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Lies, Damned Lies, and Investment Performance

2011-01-15T16:28:00.000-08:00

Mark Twain said "There are three kinds of lies: lies, damned lies, and statistics." His point was that through the judicious selection of data, statistics can be manipulated to prove just about any point a person wants to make. If this is true (and I wouldn't want to argue with Mark Twain), investment performance falls firmly into the same category.

Timing the Market vs. Time In the Market

Arguments for and against the loosely-defined "market timing" is an area that takes the most liberties when it comes to quoting investment performance numbers. The most common case for a buy-and-hold strategy is that pulling money out of the market could cause an investor to miss a big market day. A quick search on Google reveals a long list of websites and articles that follow this general theme: If you had invested $10,000 at such and such a date and kept it invested, you could now retire early and send your kids and grandkids to Harvard. But if you missed the [10 best months/best month each year/5 best days each month/etc/etc], your investment would now be practically worthless. Obviously, Time In the Market is better than trying to Time the Market.

Standard & Poor's Financial Library contains a chart that is often used in web articles to prove the case against market timing. The chart, titled "The Effect of Staying Invested vs. Missing Top Performance Days, 1997 to 2006", shows the result of investing $10,000 and staying invested over 10 years, compared to missing the best 5, 10, 15, ..., 30 days of the market. A buy-and-hold approach results in the investment growing to $22,451. Missing the best 30 days over that 10 year period results in the investment shrinking to $6,921. The conclusion stated on the chart, as well as most articles that use the chart, is that "missing the market's top-performing days can prove costly." Duh. Now let's apply a little logic.

If your market timing system is so bad that it only misses the best days in the market, then a buy-and-hold approach is clearly the way to go. However, if a case can be made based on something as ridiculous as missing ONLY the 30 best days over 10 years, then it seems there would be an equal chance of missing only the 30 worst days. What happens in that case? Well, if you invested the same $10,000 and happened to miss only the 30 worst days (also clearly ridiculous), your investment would have grown to $69,879. Clearly, Timing the Market is much better than Time-In-the-Market. Both data points are hogwash, but only one of them tends to be used in what masquerades as a serious argument.

Historical Return Of the Stock Market is X%

Now let's take a look at another way historical performance is often misused. The superior long-term performance (or lack of performance) of stocks is often used to justify portfolio allocations, indexing, actively-managed mutual funds, etc. After all, U.S. stocks have returned an average of 10.3% per year. Or they have been flat for over 4 decades when adjusted for inflation and excluding dividends. Or they have underperformed bonds. All of these statements are true in the right context and with enough disclosure. The long-term performance of stocks is a wonderful and dangerous tool because there are so many degrees of freedom with which to play. If I want a good long-term number, I can start my performance analysis in 1908 and end it in 2007. However, if I start in 1929 and end in 2008, I get a very different (and much worse) number. Going back to using stock performance to justify the buy-and-hold argument, the DJIA has had a couple of periods that work very well to support buy-and-hold. From 1943 to 1962, the DJIA had an average return of about 8.2%, and from 1982 to 2000 the return was around 12.9%. However, 1900-1943 (2.3% annual return), 1962-1982 (2.4% per year), and 1996 to 2009 (0%) didn't work out so well, and could all be used to argue the exact opposite point. I recently saw a chart of the DJIA adjusted for inflation and excluding dividends. When looking at the market this way, the market is currently at about the same level it was in 1966. Even more interesting was that you could draw a straight line on the chart between 1929 and 1992. This data could be used to justify market timing, or a bond portfolio, or real estate investing...you name it. Many may argue that you can't disregard dividends, and that the definition of inflation is up for interpretation, but however we massage the data, it can still be used to justify practically any argument...just like statistics.

How Should Performance Be Used?

The only data we have to go on is past performance, so obviously we shouldn't throw out the data just because it can be easily manipulated. However, an awareness that data can be selectively chosen to justify our own biases is important, especially since this can be done subconsciously. In severe bear markets, it is easy to point back to the latest bull market and convince ourselves that things will quickly get back to "normal" if we just hang on a little longer. If normal is defined as consistent 10.3% returns, there are long periods in the market that don't support this. Another thing to keep in mind is that it is just as easy to use the most recent market performance to justify the newest investing fad as it is to ignore recent market data in order to argue that traditional investing ideas will always work. U.S. and world economies evolve, and just because a strategy would have worked over the last 80 years does not mean it will work over the next 20. The key thing is to maintain a good dose of skepticism whenever performance data is used to justify an argument, and always ask "does this make sense". Ignoring the best market performance days but including the worst days to "prove" a point should raise some red flags, and would certainly make Mark Twain think twice.

