The gambler, stopped clock and casino owner

We spend a lot of energy anticipating bear markets and crashes and recessions and depressions but the reality is that the vast majority of the time the market is growing - what's your strategy then? 

I've already discussed what not to do with your money so what is the alternative.  If you look at the chart below there are three personalities represented.  In my view there is a gambler, a stopped clock and a casino owner; more on that later. 

What you're actually looking at are the cumulative returns for "bull" and "bear" markets in Canada from the 50's to present day.  Clearly the data supports my thesis that markets support long term growth on average and invested funds, left alone, in good times and in bad will experience growth periods about 75% of the time and negative growth periods 25% of the time, resulting in positive long term growth.  That's not news.

It may help a bit to personify the chart a bit to help makes sense of it all. 

The gambler:

The history of our industry is founded upon the principle of "beating the game".  Most brokers implicitly suggest they can help you predict the future or provide the knowledge and inside analysis that will be sure to give you the upper edge and advantage in the market.  Much like a gambler would enter a casino with a "proven system" or lucky hand and try to beat the roulette wheel.  In the investment world that might mean your broker has promised to "get you out" when markets are heading down, or provide guidance as to when you should “get back in".  The truth: that can't be done with any amount of reliable consistency. 

The stopped clock:

Ever hear of some analysts always predicting doom and gloom?  It is a failsafe system to always be right.  If someone was predicting a market meltdown leading to a worldwide global recession throughout the 90's and into 2000's they would have been able to finally say "I told you so" in 2008.  "See I was right, the market crashed".  it's the old saying, "even a stopped clock is right twice a day".  But at what cost, the opportunity lost by staying out of the market would far outweigh any benefit added by missing the 9 months of the 2008 bear market.  Predicting doom is a booming industry but adds no value when planning for your future retirement or in managing your wealth. 

The Casino Owner:

There is one sure way to make money from the message in the chart below and that is taking on the persona of the casino owner.  Unlike the gambler who tries to beat the game, the casino owner has decided to own it.  And that person knows full well that there will be times when someone walks through the doors and wins big and the casino loses that day, but the numbers are in the casino owners favour, and if he just keeps the doors open, day in day out, enough people will be walking out a little lighter in the wallet to make the business of the casino profitable.  That is my approach.  The data is clear that if we stay invested (keep the "casino"doors open) the overwhelming majority of the time we will be in positive territory and certainly there will be times of loss but they will always be temporary.  We can say short term market movements are absolutely unknowable but the long term trend is inevitable. 

This is the only sure fire way to build your wealth and it is the only responsible way to plan for your future. 

Market timers under the microscope!

http://oldprof.typepad.com/a_dash_of_insight/2012/03/the-seduction-of-market-timing.html

Let's shed some light on dishonest brokers - finally!!!

The link below highlights what I have long suggested to clients are absolutely unscrupulous compensation schemes on the part of brokers in Canada.  If you're not discussing fees with your broker in an open and fully disclosed environment you need to ask yourself what information your missing and how that might be impacting your investment. 

Newsflash - "there's no free lunch!"   

http://thewealthsteward.com/2012/02/the-flaws-in-canadas-financial-adviser-system/

Turn off the Noise - Part 3 of 4 on Market Timing

Noise and non-sense

First off, what do we mean when we say “noise”?  How about the daily and monthly movement of stock prices, or the latest headlines and the endless forecasting of the talking heads on TV and radio?   In our attempts to make responsible investment decisions we logically seek out as much info as possible to inform them.  But much of what we find is of no real value when making long term investment plans.

The challenge we have with data is that our ancient brains process them in ways that are not conducive to good decision making.  It stems from our inherent fear of loss.  And leads to what behaviourists call MYOPIC LOSS AVERSION.

Myopic Loss Aversion –is the combination of a greater sensitivity to losses than to gains and a tendency to evaluate outcomes frequently. The more frequently clients review their portfolio, the more risk averse they become due to the greater frequency that they observe losses occurring. 

In English:  The more frequently you visit an investment value the greater the likelihood of observing a negative result.  Negative results have larger impacts on our emotions, and lead to increased anxiety levels and false conclusions.

