Good Investments in a Bear Market?

[Burgundy Burner]

Actually, there are several factors that make it not quite so simple, and of which people should at least be aware.

1. I suspect that at its heart, if this strategy succeeds, it's due to the "buy and hold" nature, which studies of course show is far more likely to succeed than market timing. On the other hand, such a strategy still comes down to correctly picking stocks, and if such a strategy could consistently beat the market with similar risk, surely one of those professional money managers in the study I cited would have hit on it, yet none of them consistently beat the market. It's important not to confuse good returns with the best returns. It's probably "good enough", but why settle?

"If" it succeeds? After twenty-three years, it definitely succeeds. Actaully, some of these stocks have been in the "succeed" column for more than 100 years. You are confusing good, solid returns with your "best" idea. Sure, there are the "best" stocks that perform incredible for a while, but they also fall like a rock. You ignored how I said that these stocks provide good, solid, and continuous returns. No negative earnings, just steady growth with superior dividends.

2. That being said, it's possible there is something to this. I recently came across a reference recently to a study by Malkiel that said that if a person held just the dividend producing stocks of the S&P 500 rather than all of them, that person would have earned a 1% higher return (or something like that).

So, it's important to understand that this strategy may be more risky than you think it is (More on this later). Assessing risk properly is key to investing.

Once again, there is no risk when you have a portfolio of companies that don't have negative earnings and provide a healthy dividend. Who cares about the S&P when you have such a portfolio? Like I said earlier - trying to time markets, read charts, go with trends, and trying to guess what a market will do will leave you frustrated. All I need to do is keep on purchasing these stocks and let the dividends go back into more stock. No need to read a ton of books, study up on the latest whizz kid on Wall St., or hope that my stocks won't tank. After twenty-three years, the risk has been zero and the upside...well, I'm 49 and retired.

3. Buying individual stocks requires a broker, and thus incurs trading costs, which can be quite high if you buy a lot of different stocks (which you will have to, see below).

Once again, there is only a certain number of stocks in the portfolio. Sure, I could add more of these good stocks, but I like what is in there now. For quite sometime now, there has been no need to purchase more stock - just re-investing the dividends is more than enough. It adds up to a lot of stock being added each month without having to actually buy any stock.

Besides, any new investors are going to pay brokers anyway. It's a fact of life. Too, good discount brokers are plentiful now.

4. Besides the fact that even a year of research isn't likely to help with stock picking when the pros by all accounts can't do it successfully, dividends are not certain going forward, even with a long track record.

GM just eliminated its dividend for the first time since like 1924. Even an amazingly long history didn't help there.

This is where I start laughing. If you really think, at any time, that I have had a dog like GM in my portfolio, then I can tell that you have no clue about the companies of which I speak.

5. It is my understanding that dividend payouts are far less today than they have been historically. Companies are moving more to things like stock buybacks, apparently.

That is why I have never had any of these dogs in my portfolio.

6. Dividends are taxed immediately, while stock appreciation isn't taxed until the end, if then (obviously only important in a taxable account). Actually, if stocks are kept until death, taxes are often never paid, as heirs can receive a stepped up basis.

Right now, the tax on dividends is pretty favorable (15%), so that's good, but the political situation could change soon, so there's a risk there too.

If the dividends are re-invested, then there is no tax. They are taxed only when the dividends go to my pocket or as a gift to a family member. When it comes to these dividends, I don't worry about the political climate - it is never a factor.

7. Finally, the huge risk with holding individual stocks is the risk of not being properly diversified. The market does not compensate investors for risk that can be diversified away. * So, if you hold only 5 or 10 stocks, you're taking a risk that you're not being compensated for. Personally, I don't like taking risks I'm not being paid for.

Holding enough stocks as an individual, though, to be properly diversified can take a lot of money. So, while a really rich investor can probably lower costs by holding a bunch of individual stocks, a person in his twenties probably can't afford to.

Really? Someone in their twenties can't do this strategy? I started at age 26 and for the first eighteen months, I invested $30 a month. Even with that small amount, I was surprised at how it was growing and actually working. So yes, someone can start small and let it grow. And yes, my portfolio is diversified.

Anyway, I think it's important that people understand the risks inherent with such an approach before trying it. It's really not that simple.

Actually, it is that simple. I have no need to follow the market everyday. In fact, I rarely follow it. No need to spend countless hours each week and worry about my investments. Just let it work and enjoy life.

However, if you are comfortable with your investing strategy, then stay with it. If it works, then I'm happy for you.

