Lies, Damned Lies, and Investment Performance

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.

Two Arguments For Investing in Small Cap Securities

Investing in small cap securities is always a risky proposition for a lot of investors. After all, the Russell 2000, which tracks small cap performance, was among the worst performing index in 2007 with a scary return of negative 16.5 (vs the broader S&P 500 index that returned -10.5%).

Given the volatility that comes with investing in such securities, it may sense to avoid them altogether. However, there are some definite benefits to investing in this specialized asset classes. Among the most convincing are these following two arguments:

1. Since 1995, The Russell 2000 has outperformed the S&P 500 in 9 of 15 periods. Statistically speaking, the Russell 200 will yield greater returns than the S&P 500 sixty percent of the time; interested in an Index fund? Don’t waste your money on the broader market. In fact, since 2000, the Russell only lagged the S&P 500 twice. Odds are in your favor that highly diversified Small Cap index like the Russell will do better than the S&P 500.

2. Small cap investments, such as the Russell 2000 Index, offer most investors non-core holdings that can have tremendous benefits in terms of returns. Rather than holding 100% in core holdings, investors with the right amount of risk tolerance should consider more specialized holdings for a small percentage of their portfolio. Where the Small Cap indexes make great sense is that they are more steady performers versus other indexes such as the MSCI EAFE, MSI Emerging Markets and, of course, many bond bonds. This means that investors who are not 100% certain about taking such risks are only taking marginally greater risk when investing in the Russell 2000 (it is an easy way to test the waters).

Of course, there are other benefits to investing in small cap securities. A lot of investors believe that this market class offers the greatest opportunity for gains as these securities are among the most under-priced with their “best” years ahead of them. Companies like Microsoft, Apple and more recently, RIM (the Blackberry maker) were once small cap investments. Of course, when searching for those special “gems” investors should also be mindful of the potential risks involved — what if Microsoft had not panned out, what if Apple had been bought out by a competitor, what if the Blackberry never “took off”? These risks face this asset class on a constant basis and, as such, investors need to be cognizant of them.

Home Buying Grants – The Arguments For and Against!

Interested in home buying grants? Are you sure you know all the aspects of such programs? Just like any type of grant, loan or other such financial helps, the home buying grants present a wide range of advantages and disadvantages. And in order to make the right decision, you need to know them all before applying. Let’s start with the pro arguments! Here are a few reasons that could stimulate you to opt for the home buying grants:

1. You can finally get your own house. Basically, this is the number one reason why people apply for such programs. It is advantageous, it is efficient and it saves you the trouble of paying a monthly rent. Actually, if you think about it, the rent is not an investment, after all. But a monthly rate is, since you actually own the house! And even if some years ago, this did not seem like a possibility, nowadays, with the wide range of home buying grants available, it can actually become real. Owning a residence is a desirable thing for all of us.

2. You can find numerous affordable offers and packages when looking for the ideal home buying grants. In order to benefit from the lowest rates, you need to be informed regarding this market. Look for as many offers before making your final decision. If you chose correctly, you have fewer worries for the future.

3. Owning a home brings you a safety and security feeling. You do not worry anymore that the owner can end the contract with you at any time and you can raise your kids or start a family in a secure and safer environment. You can choose the house you desire and buy it, without worrying that it does not qualify for all your requirements. On the other hand, you should not think that the home buying grants are all milk and honey. More precisely, they come with a package of flaws and disadvantages, as well.

So, before actually opting for these home buying grants, you need to be aware of the following facts:

1. You might need to wait for a long period of time. Wait for what, you ask? Well, to obtain your money, to be more exact. Basically, most applicants say that this is the most important disadvantage of the entire process. But if you can wait for a few more moths and do not rush to get your own place, then these aids might be a good solution for you. The same applies if you’re applying for home improvement grants

2. There are certain misleading ads belonging to different agencies that have the goal to trick you regarding home buying grants. What you need to do is to keep your eyes wide open and to opt only for reputable banks. Some offers say that you won’t be dealing with any interest. But think about it – does this sound realistic? Of course not, so don’t fall for such unscrupulous programs.

3. The home buying grants process presupposes certain efforts. Obviously, you need to provide a great deal of documents and information about you, about your family, occupation and so on. Why? Simply because you need to be eligible for a certain program. And in order to obtain the home buying grants, you have to make sure that you do whatever the providers ask. Now you know all the basic aspects of the process so act and decide accordingly!