For example:

The chart* shows a hypothetical stock portfolio with an average return of 10%, and a standard deviation of 20% (approximate historical stock market returns).  Over shorter periods of time losses appear more frequently.  Real life experience approximates these results.

The tables on this page are from a paper “Risk Aversion or Myopia” by Benartzi and Thaler.  The table of 1-year returns (taken from 10,000 random drawings of US stock and bond returns between 1926-1997) was presented to one group of subjects while a second group was presented with the 30-year annualized return numbers.  Each group was then asked how much they would be willing to allocate to stocks.  The first group (1-year) median allocation to stocks was 40% whereas the second group’s (30-year) median allocation was 90%!

Explanation was that the first group was fooled (by seeing lots of one year losses) into believing the long-term risk of equities was greater than it truly is.   

The evidence is firm, an increase in the global exchange of information via 24 hour TV, internet, newspaper and business news radio hasn’t helped investors attain their goals.   The chart below demonstrates this disparity well:  average stock funds in the US actually return fairly well, but the investors in those same funds do not  - a difference of over half of the return on the fund.  This difference between the two values can be largely explained by our over confidence in our ability to get in and out of those funds at right times.  Beware the noise, it taps into that survival instinct in your brain that screams "run!"; it narrows the vision, and limits your ability to remain calm in the storm.   

Do your retirement a favour and learn to avoid the noise.   It takes a while to be able to discern between valuable financial education and plain old business news entertainment, but it’s worth the effort. 

Inflation charts your broker forgot to mention...

I've probably done over 100 financial plans in my career and it always amazes me when we start to adjust for inflation - brings everything down to earth.  Going to post a couple of items to show its impact as well as make a case for managed money in an age of fear. 

No 1 is courtesy Norman Rothery:

http://www.theglobeandmail.com/globe-investor/investment-ideas/behind-the-numbers/the-stock-market-chart-your-broker-wont-show-you/article2302406/

Part 2/4 on Market Timing Mistakes - Most common outcomes

"I'm going to wait until the market bottoms / feels better / flatlines / breaks its 90 day moving average...."

I've heard it all and it's all garbage.  Waiting for any realiable technical indicator of predictive value is going to kill your returns.  It'll smash your portfolio to pieces and leave you an emotional tattered wreck.  Investors invariably miss the best market days when they're waiting for a time that feels good to get invested.  Recoveries and bull markets always climb walls of worry and by the time BNN is giving you good news and the talking heads are crying "buy" the big gains have already passed.  Your gut is wrong, don't trust yourself, look at the slide below:  If you miss just the best month of any given year the impact to your total return is huge.  In some cases all or most of the calendar year return by missing just one month.

The long term view is even more dire.  The next image illustrates the risk of attempting to time the stock market over the past 40 yrs and 6 months.  An hypothetical $1 investment in stocks invested at the beginning of 1970 grew to $39.19 by June 2010.  However, that same $1 investment would have only grown to $15.28 had it missed the eight best months.  One dollar invested in cash over the same period would have done better at $15.62.  The unsuccessful market timer, missing the best eight months of stock returns, would have recieved a return below that of cash and would disdainfully procalim, "markets are broken, it's all a big scam".  The only scam is the one we unwittingly pull on ourselves. 


Dangers of Market Timing
Hypothetical value of $1 invested from Jan 1970–June 2010

About the data

Stocks are represented by the S&P/TSX Composite Index and cash by the 90-day Canada Treasury bill—data from the Bank of Canada. An investment cannot be made directly in an index. The data presented herein assumes reinvestment of income and does not account for taxes or transaction costs.

I wish we were hardwired a little differently but that might just be too easy wouldn't it?  Good investing is always going to be counter intutive.  If your advisor is constantly adjusting your portfolio to suit your current forethought du jour, then your likely going to be following the crowd.  Day to day your gut choices, confirmed by your advisor who just doesn't want to lose your business, will seem like good choices.  But over the long term you'll be stymied and frustrated.

Next up, recognizing and ignoring the "noise"...

