Sunday Musings: Making Up Is Hard To Do

Ulli Uncategorized 11 Comments

Last Monday, I talked about a reader’s question regarding the use of DCA (Dollar Cost Averaging) with trend tracking. GH had an interesting comment on the subject:

I am not a user of DCA nor would I recommend it. However, one should have all his facts straight before coming to any conclusions.

Here is the most interesting fact regarding DCA that I have ever come across, this should surprise some people:

If you had begun investing in the 30 stocks of the Dow just before the Crash of 1929, and you allocated exactly $15.00/month for the next 20 years, as the infamous John J. Raskob recommended in the Ladies’ Home Journal, 1929 to 1948, you would have realized a compounded annual return of better than 8%.

That’s right, and that’s not bad is it? And it is even more surprising when you consider that when you started this plan the Dow was at 300 and at the end of 20 years that same Dow was at 177.

Just another angle to consider.

While that indeed is interesting it is also a very similar argument that the buy-and-hold crowd makes in that if you held on to your investments for x number of years, your compounded annual return would be x percent.

And that presents a problem. No one I know of does these exact things over such a long period of time. In 2001, as the bear market was in full swing, I received a call from an investor who had seen his $1.2 million nest egg sliced in half.

Since he was getting ready to retire, his financial life had been changed forever. No argument could convince this man that over the next 30 years or so, he would be making up his losses, based on historical returns.

That’s why the long-term arguments for buying and holding an investment are flawed. They look at things with the benefit of hindsight and don’t consider the ill effects of a bear market on an individual portfolio when the individual is least prepared for it. In other words, life does not issue margin calls at your convenience.

2008 was another good example of how those entering their retirement years, and did not sell out before the crash, will now have to get by on less. Even if you have many years to go before leaving the job market, you will have to spend a lot of time making up investment losses.

Sure, the rebound rally has many pounding their chest that the S&P; 500 may end up in plus territory by 20% for this year. But that is not the entire story. Last year’s losses were so severe that it’ll take a while longer to get back to the breakeven point.

I have mentioned this before, but when our sell signal kicked in on 6/23/08, the S&P; 500 stood at 1,318; it closed last Friday at 1,091. That means another rally of +20.75% is needed just to get back to the point of where we sidestepped disaster.

Maybe we will get there, maybe we won’t. Given the rally we have seen this year, it seems like a long hard road ahead to squeeze another 20% out of a market supported by very questionable economic conditions.

It’s no secret that for this decade the S&P; 500 has lost 26%, most of it thanks to last year’s market crash. If it had not been for that debacle, we may have ended up the decade with at least a zero gain, but not a loss.

I looked back and found that the dividend adjusted value for the S&P; 500 was 1,469 on 12/31/1999 and had reached 1,481 on 11/30/2007. From that point on it dropped 26% as of last Friday, while via trend tracking we’re down 7% in clients’ accounts for the same period.

The bottom line is that bear markets not only destroy portfolios but also subsequently require you spending an inordinate amount of time making up losses. To me, as a trend follower, the better way is to minimize any losses (you can never avoid them altogether) in order to climb out of the hole faster.

Finally, for many investors the entire process will repeat itself when the next sharp downturn will wipe out this year’s accumulated profits because they do not have the foresight to use any exist strategy to lock in gains. Continuing to ride the Wall Street roller coaster without a plan or disciplined approach will make you realize that making up is indeed hard to do.

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Comments 11

  1. Ulli,

    The people I speak with are so happy now that they have almost got back to even and my question is what will they do when they are back to even if that should happen? The way I think of what is going on is illustrated in this little story about a guy who jumped off a 20 story hotel building and about half way down someone from the 10th floor yelled at him as he was falling by, how is it going? His reply was fine so far. I believe that sums it up very well. Most people will just ride it down again because their confidence is very high at a top in the market whenever one arrives.

  2. All baby boomers, who were sold DCA magic have to work now till 70 or 75…
    Because last year all their lifetime savings vanished in half. Now even walmart greeter job is also a dream job. People in USA are refusing to see financial dynamics change happening 'outside USA'.
    Current ralley is another bubble waiting to burst. Why ALL companies are suddenly performing the best, since March 2009??????

  3. You just hit the nail on the head. Investment managers are full of "What if…" scenarios. What they conveniently fail to recognize is that THEY don't assume any of the risks. Investors in their funds do. They make less fees on lower assets or higher fees + bonuses on higher assets. Investors lose real money.

    Let me give you another one, since the original poster came up with a scenario, that is also popular. "What if you were out of the market on the best 10 days over the past 10 years?". Anecdotes will claim results would be 50% less or something like that. Needless to say, they never ask the question "What if you were out of the market on the 10 worst days in the last 10 years?". I'm sure no one wants to spend any time figuring that one out right? Why would they? It doesn't help their argument.

    The idea behind smart buying and selling is common sense. There is nothing smart about buy and hold because it deals on hindsight. What matter is how are things today. You make decisions based on today and not on "What if". Then again, as the saying goes "Common sense is uncommon".

