Interpreting financial information can be difficult and often confusing. Someone on TV or in print suggests gold is a good buy and someone else says it is not. Talk show guests offer a stock pick they believe in while another analyst pans the same stock.
It is no wonder that the average investor makes mistakes which in the end costs them both time and money. Whom do you trust? Whom do you believe?
Let’s look at some statistics that often open the door for interpretation.
Impact of the Best and Worst Days: You probably have heard a equity sales pitch that quoted the return for the S&P 500 which has earned 8.4% per year for the last ten years ( true, for the period ending May 31, 2005). This statement is usually followed by “if you missed the 10 best days in the entire 10 year period, your average return falls to 3.4%”. Also statistically true.
This analogy is used by the “buy and hold” sales people who do not manage money and are trying to sell products quickly so they can go on to the next person. Buy and hold works in a secular bull market period like 1982 to 2000 when the major stock indexes gained 1287% during that period.
In the secular bear market from 1966 to 1982, however, when the Dow gained only 5% (cumulative), the buy and hold strategy doesn’t work.
The corollary to the best-days scenario is “if you missed the 10 worst days in the past ten years, your average annual return increases to 13.4%”. The difficulty of course is determining when the worst days occur (or the best).
Professionals who actually manage money do analyze their portfolio selections daily for both positive and negative trends. Once an asset class or sector breaks down, the money manager should rotate away from the deteriorating asset in favor of one that is showing a positive trend.
Professionals who manage money and are not just sales “asset gatherers” can also determine that an under-performing asset is sometimes worth holding in spite of a temporary weakness in performance.
The average investor that works solely on their two basic emotions, fear and greed, is doomed to lower returns because he or she cannot understand the “why” of selling. Selling is the hardest part of the equation (buying is easy). Selling requires knowledge of valuations or trend analysis, not euphoria or panic.
Value Vs Growth: Equity investing has always fought this battle of style. Of the two camps, the more conservative “value” style has produced better returns over the last ten and twenty year periods. But the “growth” style has come back in the year 2003 and again this second quarter of 2005. Most investors should stay with the majority of their equity assets in value stocks that offer less spectacular returns but are more consistent, even in the bad equity years.
Investors can offset their investment shortcomings by first determining their investment objectives. This is accomplished through the exercise of financial planning. Those who have gone through the analysis of retirement planning, for example, know what rate of return they are targeting in their portfolio to make those assets fund their cash flow needs. This is risk controlled “investment by objective”, not investment for maximized return. In this scenario, the more conservative value stocks may be sufficient to grow the portfolio over time, without the unnecessary risk of the more aggressive growth stocks.
Investing is not simple or easy; but with careful planning it can be effective if tailored to your specific needs.
George Luciani is President of Capital Planning Advisory Group, Inc. located in Yardley, PA.
Reprinted from and with the permission of the The Times of Trenton
