If you picked Value Trust you’d be…

WRONG!

Much was made about the end of Bill Miller’s 15-year streak of beating the S&P 500 Index a few years ago. Fifteen years of consecutively beating the index is a pretty mean feat. But, as you can see from the graphic below, a 15-year streak can go down the drain quite quickly with a few years of underperformance:

Notice that those numbers INCLUDE 2009’s performance through October 20th. In other words, even including 2009’s performance, Mr. Miller is STILL trailing the S&P 500 Index since 1986.

One other interesting thing to note is the difference between the average returns and the geometric average returns. If you’ll notice that average returns are neck-in-neck between the two. But, the geometric averages are vastly different. This is due to the fact that Value Trust is a highly volatile mutual fund. It has years of great performance and years of really bad performance. In other words, it’s a much bumpier ride on the Value Trust train than on the S&P 500 Index train.

Once again, this just proves how hard it is to beat the index on a long-term consistent basis and the risk that investors take when pursuing such performance.

Take a look at the returns for the S&P 500 Index over the last 10, 20, 30 and 40 years:

The last ten years were pretty pathetic and have led to new “research” like this.

Anyway, to get an idea of just how bad 2008 was, I looked at the returns for the same time periods through 2007. The results were quite different:

No, it’s not the end of the world but it will probably take us several years (or longer) to get back to pre-2008 levels. I’m not liking what I’m reading about the economy these days and the steps that our goverment (Bush and Obama) is taking to try to fix things. I have the feeling that the medicine is going to be worse than the sickness.

If anything, this post should illustrate the importance of diversification. I know I write about the S&P 500 Index a lot. That’s because it is the only index I have lots of data for.

• Through April, there were 112 months during the New Millenium.
• Of those 112 months, 63 had positive total returns, while 49 of them were negative.
• The best monthly total return occured in March of 2000 when the index returned 9.78%.
• The worst monthly total return was last October’s -16.8%.
• The average monthly total return for the S&P 500 Index during the New Millenium has been -.21%.

It will be interesting to see how 2009 closes out the first decade of the New Millenium. So far it’s not looking too good.

From the article:

It’s heresy to academics, and we can already hear the howls of protests at the very suggestion. But the stock market’s crash does beg the question: Is it time to move beyond the vanilla index fund?

It goes on:

…now is exactly the time many experts say that active management can shine. If markets bounce along the bottom (as many strategists think we’ll see this year), active managers could have an edge. Roseen says that’s because they can pare back on certain troubled sectors (think financials) and “make the appropriate bets.” Since the crash, the average actively managed fund is neck and neck with the average S&P 500 fund, according to Lipper. In six of the past 10 years, more than half the actively managed funds have beaten their index.

Where do I start??????

First off, the SmartMoney article was written with the market’s crash in hindsight. Investing via a rearview mirror is almost never a good way to go. Their comment about more than half of the actively managed fund beating their index in six out of the last ten years is flawed thinking because it’s past history. Just because a fund beat the index in the past does not mean it will beat again in the future and the FUTURE is what we are concerned with.

Second, NOBODY knows what the market is going to do in the future. Selling a depressed index fund now in order to buy an actively managed fund (that has no guarantee of beating the index in the future) just doesn’t seem like a wise move in my opinion. Seriously…I wonder how many of these “strategists” saw last year’s dismal market coming?

SmartMoney should know better than to write this crap.

I REALLY like this book!

Why? Because it is simple and easy to understand. Bill has been blessed with the ability to make an investment book almost a page-turner—or at least an enjoyable read.

The NEW Coffeehouse Investor is somewhat larger than the previous edition. Several new chapters have been added, which I think are an enhancement:

Travels of a Coffeehouse Investor – discusses the advantages of indexing over stock trading.

Spending it – discusses the basics on how to spend your money in retirement.

Index Funds and Beyond – talks about how indexing has becoming confusing with the all the unnecessary indexes that have been developed over the last few years. Stick to the basics.

The Journey Continues – a feel-good chapter that closes out the book.

