It’s been said that we can count on death and taxes. We should also add “market crises” to the list.

It seems like the stock market is always either in a crisis, recovering from a crisis, or anticipating the next crisis. Indeed, we’ve experienced numerous “crises” over the past four decades including the following:

• In the 1970s, we had stagflation, oil shocks, high inflation, and a stock market that dropped 44% in 2 years.
• In the 1980s, we had the collapse of Drexel Burnham Lambert and the stock market crash of October 1987, which sent the Dow Jones Industrial Average down more than 20% in one day.
• In the 1990s, we had the savings and loan crisis, the bailout of hedge fund Long Term Capital Management, and the Asian financial crisis.
• In the 2000s, we had two bear markets, the subprime mortgage meltdown, and the financial crisis of 2008-2009.

But, guess what? Despite these market crises, the Dow Jones Industrial Average rose from 800 at the beginning of 1970 to 10,198 at the end of last week. That’s nearly a 13-fold increase.

It’s easy for investors to let the events of the day or the “crisis du jour” cloud their thinking.

However, successful investors take a wider view and realize that crises happen, crises get resolved, and while they can sometime be scary, they should not lead you to panic mode.

Related posts:

1. Human Emotions and Successful Investing Human emotion is an important factor in successful investing. Would...
2. The Resilient Investor: Ivy League Endowment Funds Rarely do you see a headline in a mainstream newspaper...
3. The Resilient Investor: Predicting the Economy One outcome of the financial crisis is we have to...

The US stock market has taken investors on a bumpy ride in recent years.

Market volatility has tested investor discipline and prompted some people to question their commitment to equities. While no one knows the future, looking at the past may help you gain a better view of long-term market performance and put the recent market volatility in perspective.

The above chart shows the historical distribution of US market returns since 1926. The performance years are stacked in ascending order by return range. This chart illustrates that:

• Market performance over the past two years has been severe by historical standards. In 2008, US stocks experienced their second-worst calendar return in eighty-four years. Then, in 2009, stocks rebounded strongly to deliver a return in the top quartile of the historical distribution.
• Over the long term, the market’s positive return years have outnumbered the negative return years. Since 1926, the market has experienced a positive return in almost three-quarters of the calendar years.
• Not only are the positive years more numerous, the chart shows a larger concentration of performance in the higher ranges of returns.
• The sequence of calendar returns appears random, suggesting that accurately predicting future performance is a difficult task for any investor or professional manager.

Over time, the market has rewarded investors who can bear the risk of stocks and stay committed through various periods of performance. Therefore, the best strategy is to ignore the “noise” and stick to your investment plan.

Related posts:

1. Stock Market Crises It’s been said that we can count on death and...
2. Best Mutual Fund of the Decade: CGM Focus The financial media is pleased to report that the best...

Human emotion is an important factor in successful investing.

Would it surprise you to know that the worst stocks during the bear market that ran from October 9, 2007 to March 9, 2009 turned out to be–by far–the best performing stocks over the next 12 months?

Bespoke Investment Group did an interesting study where they took the S&P 500 stocks and ranked them from 1 to 500 with 1 being the worst performer and 500 being the best performer during the October 9, 2007 to March 9, 2009 bear market. Then, they sliced this ranking into deciles, with decile 1 being the 50 worst performers, decile 2 the next 50 worst performers all the way to decile 10, which were the 50 best performers.

They discovered that decile 1 (the 50 worst performing stocks during the bear market) turned around and rose, on average, 371% during the next 12 months that ended March 9, 2010. Decile 2, the next 50 worst performers, rose 184% over the ensuing 12 months. By contrast, decile 10, the 50 best performing stocks during the bear market, only rose 30% over the following 12 months. Essentially, the worst stocks during the bear market performed the best during the bull market and vice versa.

The study also showed that the average change of all stocks in the S&P 500 was 122% over the 12 months following the March 9, 2009 low.

This study points out one reason why understanding human emotion is an important factor in successful investing.

Think of it this way: on March 9, 2009, at the bear market low, would you have been enthusiastic about buying stocks that had declined 80-90% over the previous 17 months? Probably not because your emotions would have been so rattled, yet, those were the types of stocks that turned out to be the best performers over the next 12 months, according to Bespoke Investment Group.

