Saturday’s post “Buyer Beware of Risk control” elicited a number of reader comments. Here’s one I want to elaborate on:
In your post, “Buyer Beware Of Risk Control,” you highlighted the statement, “It does not really matter how much of a return you make during good times, what matters is how much you keep when the markets turn south.” I feel that is an oversimplification, and you may be inadvertently playing the same game as that of American Century management.
From 1976 to date, the S&P; 500 has provided a buy-and-hold return of 10%/year. If one is satisfied with a 10%/year return, then the (paper) losses associated with bear markets pale into insignificance. And if one compares the bear market negative with the bull market positive returns, then I submit that maybe just the inverse of your statement is more accurate.
First, the buy-and-hold crowd always looks in the rear view mirror and, with the benefit of hindsight, comes up with returns of what the S&P; 500 has done. Just to clarify, for the period from 1/2/1976 to 5/15/2009, the annual compounded rate of return was 7% and not 10% as quoted above.
Second, while that sounds great on the surface, it does not emphasize the pain and agony investors went through, including the 87 crash, to get to these numbers. Bear markets and huge portfolio draw downs along with their emotional impact on an investor’s psyche are not accurately reflected.
Third, the time period of evaluation is critical. For example, the S&P; 500 stood at 1,469 on 12/31/1999. It closed last Friday at 883. That’s a 40% loss over 9-1/2 years for those who simply bought and hold and matched the S&P;’s return. In other words, most investors have made no money during this century and only because they did not apply a sell stop discipline.
Stories like this abound. Recently an investor called and told me that his advisor made him 35% per year for 3 years in a row—before losing 80% in 2008. Put the pencil to these numbers and you realize that, after these tremendous gains, he has lost 50% of his principal. Tell me, where is the value in that? Making great returns is a useless endeavor, unless you can preserve them during market downturns.
Of course, you should strive for good returns during bull markets, but be aware that it is more important, to hang on to a large chunk of your gains when the trend reverses.
Translated into your personal life this means “it’s not how much money you earn, it’s what you keep that matters.”
Comments 9
Ulli,
Sounds like we all are playing on words here, you included. What really matters is that I make money during bull markets and lose less during bear markets than I made during bull markets. It all comes down to the bottom line. I am not in this thing to lose less money in bear markets and making very little in bull markets. I feel so sorry for buy and holders as they are for the most part just lazy uninformed losers who rely on their so called “Money Mangler” advisor. Goo-day mate.
Ulli,
If one doesn’t earn much there isn’t much to keep anyway, so I take issue with that last statement. So lets earn a lot and lose a little and then that statement makes sense. Hope that helps.
Ulli
In today's post, you challenged the 10%/year gain of the S&P; 500 over the 1/2/1976-5/15/2009 performance, and corrected it to 7%/year. Are you sure you're not looking at an inflation adjusted number? I have seen that figure cited as such. I also looked at a bar chart that compared the bull market gains vs. the bear market losses, and therein lies some very significant information. The bull market gains dwarfed the bear market losses.
The S&P; 500 had a value of 90.90 on 1/2/1976. It closed last Friday at 883. If your plug these numbers in a financial calculator, you get an annual compounded rate of return of 7%.
Bull market gains do not dwarf bear market losses. For this century, the S&P; 500 is down 40%.
Ulli…
Buy-and-Hold Investing – For Better or for Worse?“The recent bear market has rendered many investment strategies – like “buy and hold” – obsolete, while the latest 30% rally has rekindled the hope that investors may be able to buy-and-hold their way back to profits after all. Before you make a decision, here are a few must-know facts to consider.
…
Even at an optimistic 12% annual return, it would take nearly five years for the broad market to recover to previous bull market levels.”
Ulli,
Based on the begining and ending values that you indicate along with the begining and ending dates I agree with you Ulli that the SP500 compounded annual growth rate was in fact 7% not 10% as mentioned above.
T.M.
Ulli
With only a cursory review of your market timing/trend following investment approach, I find it to be quite conservative. If I remember correctly, some time early this year, your market timing index was waiting for a 20+% increase before getting back into the market. I took this snippet from the October 8th edition of the New York Times for your and your readers’ consideration. I felt the last sentence in the quotation below was most relevant for
market timers.
H. Nejat Seyhun, a professor of finance at the Ross School of Business at the University of Michigan, put together a study in 2005 for Towneley Capital Management, where he tested the long-term damage that investors could do to their portfolios if they missed out on the small percentage of days when the stock market experienced big gains.
From 1963 to 2004, the index of American stocks he tested gained 10.84 percent annually in a geometric average, which avoided overstating the true performance. For people who missed the 90 biggest-gaining days in that period, however, the annual return fell to just 3.2 percent. Less than 1 percent of the trading days accounted for 96 percent of the market gains.
This fall, Javier Estrada, a professor of finance at IESE Business School in Barcelona, published a similar study in The Journal of Investing that looked at equity markets in 15 nations, including the United States. A portfolio belonging to an investor who missed the 10 best days over several decades across all of those markets would end up, on average, with about half the balance of someone who sat tight throughout.
Doesn’t it all come down to the old fashioned “Buy low and sell high”?
Ulli,
It all boils down to who one listens to as to what they think works best, personally I don't put any faith in these studies that were mentioned because they don't say enough about what if one missed the worst down days. I feel these people are biased to the buy & hope crowd, which will believe most anything that is written.
B.D.