  4. Some parting thoughts on DCA:

    1. DCA does not have to be married to buy-and-hold. Some of the same people who praise the virtues of DCA also recommend adjusting your portfolio components between stocks and bonds depending on current prices of markets. For example, if you were 75/25 equities/bonds respectively in 2007 you would have been well advised to shift to 50/50 or 25/75 equities/bonds respectively in light of inflated market prices and looming problems in the financial industry.

    Although the word sell is not explicitly used in this example that is in fact what is implied, selling or exchanging a portion of your equity component to bonds. This would not prevent bear market losses in your equity component but it would provide substantial protection for your overall portfolio. And you would still be applying new funds regularly to your portfolio except you would be placing them in bonds rather than equities until such time as appropriate to shift the balance.

    2. Over what period of time do you pay life insurance premiums? Auto insurance premiums? Homeowners insurance? A lifetime right? Then there is no reason other than lack of discipline why a person cannot engage a structured savings program such as DCA. And reasonably expect the same results as have been achieved in any lifetime span of the stock market.

    3. DCA can remove some of the emotions from investing that can trap the unwary investor. By spreading the purchase of equities over regular intervals it will prevent the investor from being drawn into buying too much at market tops and guarantees buying when stocks are undervalued.

    Finally, before you can discount DCA altogether, some evidence is going to have to be produced showing DCA failed the investor who had 20 years to work with. Any 20 years. And show by how much competing strategies out-produced it.

    Now, I see some disagreement in this thread regarding examples used to show DCA has some positive benefits. That works both ways. Using examples of people who have lost half their life savings does not so much show the perils of the stock market as it serves as an alarming scare tactic to peddle a product. Frankly I’m a little surprised to see such stories used here. Ulli’s methods are tried and proven, they stand on their own merits and they speak for themselves. I see no need to use tragic stories to sell them.

    Anyone who is close to retirement and has left themselves exposed to the stock market with a substantial nest egg deserves whatever they get. And I don’t believe this man or any other actually lost half his retirement in the stock market. If this man had 1.2M in the market then he also had substantial equity in bonds, CDs, real estate property, and likely some form of marketable intellectual capitol as well. He still has those things, they weren’t wiped out by the stock market. Now, has he still lost half his retirement?

    I can think of only three reasons why such a thing might happen to a man, 1. His money came to him far too easy for him to understand the value of it, 2. He was too busy accumulating wealth to understand that accumulation is only half the job, 3. Greed. Easy come, easy go.

  5. G.H.

    DCA works great, but only if one still uses trend timing otherwise it will produce small gains over time due to the effects of the terrible bear markets.


  6. Linda,

    Great. Now, how are you defining "small gains over time" and how do your trend timing results over the same time period compare?

  7. G.H.

    Small gains like maybe 5% depending on how aggressive you are over 10 years as an example using DCA, but using a money market fund for the DCA and investing when the trend turns up and back to money market when the trend turns down is well over 9% at worst and using Two For The Money method by Al Thomas at (look for the link on the red verticle arrow on left side that says Two For The Money) read up on the instructions, will do about 12-15% using only two funds FUNDX long and RYURX bear over the last 10 years.

    It sounds like you have a closed mind and are dead set on DCA no matter what, if that is the case I am afraid nothing is going to change your mind.

    Hope that helps.

    Linda De Trader

  8. G.H.

    The DCA method would have worked good from 1982 thru 2000 secular bull market, but from 2000 thru the next 12 to 20 year secular bear like we are in now will most likely be a disaster for someone starting their DCA in early 2000 and holding thru this secular bear. Sure we are in a cyclical bull market at present, but don't kid yourself this market is vunerable over the next few years. Sure if you hold 40 years you might come out ahead but in 40 years I will be in the ground.

  9. Linda said:

    "It sounds like you have a closed mind and are dead set on DCA no matter what…"

    Linda, reading is fundamental. Let's take a look at what you missed:

    "GH had an interesting comment on the subject:

    I am not a user of DCA nor would I recommend it. However, one should have all his facts straight before coming to any conclusions."

    This is what's called offering an alternative viewpoint. Furthermore, I've been a user of Ulli's methods since 2004 and have been actively supporting the TTI methodology on this blog since its inception.

    The main point is that I'm offering examples using verbage such as "allocated exactly", "20 years", and "would have realized."

    And I'm not going to find much useful value in language like "maybe", "at worst", "will do about."


  10. G.H.

    I agree with you although my method of trend timing produded 19% annualized rate of return over the last ten years. What I did was DCA as money came available to invest during uptrending markets into my long funds, but went to bear fund during downtrending markets and DCA into the bear fund till the next uptrending market started. I have been in this business since 1968 so I believe I know what I am talking about, hope that answers your concerns G.H.

    Linda De Trader

  11. G.H.

    How would exact figures 16.988% over the last 11.36 years sound for an annualized rate of return? That is trend following with DCA into long positions during those secular bull markets like 1982 to 2000, but during the secular bear markets from 2000 to now I DCA only into cash account. Hope that clarifies some questions because I don't think Linda De Trader knew exactly what she got in annualized rate of return over a long peoiod, who would as one loses track, but can only estimate what it was. It looked to me too like you were closed minded about DCA as you were so defensive in the earlier message and comdemning everyone who confronted you on the subject.

    Jolly good day mate.

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