As the last few years have shown, successful investing sometimes requires that you gather your courage and do what seems most frightening because the point of maximum “frightening” may also be the point of maximum profit potential.

If you enjoyed this post, please consider leaving a comment or subscribing to the feed to have future articles delivered to your feed reader.

Related posts:

1. The Resilient Investor: Ivy League Endowment Funds Rarely do you see a headline in a mainstream newspaper...
2. Stock Market Crises It’s been said that we can count on death and...
3. Best Mutual Fund of the Decade: CGM Focus The financial media is pleased to report that the best...

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.

If you enjoyed this post, please consider leaving a comment or subscribing to the feed to have future articles delivered to your feed reader.

Related posts:

1. Ten Stock Investments for the Next Decade With the dawn of a new decade arrives the financial...
2. Human Emotions and Successful Investing Human emotion is an important factor in successful investing. Would...
3. The Resilient Investor: Ivy League Endowment Funds Rarely do you see a headline in a mainstream newspaper...

There is a difference between luck and skill and knowing when you are just lucky and when you are successful due to skill is of paramount importance as an investor.

For instance, let’s say you correctly called the flip of a coin five times in a row. What are the odds that you will correctly call the next flip?

Correctly calling five flips in a row might be considered a “hot streak” and lead you to believe that chances are high you can correctly call the next flip. Well, assuming it is a fair flip, there is, of course, only a 50/50 chance that you will be correct because flipping a coin is a game of known probability. The fact is the coin flip has no memory of your hot streak.

And, just like a coin flip, an investor who is on a “hot streak” may simply be lucky.

With millions of investors, odds are that some of them will make winning investments numerous times in a row.

If these winning investors were, in reality, just lucky, but they think they were actually skillful, then that is when the situation turns problematic. The lucky investor may start to think they are infallible and get stubborn when the market turns against them.

Eventually, when the lucky streak ends, it will likely mean serious losses for the investor.

The best antidote we know of to the danger of confusing luck and skill is to remain humble. When our investment strategy performs well, we are very thankful. When it doesn’t perform well, we accept this as part of the market cycle.

The investment business has an uncanny way of turning hubris into painful losses. We think humility is a safer route.

If you enjoyed this post, please consider leaving a comment or subscribing to the feed to have future articles delivered to your feed reader.

No related posts.

Investors are driven by the fear of losing and losing out.

Last winter, as the financial markets were seemingly in a free fall, panic and fear reigned. There was a sense that the worldwide financial system could collapse and that the problem was bigger than the government’s ability to solve it. This fear of losing spurred more selling and it became a vicious cycle – until it stopped.

Today, it’s a completely different picture.

The banking system is back from the brink. Liquidity is improving. The S&P 500 index is up about 50% from its March low. And, the economy is showing definite signs of coming back to life.

Ironically, fear is also returning to the markets. However, it is not the fear of losing money; rather, it is the fear of losing out from making a big killing as the markets recover.

Both types of fear have the ability to dramatically move the markets.

To state the obvious, humans are emotional. For example, we’re emotional about relationships, about work, about politics, about religion, about food, and, of course, about money.

As humans oscillate between the fear of losing money and the fear of missing out on making it, we tend to drive the financial markets much lower and much higher than “reason” might dictate.

The tricky question facing investors right now is, “Will the fear of missing out on a big rally drive this market even higher as investors who have been on the sideline decide they have to get in?”

Back in the late 1990s, the technology-led stock market bubble took stock prices to an unprecedented level that was far higher than justified by “fundamentals.” Could history be repeating itself?

Interestingly, as of last Friday, the S&P 500 index was 22% lower than it was 10 years ago.

For the bulls, this suggests the market still has lots of room to run higher and is in no danger of being in bubble territory.

For the bears, they point to a near 50% rise and say it’s time for a breather.

Ultimately, you should strive to take the emotions out of investing. Your investments should be a means to an end as defined by your personal financial plan.

If you enjoyed this post, please consider leaving a comment or subscribing to the feed to have future articles delivered to your feed reader.

