A Variation on Buying Low and Selling High

Credit: Stuart Miles at FreeDigitalPhotos.net

There are a lot of people out there who will tell you that the key to success in the stock market is buying low and selling high. From a strictly value investing strategy standpoint, I tend to agree. From an overall investment strategy standpoint, however, College GameDay’s Lee Corso comes to mind; "Not so fast my friend!"

The reason I’m a little cautious to blindly endorse buying low and selling high is because it can teeter right on the brink of an evil term called market timing. I say evil because market timing is often what gets investors in trouble when they repeatedly or completely buy into and sell out of the stock market. The problem with someone trying to time the market is that they are assuming that they know what direction the market is going in the short term, and, to be honest, I haven’t met many people who do. To make matters worse, if someone is going to buy low and sell high successfully and not leave any possible gains on the table, they will need to successfully time the market twice. Twice because they will need to know when a particular stock has gone as low as it is going to so they can buy it, and again when that same stock has hit its near-term peak so they can sell it. If a market timer is wrong, they can miss out on income and market movement, but they are also punished by incurring unnecessary transaction fees, expenses, and possibly taxes. Please believe me when I tell you that correct market timing is really hard once; it’s darn near impossible twice!

As I alluded to earlier, I really do like the idea of buying low and selling high, but within reason. So instead of making one-way, all-or-nothing bets that can be largely influenced by chance, I would propose you consider two, subtle but profound variations:

1. Stay invested and just periodically rebalance your investments by selling parts of your “winners” and reallocating the proceeds to other areas to bring your portfolio back in line with your long-term investment strategy.
2. Go ahead and try to time your withdrawals and deposits as best you can. In essence, deposit when the market is low and withdraw when the market is high.

Some of you may disagree with my tips, and that’s fine. There are times when there are tactical opportunities when it may make sense to totally enter and exit particular stocks, industries, and asset classes, but I believe that is more of an exception than a rule. I personally find comfort in thinking that I have about 60 – 70 years left in this crazy world, and I expect the stock market will be higher then, than it is now. Something about these historical stock market charts just gives me comfort…

 

A lot of investment managers I’m familiar with make money by buying low and selling high, but they do it by trimming their exposure as their holdings have gone up, not by timing the market. A lot of investors I know have made good financial decisions by sticking with their long-term, prudently diversified investment strategies and periodically rebalancing, not by timing the market.

 

Don’t try to time the market. Try to make your deposits and take your withdrawals strategically.

 

-Tom

Index Funds

Credit: Stuart Miles

An index fund is a mutual fund constructed to try to match or track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500), Dow Jones Industrial Average (DJIA), NASDAQ, MSCI EAFE, or Barclay’s Capital Aggregate Bond Index. This type of fund is very attractive to many people I meet. “Indexing” is a passive management investment strategy and it has, at times, outperformed actively managed investment strategies. There are aspects of index funds that I like, and aspects that I do not. Playing devil’s advocate, let’s see whether index funds are for you.

Index funds provide a good way to make sure your assets are at least somewhat diversified, and with any luck, you should roughly experience gains (and losses) similar to those other investors and companies in the same indexes experience. Index fund investors usually believe that markets incorporate and reflect all information at all times, rendering specific “security picking” futile. Therefore, index fund proponents argue the best investing strategy is to simply invest in index funds. This passive strategy usually results in less buying and selling of positions (which means fewer transaction fees and potentially less-frequent, realized capital gains). Index funds also require fewer resources to oversee, which means they usually have pretty low investment management fees. Keeping up with a particular index, paying fewer transaction fees, potentially paying less in taxes (in amount and/or frequency), and having to pay less in investment management fees sounds pretty darn good, doesn’t it?

People who decide not to go with index funds or are against “indexing” may have a wide variety of reasons. At a very basic level, it could probably be said that people invested solely in index funds are just trying to “keep up with the Joneses.” They want to make the same investment return as their next door neighbors. This is not an acceptable investment strategy for many people. It’s true that if you don’t invest in index funds, you might generate returns less than the index (or even losses when the index has gains), but you could also beat the index and do better than the Joneses! In order to have this shot, you have to do something different than the index and pursue a more actively managed investment strategy. When proponents of passive index fund investments hear the words “active management,” they may quickly cite the lower fees and taxes usually associated with index funds, but active management supporters like to remind index fund investors that if they pay any fees or expenses at all and are only invested in the index, they are actually agreeing up-front to accept a return less than the index every single time!

Most investors seem to go back and forth on whether they like passively managed index funds or not. It seems that when most index funds have recently outperformed their actively managed, competitive funds, they have lots of fans, but when they lag active funds, their support seems to dissipate. I’m like everyone else: I’d love to have owned what has recently done the best and to currently own what is about to do the best, but as always, the super short-term investment crystal ball is in the shop!

