An Investing Lesson Christmas Card from AWM

Dear Readers: I hope this Christmas season is filled with joy and peace for you and your families.

Below is short newsletter in which I have excerpted a couple recent articles that highlight the investing lessons I have emphasized to most of you.

December 2011:

We are bombarded daily with the current difficulties of the stock market. Combine that with low interest rates on bonds, CD’s and savings accounts, no wonder investors are fearful. Fortunately, time honored principles still prevail. Those principles are:

1. Have a plan - invest in a mix of asset classes that is suitable to your risk tolerance and time horizon.
2. Use Index funds to fill your asset class needs.
3. Stay the course. Don’t panic and try to move in and out of the market.

This first excerpt highlights the need for a plan and staying the course, it is from James P. O'Shaughnessy, the author of the best selling What Works on Wall Street:

"Consistency is the hallmark of great investors and it is what separates them from everyone else. If you use even a mediocre strategy consistently, you'll beat almost all investors who jump in and out of the market, change tactics in midstream and forever second-guess their decisions.

Look at the S&P 500. It is a simple strategy that buys large- capitalization stocks. Yet this one-factor, rather mediocre strategy still manages to beat 70% of all actively managed funds because it never leaves its strategy. Realistically consider your risk tolerance, plan your path and then stick to it. You may have fewer stories to tell at parties, but you'll be among the most successful long-term investors. Successful investing isn't alchemy; it's a simple matter of consistently using time-tested strategies and letting compounding work its magic."

Excerpted from James P. O'Shaughnessy's "Advisors Bookshelf" column in December 9 edition of Investment News.

This second excerpt is from a Dec. 16th Reuters story, it highlights the benefits of investing with simple index funds:

Dec 16 (Reuters) .... fund managers who pick and choose their stocks, rather than passively follow an index, are having a year to forget. Only 27 percent of large-cap managers are beating their benchmarks year-to-date, according to new research from Bank of America Merril Lynch . Growth managers, in particular, aren't earning their paychecks, with only 12 percent outperforming their indices.

Indeed, if anything, active managers seem to be getting worse. Last year, Standard & Poor's SPIVA scorecard - which measures active funds against their benchmarks - revealed that 34.3 percent of large-cap managers beat the S&P 500 for 2010.

Which begs the question: What's going on? "It's a very tough environment for active managers right now," says Srikant Dash, managing director of S&P Indices who founded the SPIVA scorecard almost a decade ago. "There seems to be limited opportunity to find winners."

Active-versus-passive investing used to be a lively debate for market wonks. On one side of the argument, index proponents like Vanguard Group founder Jack Bogle say pairing low fees with market-mirroring returns is the most reliable way to build your portfolio. On the other side, there are star managers like Legg Mason's Bill Miller, who famously beat the S&P 500 with his picks for 15 years in a row. Recently, though, the contest has turned into a bit of a rout - and even Bill Miller is exiting his flagship fund (but remaining chairman), after trailing the index for four of the last five years.

Some reasons for the mismatch are evergreen, like the higher fees that actively-managed funds must overcome. Active large-cap funds currently have an average expense ratio of 1.28 percent, versus 0.68 percent for similar index funds, according to the Chicago-based fund research firm Morningstar. ..... On the average, though, realize that expecting your active fund manager to beat the market over the long-term - especially during an era of economic Black Swans - is a risky bet. "If you want to go active in your quest to beat the market, there's nothing necessarily wrong with that," says Dash. "Just be aware of the risk: That the majority of active managers fail to outperform their benchmarks. It's remarkably consistent."

Finally, below is a chart from an investors 401K account which I advise on. He called me and asked whether he needed to change his portfolio allocation. He was no longer with the employer and stopped contributing in 2009 when he left the company. He said to me “Mike, you told me to stay the course, I have not moved out of the 80% stock portfolio.”

 I looked up his account and below is what I found. This man, who invested $11,466 over a few years, then did nothing, earned 16.8% through the worst market since the depression. Yes, he temporarily lost market value in 08 and 09, but he had an investment plan, he used index funds and he stayed the course.*

for ALL FUNDS from 03/31/2004 through 12/19/2011

Your cumulative personal rate of return during this period: 217.1%  (Annualized Return: 16.1%)

Total net investments made during this period: $11,465.97

The above lesson may seem like simple unsophisticated strategy. Sometimes we tend to over think things, especially when it comes to the stock market. The sophistication comes with the discipline to invest according to your risk tolerance, staying the course, and using cost efficient index funds.

* This is used to demonstrate a point, this man started saving in 2004, performance returns will be different for others depending on when and how money was invested.