Jerry Verseput is Certified Financial Planner and Registered Investment Advisor in El Dorado Hills, CA. More information can be found at http://www.veripax.net

Article Source: http://EzineArticles.com/?expert=Jerry_Verseput

Developing Your Personal Financial Philosophy For Long-Term Wealth Creation (Financial Library)

2009-06-20T07:07:00.000-07:00

Financial Library

Philosophy is defined as the most general beliefs, concepts and attitudes of an individual or group. A financial philosophy, therefore, is the development of general beliefs and attitudes as they relate to money and business transactions.

I began to think about this article months ago when it dawned upon me that I simply wasn't getting the level of enjoyment out of my money that I ought to be. Each new purchase has become a cause of fear and anxiety rather than a cause of joy at having the resources to make the purchase.

My in box has been flooded with blog posts all asking the same thing: what is wealth accumulation all about?

The decision to create wealth is motivated by something: too much debt, inability to send a kid to college, inability to give to charity, an upbringing in poverty. What ever the reason, when a certain level of wealth is reached, you will ask yourself the inevitable question, why am I doing this? Why do I want this money? The inability to answer those questions will threaten to undo even the best-laid plans.

So how do you develop an enduring financial philosophy?

Consciousness and awareness about personal finances begins with a financial education and a commitment to ongoing education even as you achieve your goals. "A financial education" definitely does not mean getting an MBA, but it does mean developing a personal financial library and maintaining that library over time.

Through exposure to Robert Kiyosaki and Ric Edleman I determined that my house is not an asset and that if I want to maintain liquidity I should put money aside into various accounts for investment purposes rather than prepay my home. Because I developed a philosophy of maintaining liquidity, I maximize only one tax deferred investment vehicle. Because of my personal philosophies about the stock market, I invest in stocks only through the tax-deferred vehicle. Because I want to maintain liquidity and diversify my investments, I invest in positive cashflow real estate. I rejected Suze Orman's advice of paying off consumer debt before starting an emergency fund, because I was tired of being broke and I wanted the Law of Attraction to assist me in wealth creation.

So let's look at the personal financial philosophies developed so far and the behaviors that followed:

Philosophy number 1: My house is not an asset
Behavior number 1: I saved extra principal payments for later investment

Philosophy number 2: Maintain liquidity at all times
Behavior number 2: limit the number of tax deferred vehicles that I invest through and hold my money in a high-yield savings account.

Philosophy number 3: Limit my exposure to the Stock Market
Behavior number 3: invest in cashflow real estate, precious metals, start a home business.

Philosophy number 4: Use the law of attraction to build wealth by starting an emergency fund right away.
Behavior number 4: Save small amounts of money even as I paid off high interest debt. The benefit was that I had started and begun to enjoy the habit of saving, so that when the short-term, high-interest consumer debt was gone, I had a destination for that "new money."

Philosophy number 5: Pay off all consumer debt including cars, credit cards and student loans.
Behavior number 5: Negotiate with credit card companies to reduce interest rates, then put in place a plan to eliminate all 3 sources of consumer debt. Close outstanding retail accounts and track all expenses. Pledge to pay off and then drive a car for 10 years.

To the above, I added a sixth philosophy: It is okay, under the right circumstances, to spend money for my own personal enjoyment.

Behavior number 6: Set up multiple accounts into which dedicated amounts are deposited so that I can make spending choices.

If someone develops a personal financial philosophy that all debt, even mortgage debt, is bad, then he will pay off mortgage debt rather than save extra principle payments for later investment. He will also sacrifice short-term liquidity by tying up funds, that cannot be easily accessed, in the house.