[techboy]

Burgundy Burner, if you like your investment strategy, great. More power to you. My post was intended to point out the risks and issues with your particular approach, for those who might be considering it.

I'll just address two points of what you just wrote.

Once again, there is no risk when you have a portfolio of companies that don't have negative earnings and provide a healthy dividend.

When I see someone write something like this, alarm bells start ringing in my head. Normally, the person claiming this is selling something. In your case, I suspect you're just honestly mistaken.

There is no such thing as a riskless stock.

That's economics 101. Companies don't pay dividends and issue stock because they're nice guys that want to fund your portfolio for retirement. They do so because they need funding, and investors demand compensation for their risk. If the stock wasn't risky, the company wouldn't have to offer anything more than TBill returns.

If you think you're not taking a risk, regardless of how well you think you've screened your stocks, then you've either turned the entire system of capitalism on its head, or you don't properly understand the concept of risk.

Try reading the Bernstein article I cited for just two of the ways you are taking on risk.

If the dividends are re-invested, then there is no tax. They are taxed only when the dividends go to my pocket or as a gift to a family member. When it comes to these dividends, I don't worry about the political climate - it is never a factor.

You're right. I was thinking of taking stock dividends as cash, which is taxed. If you use a stock's DRIP, the payment is considered to be more stock, which merely adds to the eventual cost basis, but is not taxed immediately.

Strike point 6, if that's your approach.

[Predicto]

Lots of good advice here.

All I'll add is this: don't try to "play" the market.

Just buy some stocks in companies that do basic and needed things in our economy, things that that you understand, industry leaders, and hold those stocks for the long run, reinvesting the dividends. Sell them if they start to lose their focus or their place in the market (a la GM), but generally buy them and hold them. In the long run, you will do well.

90 percent of the amateurs who play the market like a game are going to do poorly.

[Fergasun]

techboy,

Have you read Bogle's book, "Battle for the Soul of Capitalism"? Interesting read... basic theory is that Wall Street is full of bad apples and rotten to the core... and most people who own stocks don't actually own long term anymore, so companies can get away with murder, and no one holds management accountable (since ownership among individuals is diluted, however IBs own a lot of the market but are afraid to be activist since they don't want to tick off managers).

It was an interesting books I happened to pick up looking for airplane reading. Not sure how I'm going to change my investment strategy based on his thesis, but it was compelling.

[iheartskins]

Taking techboy's point a little further, there's not such thing as a riskless investment--even Treasuries carry certain risks.

Consider Auction Rate Securities, which for years were considered to be cash equivalents and banks/pensions/institutional investors poured money into them--

Then WHAM! all of the sudden there was no liquidity and instead of being cash equivalents, ARS traded more like privates/144A/etc.

Caveat emptor!

[prophet]

I've been making a killing the past two weeks in the market.

I fliped a few of the banks the last few days, but I wouldn't hold them over nite for anything. WM has been really good to me.

After Fliping LCC for a quick gain, AUY(gold) is the one I loaded up on today.

POT & MON are always pretty strong plays.

Natural Gas has tanked so It's a pretty good buy right now.

[techboy]

techboy,

Have you read Bogle's book, "Battle for the Soul of Capitalism"? Interesting read... basic theory is that Wall Street is full of bad apples and rotten to the core... and most people who own stocks don't actually own long term anymore, so companies can get away with murder, and no one holds management accountable (since ownership among individuals is diluted, however IBs own a lot of the market but are afraid to be activist since they don't want to tick off managers).

It was an interesting books I happened to pick up looking for airplane reading. Not sure how I'm going to change my investment strategy based on his thesis, but it was compelling.

I haven't read it, but I am very familiar with the philosophy of Jack Bogle. The man is a hero to the common investor. As I understand it, he effectively pioneered the index fund as an investable commodity. Before his S&P 500 fund, people would compare mutual funds to "indexes", but no one ever thought (or wanted) to let people actually invest in the index.

He started Vanguard with the idea of keeping costs low and giving a fair shake to the little guy investor, and still tirelessly promotes such, even today semi-retired in his 80's. I've read stories of him demanding a smaller hotel room to save Vanguard money while he was attending a conference.

Great guy.

As to what changes you make to your investment strategy because of what he showed about the inherent conflict of interest of the Wall Street establishment (they make the most on strategies, like stock picking and market timing, via fees, that serve the customer least), if you'd like to know what Bogle recommends, you can read either his The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (Little Books. Big Profits), or a book he wrote the forward to, The Bogleheads’ Guide to Investing.

