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Imagine for a moment that today’s mail included an
advertisement offering you a chance to get in on the ground floor and
be one of the first people to own a new luxury car. Shown in a drawing
as elegant and sleek, this new car supposedly handles like a dream, has
a top speed of 140 miles per hour, goes 60 miles on a gallon of gas,
holds six adults in comfort and even does your laundry. And it
costs…for a limited time, only $9,999 by mail order.
Would you believe that advertisement? Probably not. Would you send away for it? I hope not!
Most
of us have learned to be savvy consumers, and we’re pretty good at
detecting obvious nonsense. We’re skeptics, and we know that if
something sounds far too good to be true, it probably IS too good to be
true.
So why is it that so many of us seem to suspend
our common sense when it comes to investing? Why do we just seem to
check our skepticism at the door?
That question was
posed recently at the Seattle Money Show by Mark Hulbert, editor of the
Hulbert Financial Digest, which tracks the recommendations of
investment newsletter portfolios. In a presentation that we wish we had
on tape, Hulbert offered several lessons he has learned from investment
newsletters.
Lesson 1: Most newsletter portfolios don’t
even match the performance of the market. Of the 36 newsletters he
began tracking in mid-1980, 19 still survive. Of those, only four had
portfolios that have outperformed the Standard & Poor's 500 Index.
The lesson: Only about one in five attempts to beat the market over
time will succeed. This applies to mutual funds. It applies to
investment advisors. It applies to portfolio managers. And knowing
these odds is the first step toward acquiring investment wisdom.
Hulbert
confidently predicted that the Standard & Poor's 500 Index "will
outperform 80 percent of us over the next 18 years. This is an
amazingly sobering result" that seems to be repeated with remarkable
consistency over lots of historical periods, he said.
COMMENT:
The numbers are probably worse than those Hulbert cites. He doesn’t
tell us anything about the 17 newsletters that did not survive from
1980 to 1998. We don’t have the facts about those letters. But this is
probably a very safe assumption: Newsletters that beat the market year
after year would not simply vanish. Therefore, it’s a very good
assumption that most – and perhaps all – of the 17 non-surviving
newsletters failed to outperform the Standard & Poor's 500 Index.
And that means the odds are worse than portrayed by Hulbert’s numbers.
Lesson
2: Long-term track records of newsletters (as well as mutual funds)
mean less than they seem to mean, because so few investors embark on a
strategy and then stick with it for years, no matter what. Very few
people buy and hold through a bear market. They can’t. Typically,
investors lose their faith, lose their courage and get spooked out of
the market near the bottom. Later, they typically get lured back in
when the market is near its top.
"I don’t make many
guarantees, but I can guarantee you that most of the people who are
saying today they are buy-and-hold investors will not be fully invested
at the bottom of the next bear market," Hulbert said. The statistical
case made by buy-and-hold advocates is "absolutely compelling." But
almost nobody actually invests with a true buy-and-hold approach.
Hulbert wrote the following paragraph in a New York Times column on this subject.
"Latter-day
converts to the buy-and-hold strategy assure me that they won’t be
foolish and throw in the towel in a bear market. But I don’t believe
them. The only investors who could persuade me otherwise are those who
were fully invested in late 1974, at the bottom of the last severe bear
market. And there are precious few of them. All the other
buy-and-holders either aren’t telling the truth or are too young to
have anything more than hope about how they will behave in the next
bear market."
Now maybe you think you are
the exception, the really serious buy-and-holder. If so, ask yourself
this: In non-investing areas of your life, are you unwavering in your
convictions and able to ignore the views of your friends, your family,
the experts, the pundits, the conventional wisdom? If so, maybe you
have what it takes to buy and hold. But it’s not easy.
If
you ever want an objective measurement of the public’s current mood
about investments, look at newsletter advertisements in Barron’s. How
many ads are bullish, how many bearish? In his column, Hulbert said
Marty Zweig, a market forecaster, kept track of this indicator during
the 1973-1974 bear market. During the last six months of that period …
which in retrospect was one of the best times of the 20th century to
load up on U.S. stocks … there were a number of weeks in which not one
investment newsletter ad was bullish on stocks.
Remember,
the people who wrote these ads make their living selling advice to
individual investors looking for guidance on what to do. And most of
the newsletter publishers didn’t have a clue about the great
opportunity that was in front of their faces. If any of them did have a
clue, they didn’t advertise. Probably because they didn’t think anybody
would believe them.
Because the market’s long-term bias
is upward, the theory goes, if you hold stocks long enough you will
beat the relatively risk-free return on Treasury bills and money-market
funds, which in recent years has typically been around 5 percent.
Using
that 5 percent return as a benchmark, Hulbert asked: How long do you
need to leave your money in stocks to be reasonably sure you’ll get at
least 5 percent?
"Most people on Wall Street today
believe the long term is a month or two," he said. But, as he hardly
had to point out, those people are living in a fantasy world.
Citing figures that go back to 1802, Hulbert said:
- In 42 percent of all one-year periods, the stock market loses money. So obviously one year isn’t enough.
- In one out of four rolling five-year periods since 1802, stocks failed to produce a 5 percent return.
- In one out of five 10-year periods, stocks failed to make the grade.
- In
fact, if you want a 95 percent or better chance of achieving at least a
5 percent compound return in stocks, you’ve got to hold for more than
20 years.
Most people who are buy-and-holders have no
idea they are getting into a proposition that requires them to wait for
20 to 30 years to be pretty sure of being bailed out, Hulbert said.