Related posts:

1. The Resilient Investor: Predicting the Economy One outcome of the financial crisis is we have to...
2. The Resilient Investor: Consumer Sentiment The Reuters/University of Michigan consumer sentiment preliminary index for February...

Sunk costs and mental accounting can be hazardous to your wealth.

Imagine you just arrived at a theater and as you reach into your pocket to pull out the $10 ticket you purchased in advance, you discover that it’s missing. Would you fork over another $10 to see the movie?

Compare that to a second scenario in which you did not buy the ticket in advance, but when you arrive at the theater, you discover you lost a $10 bill. Would you still buy a movie ticket?

In these two scenarios, you effectively lost $10, but here’s where it gets interesting. Psychologists Amos Tversky and Daniel Kahneman of Princeton University conducted the above study in 1984.

They discovered that only 46% of the study participants in scenario one said they would spend another $10 to buy another movie ticket. However, a whopping 88% of the subjects in scenario two said they would still spend $10 to buy a theater ticket.

Here’s what happened.

More than half of the subjects in scenario one created a “mental account” for the theater ticket. They equated the $10 they spent on buying the ticket in advance with the additional $10 they would have to spend to replace that ticket and concluded that the theater ticket actually would cost them $20. Paying $20 for a $10 ticket was a non-starter for 54% of the study participants.

Conversely, in scenario two, 88% of the study participants did not create a “mental account” that equated the $10 theater ticket with the $10 bill they lost on the way to the theater.

But, as you can see, in both scenarios, the study participants still lost $10.

So, are humans completely irrational?

Sort of. The participants who lost the theater ticket succumbed to the “sunk cost” trap. They let the price they paid for the lost ticket affect their decision to buy a new ticket even though the two are technically unrelated.

Investors frequently do the same thing.

They buy a security, watch it go down, and then tell themselves, “as soon as it gets back to breakeven, I’ll sell it.”

But, the fact is, a losing security is a sunk cost and there should be no commingled “mental accounting.” Instead, each investment decision should stand on its own and be made based on the most current information.

Remember, you don’t have to recoup a loss in the same way that you generated it. Sometimes it’s best to take a loss and move on to a more promising investment.

If you enjoyed this post, please consider leaving a comment or subscribing to the feed to have future articles delivered to your feed reader.

Related posts:

1. Human Emotions and Successful Investing Human emotion is an important factor in successful investing. Would...

Would you agree that the stock market has been volatile in the last six months?

As you may have guessed, that’s a bit of a trick question. Most people would say that, yes, the stock market has been very volatile since early November 2008.

For example, just from November 7, 2008 to November 20, 2008, the S&P 500 index dropped 19%. It then rallied 24% by January 6, 2009.

But, that was just a tease. Between January 6 and March 9, the S&P 500 index dropped a frightful 28%.

And, just when people thought the financial system was coming to an end, the index turned around and proceeded to rise a whopping 37% from the March 9 low to last Friday.

It’s enough to make your head spin.

But, let’s assume for a moment that you went into hibernation for the past six months and slept right through this volatility. Would you wake up happy or sad about your portfolio?

Well, if your portfolio performed similar to the S&P 500 index, then you’d wake up essentially the same as you went to bed, meaning, there was no net change in your portfolio. Surprisingly, from November 7, 2008 to May 8, 2009, the S&P 500 index moved less than 1%.

That’s right, after netting the 19% drop, the 24% gain, the 28% drop, and the 37% gain, the index is essentially flat.

One of the keys to being a successful investor is to get neither too depressed when the market is down nor too euphoric when the market is up. Checking your portfolio on a daily basis can lead to a daily dizzy spell while checking it on a less frequent basis may help keep you on an even keel.

If you enjoyed this post, please consider leaving a comment or subscribing to the feed to have future articles delivered to your feed reader.

Related posts:

1. Human Emotions and Successful Investing Human emotion is an important factor in successful investing. Would...
2. Ten Stock Investments for the Next Decade With the dawn of a new decade arrives the financial...
3. The Resilient Investor: Ivy League Endowment Funds Rarely do you see a headline in a mainstream newspaper...