Or, for that matter, the books I cited earlier, by Swenson, Malkiel, Ferri, Swedroe, etc., but the two linked above would be the most pure Bogle.

[Monte51Coleman]

Techboy-

what's your opinion on Swensen's model of:

30% Domestic Equity Index's

15% Foreign Equity Index's

5% Emerging Market Index's

20% REIT Index's

15% Treasury Bonds

15% TIPS

[Fergasun]

techboy,

Well his book is a thrashing of the financial industry. Particularly in the way that stocks are valued, and also regarding the way CEO/CFO type of managers are rewarded. Since most of the "owners" of stocks are through mutual funds themselves there is little impetus to change the way of golden parachutes and executive compensation, even if it is in the owners best interests... further more he says these practices are a threat to capitalism itself.

I'm not sure how that changes anything as far as investment strategy... but it makes me want to take all my money and run in a different direction...

[illone]

Cash out the savings account and buy a safe.

Or, if you're interested in the markets look at some growth stock mutual funds with a 10 year history.

[da#1skinsfan]

Thats probably going to end up being a pretty brilliant move.

re: increasing your 401k...why?

[dockeryfan]

re: increasing your 401k...why?

because if a company survives and you buy it in a down cycle, by the time you retire it has regained all that it lost and grew in the process.

I increased my position in Bank of America when it reached around 22. If the bank survives, and it is the biggest depositor in the US, it should grow in my retirement account. Hopefully it will survive.

My shares are at 32 right now, so that's about a 45% gain from when I bought it just a few days ago.

I was long in Bank of Amreica, so I had lost quite a bit on this stock (unrealized), but when I added to my position at such a low price point my average price per share went down significantly, to the point where it is bellow where the price is now. So I'm making money. It's DRIP as well, so it should grow over the course of the next 25 years.

Now I watch my stocks daily, but I hope for the best in the case of banking stocks.

[techboy]

what's your opinion on Swensen's model of:

Swenson is a top-notch investing expert. I respect him greatly, not only because of his ridiculous success at Yale, but because he is an academic, who has passed up the opportunity to make obscene amounts of money running his own hedge fund or something, preferring instead to work and teach at Yale for a relatively small sum (still being in the millions, of course ).

I, on the other hand, am not an expert in any sense. I don't feel comfortable giving portfoilio advice, or critiquing a guy like David Swenson, but I can (and have) share what I have learned from people who are experts, so I'll offer a few thoughts based on my own research.

First, every one of the experts I have cited, from Swenson to Malkiel to Bogle to Swedroe to Ferri and so on say that the most important thing an investor can do is to have a portfolio which is low-cost, highly diversified, and tax-efficient. You won't hear that from most people on Wall Street or most investment advisors, because they make very little money that way. The article I cited earlier about Blaine Lourd highlights this conflict of interest, and is why the small investor needs to avoid the "financial pornography" that fills CNBC, Bloomberg, and the rest of the financial media.

Buying and holding a low-cost, highly diversified, and tax-efficient portfolio using Modern Portfolio Theory (which won Markowitz a Nobel Prize in Economics) might be the best method for investors, but it doesn't sell magazines or advertising (how many articles do you need to recommend "buy and hold"), and it doesn't put fees in Wall Street's pocket.

Anyway, this model portfolio certainly meets that criteria.

Second, though we can know which portfolio or mutual fund worked best in the past, there is absolutely no way of knowing going forward which will work best in the future. So, Swenson's low-cost, highly diversified, tax-efficient approach is probably no better or worse than Ferri's, or Swedroe's, or Malkiel's, or whatever. They all use MPT. One of them will be the best, but we won't know which until it's too late to choose.

As Ferri once wrote on the Bogleheads forum:

PS. On this new forum, I am going to be brutally honest. Most of the stuff you see about optimal allocation is garbage. It is trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that there are diminishing returns. The mutual funds you choose to represent those asset classes should be the lowest cost funds you can buy.

All of this nonsense about finding the ideal allocation is non-sense. The ideal portfolio can only be known in retrospect. We can only know what we should have done, not what will happen. So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.

All that being said, Swenson's portfolio heavily influenced mine. I was persuaded by his book (and Swedroe's) that the fixed income side is for stability, and that non-Treasuries don't compensate adequately for the risk. Swedroe also notes that risk in bonds can lead to tax-efficiency placement issues, and that the literature today suggests that one's fixed income portfolio be "dominated" by TIPS, whatever that means. So, I use Swenson's 50/50 Treasuries TIPS split.

