What the Heck is Going On?

What the heck is going on? Stocks are selling off. What is the market doing on sell off days?  A couple things are happening:.

1. Lets say that based on information known to you a few days ago, you owned an investment called the stock market and because of the risk in the market you demanded an 8% return. Therefore, if you owned $100 worth of the stock market you expect to earn $8/year from that stock market investment. This $8 is made up of profits in the form of dividends and growth in the price of the stock market.
Then information on the economy is reported. The new information says the economic future is not as bright as yesterday. That may mean that the expected profits of stocks will be less than expected, so the $8 you thought you may receive is now expected to be only $7.  If you want to sell your $100 worth of stock on the bad day, nobody will pay you $100 because the buyer wants an 8% return, and a $7 return on a $100 purchase is not an 8% return. In order to get that return, the buyer will only buy your stock for an amount less than $100, in fact they may only be willing to buy your stock for $87 ($7 earnings divided by $87 = 8% return).  Thus the market goes down on the bad news day.

2. The second thing that is happening, is people panic. They see the prices going down and they want to protect themselves so they start selling their investments and there may not be as many buyers as sellers on a bad day. Guess what happens then, the buyers demand a better deal from you and further drive down your price.

The crazy thing is that today or Monday or next month, nobody knows, the news could be good and this whole thing is reversed. The markets swing wildly over short periods because day to day buying and selling is based on the news of the day.

This is all bad if you need to sell your stock on the bad days or during bad periods.

But, over long periods of time we do know that news averages out and historically has been positive. That is why the market is higher today than it was 20+ years ago. Stocks have always been like a person with a yo-yo walking up a hill.

Its the2nd item above, the panic selling, that usually drives prices far below their actual future value. That is why buying during a sell off is generally positive over the long term. You are buying shares that are undervalued.

For those who are young and are buying stocks (mutual funds) on an weekly basis in your 401K then you are most likely buying when the market is low compared to where it will be when you retire. Because when the current bad news turns good then your investments will start paying more in the form of higher dividends and market growth.

Mutual Funds - Fees Matter. New Study from Vanguard

Although Vanguard promotes low cost mutual funds, their data is consistent with a 2011 Morningstar study and many other studies that have been done over the years. Bottom line: fees may be the best predictor of long term mutual fund performance. FYI:  1. alpha is the amount a mutual fund outperforms the market.          2. survivorship bias-some studies remove closed mutual funds

Probability of remaining in top-performing fund quartile: Holding periods of 1, 3, 5, and 10 years (1990 through 2010) Too often, investors view a fund's historical performance as the most accurate predictor of its future success. But Vanguard has found that more than any other quantifiable attribute that we examined, lower costs are associated with higher risk-adjusted returns. The figure below shows the probability that an actively managed mutual fund in the top-performing quartile would remain among the highest-alpha funds in subsequent 1-, 3-, 5-, and 10-year periods. The outcome was no better than would be expected from a random selection of funds and was sometimes worse. Notes: Each fund was evaluated relative to its customized benchmark using the Fama-French-Carhart expanded market model (Fama and French, Journal of Financial Economics 33:3-56, 1993; Carhart, Journal of Finance 52:57-82, 1997). Sources: Vanguard calculations, using data from Morningstar, Inc. Data exclude sector funds, real estate funds, and specialty funds such as bear-market funds. Outperformance of U.S. equity mutual funds by expense-ratio quartiles: 5, 10, 15, and 20 years ended December 31, 2010 Our research shows that a fund's expense ratio is a more powerful predictor of relative performance than other readily observable fund characteristics. On average, for every 1 percentage point increase in expenses, alpha declined by 0.78 percentage point. The second most powerful variable was portfolio turnover.1 For every 1 percentage point increase in portfolio turnover, alpha declined by 0.22 percentage point. In the figure below, actively managed funds that outperformed their relevant style indexes over the 5, 10, 15, and 20 years ended December 31, 2010, are grouped by cost quartile. Over the 20-year period, 49% of the funds in the lowest-cost quartile beat the benchmark while a mere 16% of funds in the highest-cost quartile did so. Similar patterns were apparent in shorter time periods. Since selecting active managers that consistently outperform their respective benchmarks is such a difficult task, focusing on low-cost index funds is a helpful and valuable quantitative measure. Notes: Data reflect percentage of U.S. equity mutual funds that outperformed their style benchmark for periods ended December 31, 2010. Data include only funds that survived the respective 5-, 10-, 15-, or 20-year periods. “U.S. equity mutual funds” refers to all funds, including those focused on a particular style or market capitalization such as large growth or small value. Sector funds, specialty funds such as bear-market funds, and real estate funds were excluded from the list. Sources: Vanguard calculations, using data from Morningstar, Inc., MSCI, and Standard & Poor’s. Style benchmarks represented by the following indexes: large blend—S&P 500 Index, 1/1/1990 through 11/30/2002, and MSCI US Prime Market 750 Index thereafter; large value—S&P 500 Value Index, 1/1/1990 through 11/30/2002, and MSCI US Prime Market 750 Index thereafter; large growth—S&P 500 Growth Index, 1/1/1990 through 11/30/2002, and MSCI US Prime Market Growth Index thereafter; mid blend—S&P MidCap 400 Index, 1/1/1990 through 11/30/2002, and MSCI US Mid Cap 450 Index thereafter; mid value—S&P MidCap 400 Value Index, 1/1/1990 through 11/30/2002, and MSCI US Mid Cap Value Index thereafter; mid growth—S&P MidCap 400 Growth Index, 1/1/1990 through 11/30/2002, and MSCI US Mid Cap Growth Index thereafter; small blend—S&P SmallCap 600 Index, 1/1/1990 through 11/30/2002, and MSCI US Small Cap 1750 Index thereafter; small value—S&P SmallCap 600 Value Index, 1/1/1990 through 11/30/2002, and MSCI US Small Cap Value Index thereafter; small growth—S&P SmallCap 600 Growth Index, 1/1/1990 through 11/30/2002, and MSCI US Small Cap Growth Index thereafter. Past performance is not a guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. 1 Turnover is a measure of a fund's trading activity. For this analysis, turnover was based on the lesser of the value of a fund's purchases or sales divided by average total net assets, as reported by Morningstar for the period specified.