Time period – August, 2000 through November, 2009.

Fortune’s stock picks drastically underperformed both the market and a fully diversified portfolio.

A second article by The New York Times asked for Buy and Hold picks from “10 very smart, very successful investment professionals…”

So how did these stock picks fair versus the market and a fully diversified portfolio?

• New York Times:  +25.17%
• S&P 500: -4.29%
• Diversified Portfolio:  +84.35%

Time period – February, 2000 through November, 2009

The New York Time’s picks beat the market but it seems a passively managed diversified portfolio drastically outperformed these “very smart, very successful investment professionals…”

Think twice before rushing out and investing your money in any of the media’s picks for the next ten years!

Having a financial plan and a fully diversified portfolio based on this plan is the best bet when investing for your goals and future.

*Fully Diversified Portfolio:
Dimensional US Adjusted Market 2 Index: 30%
DFA Equally Weighted Emerging Markets Index: 5%
Five-Year US Treasury Notes: 40%
Dimensional International Market Index: 25%
Rebalanced annually

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Rarely do you see a headline in a mainstream newspaper containing the three words, “Yale,” “Harvard,” and “Losers,” but that’s exactly what happened last week in The Wall Street Journal.

The Journal certainly wasn’t talking about the Universities’ academic prowess or even their athletic exploits; rather, it was the disappointing performance of their once invincible endowment funds.

The value of their endowments each dropped by 30 % for the 12 months ending June 30, 2009. By comparison, a typical plain-vanilla endowment allocation of 60 % stocks and 40 % bonds lost only 13 % during that period, according to the Journal.

What’s newsworthy about these losses is that Yale had pioneered an unorthodox approach to endowment investing that worked spectacularly for years (and was copied by Harvard), but like many investment ideas, it eventually ran into a brick wall.

Under the leadership of David Swensen, Yale’s portfolio mix changed dramatically.

For example, the allocation to private equity rose from 3.2 to 20.2 %; real assets – timber, real estate, and the like, rose from 8.5 to 29.3 %; and hedge funds went from zero to 25.1 %. To accomplish this mix, the allocation to domestic stocks and bonds dropped from 71.9 to 14.1 %, according to a March 2009 article from Portfolio.

Essentially, Swensen argued that endowment funds should avoid traditional stocks and bonds and, instead, invest in higher yielding and less liquid assets that more closely match an endowment fund’s long-time horizon.

So keep in mind – even the best and the brightest such as Swensen eventually stumble, if only temporarily.

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A recent Wall Street Journal article epitomizes the new “conventional wisdom” that asset allocation failed in 2008.

It is true that correlations among major asset classes have increased in recent years giving the impression that asset allocation no longer works.

During the 2008 financial crisis all major equity asset classes experienced severe declines. Even commodities, which historically had exhibited low correlations to equities, dropped dramatically.

This does not mean that diversification and asset allocation failed.

• High-quality fixed income securities, i.e. U.S. Government bonds, of all maturities were a safe haven and had returns ranging from 1.6% to 25.8% percent in 2008.*
• Financial and economic shocks are rare occurrences, and investors must understand that they are part of the risk of investing in equity markets. Correlations historically have increased during economic shocks but returned to more normal levels as economic conditions normalized.
• Asset allocation depends on individual circumstances. If one has a high overall risk tolerance and a very long investment time horizon, accumulating shares during bear markets may be a wise strategy.

The major problem is, so many articles in the financial press are devoted to attempting to avoid investment losses. These articles make it seem that market timing can work for most investors. Many nervous investors needlessly adjust portfolio holdings, usually to their long-term detriment, in an attempt to grab the current “trend.”

In reality, alternatives like market timing, short selling, and stock picking have historically tended not to work as claimed for most money managers.

Your best bet for financial success is to stick to your plan and your appropriate asset allocation.

*Source: DFA Returns 2.0; One-month T-Bills and Long Term Government Bonds, respectively.

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This question has been coming up a lot lately in the media and some academic journals. Thinking Modern Portfolio Theory died last year is based on the misconception that Modern Portfolio Theory will guarantee against a loss.

That is simply not the case. What MPT believes is diversification to a portfolio, which over the long term can potentially reduce a portfolio’s volatility versus a single asset portfolio.