I also like the 60/40 U.S./Foreign split he uses for equities, as well as placing 25% of foreign in EM. This is all consistent with many other pieces I've read.

The one place his portfolio is a bit unusual is the very high allocation to REIT (only Malkiel comes close in his recommendation for older investors). Most other experts that recommend this asset class top out at 10%, or less.

I also am persuaded by Ferri, Swedroe, and others that there is a small/value premium, so I tilt my own portfolio towards those, where Swenson does not. I don't know, though, if that's because he himself does not believe such a premium exists or is worthwhile, or if it's because his book is for the masses, and small/value investing requires a lot of discipline because it involves a huge amount of tracking error, which might make most people bail out, leaving them worse off than if they had never tried in the first place.

But, like I said, there's no way to tell which portfolio is the perfect one, going forward, so Swenson's seems to be as good as any.

To quote John Bogle quoting some general: "The greatest enemy of a good plan is the dream of a perfect plan."

techboy,

Well his book is a thrashing of the financial industry. Particularly in the way that stocks are valued, and also regarding the way CEO/CFO type of managers are rewarded. Since most of the "owners" of stocks are through mutual funds themselves there is little impetus to change the way of golden parachutes and executive compensation, even if it is in the owners best interests... further more he says these practices are a threat to capitalism itself.

I'm not sure how that changes anything as far as investment strategy... but it makes me want to take all my money and run in a different direction...

Bogle himself wouldn't do that, and anyway, where are you going to go?

Cash out the savings account and buy a safe.

Or, if you're interested in the markets look at some growth stock mutual funds with a 10 year history.

The "10 Year History" is one of the biggest myths pushed by Wall Street.

This excerpt is from a speech by John Bogle on the topic of Investing with Simplicity.

My third rule comes to grips with the first element that catches the eye of most investors—whether experienced or novice—the fund's past "track record." (The implied analogy to a horse race is presumably unintentional!) But track records, helpful as they may be in appraising how thoroughbred horses will run, are usually hopelessly misleading in helping you appraise how money managers will perform. There is simply no way under the sun to forecast a fund's future returns based on its past record. Rule 3. Do Not Overrate Past Fund Performance.

Now, I must contradict myself ever so slightly. For exceptional funds with exceptional past returns that are substantially superior to the market will regress toward, and usually below, the market in the future. Regression to the mean—I call it the law of gravity in the financial markets—is measurable and apparently almost inevitable. For example, in two studies of returns over consecutive decades, a remarkable 99% of top-quartile funds moved closer to—and even below—the market mean from the first 10-year period to the subsequent 10-year period. There was only one single, solitary exception to the rule, a fund that ruled the world during the 1970s and 1980s alike. But so far in the 1990s, it has regressed magnificently, falling far below the market's return. Sometimes mean reversion requires patience!

Make no mistake about it: the record is clear that top-performing funds inevitably lose their edge. This industry is well aware of that certainty. Yet fund sponsors persist in promoting their most successful (past) performers. Such a strategy defies all reason except for this one: Promotion of such funds brings in lots of new money, and lots of new fees to the adviser. But such promotions, finally, lead investors in precisely the wrong direction. Ignore them.

Actually, it's a great speech overall, and well worth reading for tips on investing.

Or, consider again The Difficulty of Selecting Superior Mutual Fund Performance. The abstract:

-Much has been written about the management of mutual funds and active versus passive management. This study attempts to quantify the relative performance of actively managed large- and mid-cap domestic stock mutual funds with a passive strategy during a 20-year period, including 11 10-year rolling periods.

-During the study period, most actively managed large- and mid-cap mutual funds underperformed their respective passive strategies. While every period under review had mutual funds that outperformed the passive strategy, few funds did so consistently.

-Furthermore, predicting in advance which mutual funds would outperform was difficult, if not impossible, and the cost of selecting the "wrong" manager was high. These factors combined demonstrate the difficulty for financial planners to select superior performance.

-The study also reviewed the impact of taxes on large-cap investments.

Finally, the author provides recommendations for financial planners in discussing action steps regarding clients' portfolios.

Emphasis mine.

There's virtually no way to predict future success of a particular mutual fund, and certainly not 10 year track record. All the research is very clear on this.

There's a reason the government makes them add the disclaimer "Past performance is not indicative of future results."

[techboy]

By the way, there's a great speech by Swenson here. I know the page is in Swedish, but if you click on Swenson's name, it brings up a video of a speech he gave in Stockholm, in English.

He discusses many of the issues we've discussed here, like asset allocation, the effect (if any) of stock picking and market timing, and general investment strategy, including how they do it at Yale.