“Whoever manages my money better beat the S&P 500! What’s your strategy? What’s your performance? Jim Cramer says buy Lehman Brothers. What do you think of Lehman Brothers? Should I buy gold? ”

A prospective client asked these questions during a meeting last year. When I attempted to discuss goals, he directly focused on investments and described the classic investors mistakes he made over the last decade including:

• Buying technology and growth stocks in 1999 and holding to the end of 2002 realizing a huge loss.
• Buying bonds in 2003, just in time for the bond market to decline. (Yes, bonds can and do decline.)
• Buying a property to fix up and flip in 2006. Still holds the property at a loss and cannot sell as the mortgage is higher than the home’s value.

He planned to retire in a few years and wanted advice but didn’t want to talk about goals. He only wanted to focus on investments and strategy.

After a decade of making mistakes, this investor is still looking for the secret to maximize investment returns. But the reality is this: The more you search for investing secrets, the worse your returns will be!

Now, suppose in 1999 he:

• Identified his goals
• Designed a plan with a real financial planner focused on these goals
• Understood the portfolio was a tool, a means to an end.

First, a financial planner would have helped avoid the classic investor mistakes he made.

Second, a financial planner would have designed a diversified portfolio based on his goals. A portfolio designed with an end in mind!

Last, a financial planner would continually monitor the plan, adjusting goals and/or the portfolio allocation based on the plan. In other words, benchmarking the portfolio against the plan, not an arbitrary index.

The time has come to stop searching for the next “hot” investment or guru who can provide market beating returns.

It’s time to define life goals and design a plan with a financial planner toward achieving these goals.

It’s time to meet with a financial planner on a regular basis to benchmark your portfolio against the plan and adjust as required.

It’s time to understand a portfolio is not the end. A portfolio is a means to an end.

If you enjoyed this post, please consider leaving a comment or subscribing to the feed to have future articles delivered to your feed reader.

Related posts:

1. Ten Stock Investments for the Next Decade With the dawn of a new decade arrives the financial...
2. Best Mutual Fund of the Decade: CGM Focus The financial media is pleased to report that the best...

The occurrence of “market watching” unleashes during a robust bear or bull market. The practice of investors checking the stock market’s daily swings has spread faster than the Pinot Noir fad.

Frequent overused phrases in the media include, “The Market is up big!” or “The Market plunged.”

These market commentary one-liners pop up with increasing frequency at gas stations, soccer fields, grocery stores and permeate everyday life.

But watching the stock market creates bad habits.

Let’s face it-people do not make financial decisions based on what the market does today. Market watching is as productive as staring at a thermometer and shouting numbers in degrees Fahrenheit as the temperature rises and falls by fractions of a degree.

Friends don’t let friends watch the market. A better use of your time is:

1. Determine which of your investments are tax efficient. Most investors have tax deferred accounts (such as IRAs) and taxable accounts (such as joint accounts). Position tax-efficient investments in taxable accounts and  tax-inefficient holdings in IRA accounts.
2. Verify beneficiaries on IRA, 401(k), or any Trust accounts are up to date.
3. Consider refinancing your home. Currently, 30-year fixed rates are below 5%.
4. Have you fully harvested any unrealized losses in your taxable accounts?  These losses have an intrinsic worth as they offset future capital gains and even provide an annual $3,000 tax deduction from normal income each year until fully exhausted.
5. What is the potential estate tax liability if you pass away?  Does your potential estate have the liquidity to pay those taxes or would your heirs have to sell real estate, heirlooms, or even borrow money to meet those tax obligations?
6. What is the deductible on your homeowner’s insurance policy?  It may be too low. If the deductible is $1,000 and you experience a $1,500 loss is it worth filing a claim to collect that $500 and potentially hurt your insurability?  Raising the deductible to $2,500 or higher could lower the premium.

I look forward to a day when investors behave rationally-when they don’t know what the stock market “did” that day. I’m not naive enough to expect good investor behavior, but at least we can take a time out from market watching and focus on areas of our financial lives over which we have control.

If you enjoyed this post, please consider leaving a comment or subscribing to the feed to have future articles delivered to your feed reader.

No related posts.