According to a recent article in Investment News:

• MPT does not guarantee against a loss
• Fixed income helped reduce the amount of loss in many portfolios last year
• Many advisors are finding that their clients had too much equities and not enough fixed income for their risk tolerance

Remember, when investing in a diversified portfolio, you will experience negative returns periodically.

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According to a recent article in CNN Money, only if you attempt to sort out the handful of winners from the rest of the market.

As the article points out, the majority of indi­vidual securities tend to post negative returns over the long run.

In fact, research by Dimensional Fund Advisors found that from 1980 to 2008, the top-performing 25% of stocks were respon­sible for all the gains in the broad market, as represented by the University of Chicago’s CRSP total equity market database.

As for the bottom 75% of stocks in the U.S. market, they collectively generated annual losses of around 2% over the past 29 years.

So what can you do?

According to the article, diversify as broadly as you can. With a small list of stocks, it’s easy to miss out entirely on the top 10% performers. Doing so would have cut your annual returns to 6.6% from 10.4% over the past 29 years.

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From the January, 2000 Smart Money Magazine:

“The Underachiever’s Club – Thanks for Nothing: Sixteen mutual funds reopened to new investors in 1999. But returns for these three make you wonder why they bothered.”

The three mutual funds highlighted in Smart Money’s “Underachiever’s Club” were:

• Lord Abbett Small-Cap Value
• Neuberger Berman Genesis
• Vanguard Windsor

The Smart Money article focused on each fund’s market underperformance since reopening – a period of only six months! Six months is hardly enough time to judge an investment or investment strategy.

Of course, it’s easy to find winners and losers using hindsight. The problem was, this article highlighted these funds as losers although they were on the verge of outperformance.

Look at the subsequent five-year (2000-2005) compound returns for each of Smart Money’s “underachievers” versus the general market.

• Lord Abbett Small-Cap Value: 17.05%
• Neuberger Berman Genesis: 17.44%
• Vanguard Windsor: 7.62%
• S&P 500: -1.13%

Investing based on tips from the financial media is dangerous to your wealth and will not help achieve your goals.

Finding an advisor you trust and developing a plan with that advisor will!

*This article does not represent a recommendation to buy or sell the mentioned funds. Past performance does not guarantee future results!

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The financial media is back at it.

A recent article in the Financial Times announced that “Anyone who started saving 40 years ago…has found that stocks have performed no better than bonds.”

The article also contains a graph that proudly displays over a 20-year span, from 1929-1949, bonds beat stocks.

Further, the article continues with opinions that stock investing is dead and gives examples of real investors damaged by this market. (We can’t dispute this last part, as many have been damaged by this down market. However, the article tells us nothing about the planning or investment strategy these people followed.)

Of course, the article offers no solutions.

First, let’s examine the claims.

Looking back at the data from February, 1969 through February, 2009, Long-Term Government bonds annualized 8.65% while the S&P 500 annualized 8.44%.

From January, 1929 through December, 1949, Long-Term Government bonds annualized 4.02% while the S&P 500 annualized 3.80%.

And there it is.

The data that proves bonds beat stocks over long periods of time.

Of course, it would have been nice if the Financial Times (or anyone, for that matter) told us in 1969 or 1929 this would happen. No one did.

And, who in the real world does this data apply to?

It only applies to those who invested all their money in stocks on the exact date in 1969 or 1929, and had to withdrawal their entire sum in February, 2009 or December, 1949.  That is an unlikely scenario.

But that is beside the point. The real point is, anyone can make a case for anything using hindsight and data mining.

For instance, take the 1929 through 1949 period. How are the returns affected by simply moving the time period forward one year, from 1930 through 1950, and fully diversifying* the equity portfolio?

• Long-Term Bonds annualized return: 3.86%
• Fully diversified equity portfolio: 9.39%

And, what if we move the time period back one year in the 1969-2009 scenario, to 1968-2008?

• Long-Term Bonds annualized return: 8.34%
• Fully diversified equity portfolio: 11.10%

Simply moving the time period makes a big difference!

For you, the reader, these articles are pointless and will do nothing but scare you into inappropriate behavior.

The best move to make is to develop a financial plan with a trusted advisor, and implement the plan with a portfolio specifically targeted for your personal goals. Then, meet regularly with your advisor and adjust the plan and portfolio as needed.

And leave these articles to those who believe everything they read.