Part I: Yet another last word on Market Timing or why Jim Cramer is not your friend.

How many times have we done and over done the old debate about timing the markets?  Too many to count and yet the conversation doesn't end. There is a good reason for that.  It is core to one of our central needs as humans: there is an intense human need to control those things that are, to variuos extents, beyond our control  - the weather, our health, life, death, and above all, the future.  That is the heart of the matter in this debate.  It is in our nature to look for advisors who might have an edge or give us some insight into the future, and put us on the path to riches.  So many of the hundreds of clients and potential clients who have sat across my desk over the last 10 + yrs have essentially been asking me one question, "Can you help me predict the future?" 

Let me set the record straight, can it be done?  Can a person with enough foresight, intuition and depth of research be able to make the right call on their investments such that the future markets will reward them handsomely?  Absolutely, no question about it, and history is loaded with examples of men and women who have done so.  But, can it be done consistently, with manageable risk over long periods of time?  Absolutely not.  And that is the key and the ultimate truth.  I would never deny that certain advantages in certain times can be gained in investing thanks to research, proximity, education, hard work, intuition and a little luck.  I would unequivocally deny that these advantages can be maintained indefinitely.  It can't be done; the world is too complex, there are too many people and macro global emotional factors such as uncertainty, fear, greed, regret, interest, excitement and doubt with unlimited variables at play that are waiting to sobotage every next "system" or magic ratio or investment insight. 

I should be clear, I am not suggesting blind faith in failing and expensive investment schemes.  And I am not simply shouting "buy and hold."  I believe strongly that we need good people picking and choosing good buisnesses.  But that is where our abilties end.  Buy a good company and own enough of them in sufficient diversity and you'll be rewarded  - trying to time the market's highs and lows and going all in or none in only when our forecasting feels right is a recipe for disaster.  If you do things properly, there will inevtiablty be periods and cycles when your perfectly good shares in a perfectly good company will decrease in value.  And predicting when those periods come and go is an absolute exercise in futility. 

It wouldn't be fair to pick on Jim Cramer since he's really in the entertainment business not the business of advice giving, if it were not for the fact that he protrays himself as one of the great seers and at least implicitly suggests he "knows".  So how did he help his legions of market timers profit throughout the last bear market?  Check out the link below:

http://www.youtube.com/watch?v=FP3YyJz3HsU

In this iconic showdown between Jon Stewart and Jim Cramer both sides really miss the point.  Jim in profiting from creating the illusion that he knew, and jon in profiting from the the delusion we have all shared that he should have known better.  They both miss it. 

But don't take my word for it, look at the facts.  Let's start with the experts.  

William Sherden, author of The Fortune Sellers, reviewed leading research on forecasting accuracy from 1979 to 1995 and actual forecasts made from 1970 to 1995, this is what he concluded:

1. Economists cannot predict the turning points in the economy.  Of the 48 predictions made by economists 46 missed the turning points. 
2. Economists forecasting skill is about as good as guessing.  For example, even the economists who directly or indirectly run the economy (US), the Federal Reserve, the Council of Economic Advisors, and the Congressional Budget Comittee have forecasting records that were worse than pure chance. 
3. There are no economic forecasters who consistently lead the pack in forecasting accuraccy. 
4. There are no economic ideologies whose adherents produce consitently superior economic forecasts.
5. Increased sophistication provides no improvement in economic forecasting accuraccy.
6. Consencus forecasting offers little improvement.
7. Forecasting may be affected by pshycological biases.  Some economists are perpetually optomistic and some are perpetually pessimistic. 

In laymens terms, if you're watching BNN to get a sense of where analysts think the markets are headed, you'd be better off saving your half hour and flipping a coin. 

This leaves us with a few importnant considerations: 

1.  What is at stake when we try to time market cycles.  What do we have to lose.  Or put differently, what is the most propable impact from our attempting to time markets.  It isn't pretty. 

2.  How can we differentiate the noise from helpful and genuine advice. 

3.  What is the best way manage money in a age of unpredictable and uncertain markets.

Stay tuned...