Each new behavior in the world of personal finance will require some form of sacrifice. Whether or not one chooses to incorporate mortgage reduction into a personal financial philosophy or not, the above philosophies and behavior will result in an increase in wealth so that one will inevitably ask five or ten years down the road, when the financial pressures are lessened, "why am I doing this?" "Why am I sacrificing to gain wealth"?

This is where I am today: at a point where my financial philosophies are in conflict. The need to maintain liquidity is clashing with my sixth philosophy, that it is okay to spend money for my own personal enjoyment.

How can you avoid this clash in philosophies? The easiest answer is to understand your "why" for improving your financial picture. Very often the decision to improve one's financial situation is made in the heat of a crisis when there is very little time or inclination to ask the probing "why" questions. Just wanting the pain to stop is enough motivation. The key, then, is to begin to ask the "why" questions as soon as you have some distance from your problem, just after you hit a short-term financial goal.

Begin by asking yourself what it is you enjoy doing. Let's say you enjoy fly-fishing or wood working or spending time with the kids. You may have eliminated the hobbies altogether or reduced time with your family to take on extra projects to increase revenue. As quickly as you can, begin to add your activities back. Maybe you wanted to change your financial picture so that you could take guilt-free trips. As quickly as you can, set up an account to fund the trip and then take it without guilt. Maybe you want to leave a legacy, gifts to charity. Set up an account so that you can realize that desire now rather than have it waste away on "someday isle."

Developing an enduring financial philosophy begins with financial curiosity and financial knowledge. The financial knowledge will inform philosophies. The philosophies will inform behavior, finally the behavior must be tempered by awareness of your long-term goals and passions for your philosophy to become truly enduring. Determining your long-term goals and passions starts by asking yourself "why" as early in the process of wealth creation as possible otherwise you will create monetary wealth for the sake of monetary wealth and monetary wealth without purpose will not last.

Ouida Vincent is an active real estate investor and entrepreneur who has watched her friends and family members struggle under the burden of home ownership and poor returns in today?s market. She has also watched talked with hundreds of business owners who have tried and failed to earn more money and establish multiple streams of income. To find business tips and key success philosophies go to http://www.ouidavincentsblog.blogspot.com/

Article Source: http://EzineArticles.com/?expert=Ouida_Vincent

Financial Library

Help With Financial Planning - Why Try? (Financial Library)

2009-06-18T20:41:00.000-07:00

Financial Library

Since the economy has been a rut for so long more and more people are seeking help with financial planning. People are starting to wake up and understand that the economy isn't always going to be good to them.

In the overall world economy there are periods of ups and downs. The "up" periods are when the economy is booming and everyone seems to be doing well financially. The "down" periods are times when the economy is slowing down. Down periods in the economy can sometimes lead to a recession (like the one we are currently facing) or a depression (like the one in the United States during 1929).

When you start to find help with financial planning you will be able to map out a path to follow. This path will ultimately lead to your end financial goals. Having a plan will enable you to ride out the sudden ups and downs in the economy. It will provide you will financial balance and security, something that is needed in our day and age.

That isn't to say there aren't any risks involved. Everything has risks. By planning your finances you are titling the odds in your favor - odds that disaster will not strike your financial life. When you have a solid plan getting laid off from your job won't be as big of a deal as it would be had you not planned.

You can find help with financial planning on a number of websites online. There are a lot of good articles that cover this topic in the EzineArticles finance section.

You should read and apply as much as you can until you have a decent understanding of key financial principles. You can also get help with financial planning from books at the library. In fact, that's how I started learning about all of this.

It's a funny fact, the more you read the more you learn.

One other thing I should point out are financial planning firms. Some people turn to firms like these to save time and avoid hassle. I want to point out that this is not an excuse to stop learning about financial planning. It is imperative that you understand certain key things like saving and budgeting. These are essential life skills.

Whatever you do make sure you never stop learning!

Andrew Patrick is the creator and founder of Financial Health Zone. A popular blog that provides online financial advice. Andrew covers a variety of financial topics for both the financial idiots and the financial geniuses. Part one of An Idiot's guide to Creating a Personal Financial Plan can be found on his site. Andrew prides himself on the fact that he was once financially illiterate and studied hard to become one of the internets leading financial advisors, in only a few short years.

Article Source: http://EzineArticles.com/?expert=Andrew_Patrick

Financial Library