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* Diversified Portfolio:

Rebalance: Per 12 Months
Fama/French US Small Value Index (ex utilities): 25%
Fama/French US Large Value Index (ex utilities): 25%
Fama/French US Large Growth Index (ex utilities): 25%
Fama/French US Small Growth Index (ex utilities): 25%
Currency: USD

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A recent article in The New York Times announced that sound investment strategies might have run their course.

It warned investors it could take as long as 20 years for stocks to regain their losses. As evidence to back up this rather large assertion, the article mentions from 1966 through 1982 — a full 16 years — stocks returned almost nothing.

And it’s true – that fact, without the key addition of any perspective or back story, is enough to scare anyone away from ever investing in stocks again.

Looking back over that 16-year period, we see the S&P 500 closed at 94.06 on February 9, 1966.

On August 12, 1982 – 16 years later — the S&P 500 closed at 102.42, barely above the February closing of 1966.

It’s easy to see, then, that stocks can do nothing over long periods of time. This leads many to believe the current market can, and probably will be as “bad” as this ’66 — ’82 period.

Of course, there is one major flaw in that assumption.

Why do dividends matter?

The article discloses the figures provided are a “price-basis” only. So what exactly does this mean? It’s simple: they don’t include dividends.

And dividends have a major impact on total return.

For instance, if you bought the S&P 500 in February 1966, and held them for 16 years through to the end of August 1982 — and reinvested your dividends along the way — your annualized return would have been 5.80%.

Not as bad as the article makes it seem, right?

How important is diversification?

What if you, as a prudent investor…

• Diversified your portfolio* by putting 30% into Treasury Notes
• Divided the rest between large and small U.S. stocks
• Rebalanced the portfolio annually
• Reinvested all dividends and interest during the same period

The results? Your annualized return would have been 8.40%.

That’s certainly not what I’d call “doing nothing” over a 16-year period!

I’ll give the article some credit for encouraging investors to diversify, especially through the use of U.S. Treasury Bonds. While this is good advice, it is old news to prudent investors who always hold and rebalance a fully diversified portfolio.

Sound investment strategies will never run their course.

* Portfolio – 02/1966 to 08/1982. Rebalanced annually. Components: Dimensional US Adjusted Market 2 Index: 70% Five-Year US Treasury Notes: 30% The S&P Data are provided by Standard & Poor’s Index Services Group January 1926-December 1989: S&P 500 Index Ibbotson data courtesy of © Stocks, Bonds, Bills and Inflation Yearbook^TM, Ibbotson Associates, Chicago (annually updated works by Roger C. Ibbotson and Rex Sinquefield).

Investors can not invest directly into an index.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.

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Every January, USA Today asks the “best minds” in the financial services industry for their thoughts on how the S&P 500 will do.

As you can see below, their predictions were less than stellar in 2008.

2008 Predictions for the S&P 500

• Abhijit Chakrabortti (Morgan Stanley): 1520
• Richard Bernstein (Merrill Lynch): 1525
• Stuart Freeman (A.G. Edwards): 1575
• Rod Smyth (Wachovia Securities): 1590
• Thomas Lee (JP Morgan Chase): 1590
• Tom McManus (Bank of America Securities): 1625
• Abby Joseph Cohen (Goldman Sachs): 1675
• Tobias Levkovich (Citigroup): 1675
• Jason Trennert (Strategas Research Partners): 1680

And the real result? The S&P 500 began 2008 at 1468 and ended at 885

Source: USA Today. 2008 predictions for the S&P 500. January 2, 2008.

2008 was an unusual year, no doubt.

But if “expert strategists” can’t gauge even the ballpark performance – let alone the direction — of a single index right, how much confidence can we have in their ability to build a quality portfolio?

Need further confirmation that active management creates significant risk?

Check out their ability to choose successful stocks: USA Today asked five prognosticators to select their top 5 stocks for 2008.

Their top picks returned -44% in 2008 … easily outpaced by the S&P 500′s -37%.

This track record sends a very important message to investors: you shouldn’t depend on what these experts see in the crystal ball for 2009. In reality, flipping a coin would likely offer you the same level of accuracy.

While markets can be chaotic and unpredictable in the short term – as we are experiencing now — over the long-term they are remarkably efficient, and almost impossible to beat.

Resilient investors make the choice to follow a prudent, diversified, consistent approach… and stay the course.

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