Good speech, if for a somewhat limited audience. I especially liked his story about his struggles to make an early morning Econ class interesting to his sleeping students.

[Monte51Coleman]

All that being said, Swenson's portfolio heavily influenced mine. I was persuaded by his book (and Swedroe's) that the fixed income side is for stability, and that non-Treasuries don't compensate adequately for the risk. Swedroe also notes that risk in bonds can lead to tax-efficiency placement issues, and that the literature today suggests that one's fixed income portfolio be "dominated" by TIPS, whatever that means. So, I use Swenson's 50/50 Treasuries TIPS split.

I also like the 60/40 U.S./Foreign split he uses for equities, as well as placing 25% of foreign in EM. This is all consistent with many other pieces I've read.

The one place his portfolio is a bit unusual is the very high allocation to REIT (only Malkiel comes close in his recommendation for older investors). Most other experts that recommend this asset class top out at 10%, or less.

I share your concern with the 20% real estate (REIT) portion of his recommended allocation plan for a couple of reasons.

1. My residence, which will be paid off in less than one year, is my largest asset and I have a rental property that is worth far more than is owed on it. Now even though both of those are decidedly un-diversified investments, when coupled with 20% of an investment portfolio in REIT's seems to me to throw an entire asset allocation plan out of balance.

2. I'm not sure that a 3/2 domestic equity to domestic real estate split makes sense to me.

Any thoughts?

[Predicto]

First, every one of the experts I have cited, from Swenson to Malkiel to Bogle to Swedroe to Ferri and so on say that the most important thing an investor can do is to have a portfolio which is low-cost, highly diversified, and tax-efficient. You won't hear that from most people on Wall Street or most investment advisors, because they make very little money that way. The article I cited earlier about Blaine Lourd highlights this conflict of interest, and is why the small investor needs to avoid the "financial pornography" that fills CNBC, Bloomberg, and the rest of the financial media.

Buying and holding a low-cost, highly diversified, and tax-efficient portfolio using Modern Portfolio Theory (which won Markowitz a Nobel Prize in Economics) might be the best method for investors, but it doesn't sell magazines or advertising (how many articles do you need to recommend "buy and hold"), and it doesn't put fees in Wall Street's pocket.

Quoted again for emphasis. Keep your costs down, don't overtrade, avoid taxes, diversify, and hold for the long term. You will win.

[techboy]

I share your concern with the 20% real estate (REIT) portion of his recommended allocation plan for a couple of reasons.

1. My residence, which will be paid off in less than one year, is my largest asset and I have a rental property that is worth far more than is owed on it. Now even though both of those are decidedly un-diversified investments, when coupled with 20% of an investment portfolio in REIT's seems to me to throw an entire asset allocation plan out of balance.

2. I'm not sure that a 3/2 domestic equity to domestic real estate split makes sense to me.

Any thoughts?

I don't know if I'd call it a "concern". It's just unusual. I'd say to read several books, and if you don't like having that much in REITs, drop the number. Or, leave them out altogether... Taylor Larimore's "Four Fund Portfolio" is just Vanguard's Total Stock, Total International, Total Bond, and Money Market (for the emergency fund and payouts when in withdrawl stage), mixed to taste for proper risk. He (and Bogle) argue that REITs are found in the market as a whole, so no need to overweight them.

Swenson and others, though, see REITs as a seperate class that is difficult to invest in directly via stock, and historically it has been a good diversifier, with slighly lower returns than the total market, but with much less volatility.

As I said, it's hard to say who's right without a time machine, and ultimately, it probably doesn't make that much difference anyway. Taylor Larimore is fond of saying "There are many roads to Dublin". 99 percent of the battle is keeping the portfolio low-cost, tax-efficient, and diversified.

As to the issue of personal real estate holdings, my understanding is that a home or rental property doesn't really count, because REITs are a very different animal, being mostly commercial real estate. I think, though, that Malkiel in his book did recommend that a person with significant real estate holdings might want to lower his exposure to REITs (and Malkiel's another heavy REIT guy), so you might want to read that.

And of course, the Talmud recommends 1/3 Business (Stock), 1/3 Cash, and 1/3 Land, so by that standard, even Swenson is underweight.

[Monte51Coleman]

I just bought myself some Chesapeake... which is a natural gas play... I would try to get in when CHK has another pull back (it just had one last week)...

Ouch! Chesapeake Energy is down about 20% since your post. I hope anybody who went long on it had a hard stop in place.