What? Oh, you’re going to force me to choose? Look, I respect and understand people who swear by index funds, but I’m personally not a huge fan. I think having some index funds as part of your portfolio is certainly reasonable and it could even be a good idea, but I could not solely invest in them. I don’t want to keep up with the Joneses, I want to pass by the Joneses and move to another neighborhood! It comes down to two things for me: 1) I believe there is almost always a part of every index that I don’t want to invest in, and if I “index,” I can’t avoid that piece, and 2) as a very simple and not-so-technically-versed client of mine told me after we discussed index funds, “I prefer actively managed funds because I know there is at least someone at the wheel as opposed to my investments being on auto-pilot.”

-Tom

Fantasy Football

Credit: Idea go

When I sit at my desk in the fall and should be thinking about investing, I occasionally have my thoughts wander to football and fantasy football. A few glorious Saturdays ago at a splendid tailgate I came up with the notion that instead of fighting my fall thoughts it might be fun to combine them and see what fantasy football can teach us about investing. Maybe it was that 7-layer dip, or maybe it was my Dixie Cup “talking,” but the more I’ve thought about it, the more I think there are some simple investing lessons buried in the fantasy football world:

• Diversify- In one of the leagues I’m in, I walked away from the draft with an unusually high number of Green Bay Packers. It wasn’t my plan, it just kind of happened that way. Aaron Rodgers, Randall Cobb, Mason Crosby, and the Green Bay defense aren’t too shabby, but they are all from one team. My fantasy team seems to do well when Green Bay does well, and it stinks when Green Bay stinks. When Green Bay had their bye week, do you think that was fun? No, my fantasy team was a wreck. This could happen to your investment portfolio, too! If most of your investments are in one stock, one industry, or even one mutual fund, you can lose a lot when your investments don’t perform well, just like I lose a lot when the Green Bay Packers don’t perform well. Had I sprinkled in a few more 49ers, Falcons, and Steelers who didn’t have Week 10 byes in my fantasy football portfolio, I could have avoided relying on the Green Bay Packers every week, and skipped my Week 10 bye problem entirely.
• Long-Term Strategy- If you are in a “keeper league,” you already know where I’m headed. Most fantasy leagues have completely new drafts every year where every manager starts from scratch, but some leagues allow you to keep a certain number of players from the previous year. If you know you are going to have the opportunity to keep some of your players, deciding between drafting Peyton Manning (who is nearing the sunset of his career) and drafting Robert Griffin, III (who could be around for the next fifteen years) becomes a little bit more difficult of a decision. In a “keeper league,” you probably should lean more favorably toward the up-and-coming players with potential and a high probability of future growth. The stock market is also a keeper league, as you don’t get to start fresh every time you invest and your previous gains and losses go with you. Therefore, in the stock market you need to think long term and focus on earnings potential and future cash flows - not how the stock will briefly overreact to tomorrow’s earnings announcement.
• Buy Low, Sell High- Take my team for example: had I traded away Tony Romo after his Week 1 307 pass yards and 3 TDs performance for Alfred Morris, Washington’s little-known running back at the time who has been lighting it up lately, I would have bought low and sold high. Everyone in my league would have thought I was crazy then, but my team would be better now as we speak. It’s almost counter-intuitive to buy low and sell high, but that’s how you win fantasy leagues, and come to think of it, make money investing. When do you want to purchase a stock? When it’s very cheap or low. When do you want to sell a stock? When it’s high or overpriced. This sounds easy, but it’s very hard to do. Did you naturally want to buy Bank of America at $3 and sell Apple at $700? I rest my case. 
• Active Management- Let me go on the record for all fantasy sports enthusiasts out there and express my displeasure with those of you who draft your team and don’t keep up with it. You sadden me. You don’t have any idea when your fantasy team does well, and you don’t have any idea when your fantasy team gets crushed. There is nothing more frustrating than losing to someone who has not updated his or her team, but I can honestly say I’ve never been in a league where, by the end of the year, someone who had not managed his or her team took home the trophy. I believe the same holds true for investing. You, or at least your financial advisor, need to pay attention to what’s going on in your investment portfolio, or the risk of terrible losses is huge. Passively letting your investment portfolio (or drafted fantasy team) roll on its own can work for a while (cough, cough, team I beat in the playoffs last year), but I’m a firm believer that, eventually, active management will win.

For those of you who play fantasy sports, I hope you got something out of this. For those of you who think fantasy sports are for geeks or crazed sport fanatics, you’re right, but you’re also missing out on the fun. Either way, I believe diversifying, having a long-term strategy, buying low and selling high, and actively managing your investments add up to a simple recipe for success for your fantasy and  financial portfolios.

And, as I always tell my friends, [insert your favorite team here] before fantasy. Go Falcons!

-Tom