(However,
remember he is talking about an all-equity portfolio. Adding
fixed-income funds, though it will reduce your expected return, will
certainly increase your chances of achieving at least 5 percent in any
given period of time.)
"At the top of every bull
market, everybody talks about buy-and-hold," Hulbert said. "At the
bottom of a bear market, you can’t find anybody talking about
buy-and-hold." At investment conferences in 1980, some people seriously
thought the price of gold (then flirting with its all-time highs of
over $800 an ounce) was on its way to $4,000. (Gold subsequently sank
to less than $300.) And at those 1980 investment conferences, nobody
was talking about buying and holding stocks. Back then, that was
regarded as a fool’s game.
Hulbert’s advice: Examine
what kind of an investor you really are. Unless you can look yourself
honestly in the mirror and know you’ll hang on through the next bear
market, you are a market timer. Even though history supports the
buy-and-hold approach, "When the human psyche runs up against
statistics, the psyche wins," he said.
Lesson 3: A
sustainable annual return is less than most people think. Expectations
appear to vary inversely with age. Some surveys show people in their
20s and 30s expecting to receive returns of 25 to 35 percent in stocks
over the next decade. But many retirees know from experience that those
are pie-in-the-sky hopes.
In his August 1998 issue,
Hulbert listed the top five newsletter performances for the 15 years
ended July 31. The top-performing letter, The Chartist, had a 16.5
percent annual rate of return. That is only 0.4 percent better than the
Wilshire 5000 Index, which represents the entire stock market. That’s a
mighty thin advantage for the best of 29 letters Hulbert has followed
for 15 years.
So what could a good investor reasonably hope to achieve?
Hulbert
suggested looking at the record of Warren Buffet, probably the most
successful portfolio manager in the world today. Since the 1960s, the
book value of Berkshire Hathaway, the company that mostly holds
Buffet’s investments, has grown at about 23 percent a year.
If the best investor in the world gets 23 percent, what makes you think you will find a newsletter publisher who can do better?
"My
reasoning is that you should give up trying to find the next Warren
Buffet" to guide you, he said. In return, you’ll also give up the risk
of huge losses.
Hulbert’s conclusion went something
like this: If you see advertisements claiming 50 percent to 100 percent
annual performance, "you can throw it away. It does not require any
more attention from you. It is not believable. Period." Such claims can
exist only two ways, he said. Either the advertisement is simply a lie
or its performance is being measured over a period so short that it is
meaningless.
Yet those ads keep bringing in new
subscribers. "It is always amazing to me how people who are so rational
become incredibly gullible when it comes to investing large amounts of
money," Hulbert said. In the quest for Moses leading them to the
Promised Land, people are willing to suspend nearly everything that
they know about life.
During the Money Show, with permission, we handed out copies of a table that
Hulbert published showing 11 years of performance from August 1987
through August 1998 for 57 newsletters he tracked in that period.
For
each letter, the table shows the annualized portfolio gain, a measure
of risk (either more or less than the Wilshire 5000 index) and the
results of three down periods: the three months from August 31, 1987,
through November 30, 1987; the four months from June 30, 1990, through
October 31, 1990; and the two months from June 30, 1998, through August
31, 1998.
The numbers are not encouraging for anybody hoping to achieve wealth by following investment newsletter recommendations.
- Over
those 11 years, fewer than 10 percent of the letters beat the Wilshire
5000 index’s compound rate of return, 12.4 percent. In the three down
periods, the index fell 30 percent, 16 percent and 17 percent,
respectively.
- The worst 11-year performance was that
of The Granville Market Letter, with a compound annual return of minus
19 percent. (That means $10,000 at the start of the period shrank to
$985 – a loss of more than 90 percent.) Perhaps this is a moot point,
but the risk in that portfolio was 4.6 times as great as that of the
Wilshire 5000. If there’s any good news in the performance of
Granville’s portfolio, it’s this: in the 1990 down period, the
portfolio was up 8.7 percent. But on the other hand, Granville’s
portfolio declined 78.1 percent in 1987.
- The very best
11-year performance was that of OTC Insight, a compound rate of return
of 19.8 percent. But this portfolio had more than twice the risk of the
index and subjected investors to losses of 41 percent, 33 percent and
24 percent, respectively, in the three bad periods.
- FundAdvice.com was
in the top one-third, with an annual 11-year gain of 8.8 percent, with
only 46 percent as much risk as the Wilshire 5000 index. Our risk and
return would have been higher if Hulbert had not included our bond and
gold timing. (Almost all the other portfolios in Hulbert’s study are
actively managed all-equity accounts.) Our three down-period losses
were 0.4 percent, 2.1 percent and 7.8 percent, respectively. There’s a
good reason for the sharper down-period loss in 1998: We now have
several buy-and-hold portfolios that did not have the protection of
timing.
- Although this 11 years included one of the century’s
greatest bull markets, 18 of the 57 letters, or nearly a third, failed
to achieve Hulbert’s own benchmark 5 percent risk-free return.
Mark
Hulbert didn’t give the investors in his audience what they may have
wanted most: some surefire tips to achieve wealth easily and quickly.
We can’t give you that either. Frankly, we don’t think it exists.
But to our way of thinking, Hulbert gave his audience a very valuable message, which we might sum up something like this:
- Keep your expectations realistic.
- Recognize that if you’re trying to beat the averages, the odds are heavily stacked against you.
- When
you’re looking for investment guidance, trust neither your own emotions
nor the claims of newsletter publishers promising very high returns.
- Remember
that the world’s best investor can produce 23 percent annual gains,
Hulbert said. If you can achieve 20 percent over your lifetime, you
will be wealthier than you have any right to expect, he added.
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