One thing that I think could have been done better in the book is when Bill discusses the importance of investing based on time horizon. He uses several graphs to show the volatility of stocks based on one-year, five-year, and ten-year holding periods. These holding period returns do not take into account inflation, which surely would have impacted the results. It wouldn’t have been such a big deal if it weren’t for the fact that these charts appear in the same chapter in which he claims INFLATION to be the biggest risk to investors. It seems kind of silly to tell your readers that inflation risk is a big deal and then show them historical returns that don’t include inflation.

Other than that, The New Coffeehouse Investor* is an excellent little book. I highly recommend it!

I’m also excited to announce that AFM readers will have a chance to win a copy of the book. I have two copies to give away. All you have to do is leave a comment, making sure you heed my two rules (I know you get tired of reading my two rules but the first time I don’t print them I’ll get called on it):

1. You must be a resident of the North America (the U.S. and Canada). I won’t ship internationally.

2. You can only enter ONE TIME.

I’ll announce the winners on Monday, April 13. Good luck!

*Affiliate Link

1. Beware of market forecasts, even by experts. – His point being that forecasts are nearly always optimistic and although sometimes they may be right, they are more often wrong.

2. Never underrate the importance of asset allocation.

3. Mutual funds with superior performance records often falter. – The S&P 500 was down 37% in 2008 while Bill Miller’s Value Trust was down 55%—and that was the second year in a row his fund had underperformed the S&P 500 after fifteen straight years of beating the average.

4. Owning the market remains the strategy of choice. – If you own the market, you don’t have to worry as much about problems with one particular company. Yes, if the economy tanks, you’re still going to lose money.

5. Look before you leap into alternative asset classes. – It hurts to be a bandwagon investor!

6. Beware of financial innovation. – Lumping together crappy mortgages and selling them off as “safe” securities was a financial innovation—a really stupid one!

Related: Jonathan Clements on the Credit Crisis and Current Economy

I was wondering what’s the best way to go about buying stocks? I have about $10,000 that I am willing to invest and right now during this melt down seems like a good time. I have never bought stocks before, do you have any good advice?

Well, since you asked…

Since you have never bought stocks before I would recommend against buying individual stocks. Instead, focus on investing in stocks via a good low-cost index fund or exchange-traded fund (ETF). Keep in mind that if you go the ETF route, you will have brokerage charges. For simplicity’s sake, I would just open an account at Vanguard and put half of your money in either the Vanguard Total Stock Market Index fund (VTSMX) or the Vanguard S&P 500 Index fund (VFINX) and half in the Vanguard Total International Index fund (VGTSX).

If you’re concerned that the market hasn’t yet bottomed, you could dollar-cost-average your way into the market by investing a portion of your money over several weeks or months—of course that’s up to you.

The main thing is to be sure you have the stomach to ride out this storm. It could be years before we return to normal. One thing you could do to help with volatility would be to put a portion of your portfolio in the Vanguard Total Bond Market Index fund (VBMFX). Just remember that Vanguard has a $3,000 minimum investment for all their funds and since you are only investing $10,000, you won’t have enough to meet the minimums on more than three different funds.

I hope this helps.

The average sector lost nearly 11% during the month of September alone. The worst-performing sector was the Basic Materials Index, which lost 22.5%. The best performing sector for the month of September was Consumer Goods, which was down 2.43%. Not one sector turned in a positive performance in September. It’s also interesting to note that NONE of the sectors are positive year-to-date (January 1 through September 30).

For those who are interested, I put together a table of year-to-date monthly returns for the ten indexes (click on the graphic to see a larger version):

Depending on how you look at it, 2008 will go down as either a bad year or a buying opportunity.

1. Invested $500 on the 1st and 15th of each month.

2. If the 1st and the 15th fell on a weekend or holiday, I used the price for the trading day preceding the 1st or the 15th.

3. I assumed this was a 401(k) account.

So, here’s where you would stand right now had you invested $500 into VFINX on the 1st and 15th of every month during 2008:

So, you would have invested $7000 during the year and it’s worth $6,509. You’re down 7.01%, right? Not exactly.

Why?

Because you weren’t fully invested the entire year. In order to figure out your personal rate of return, you need to add in the purchase dates. The easiest way to do this is with Excel’s XIRR function. I ran the function myself. Here are the results:

So, according to those numbers, you’re personal rate of return is -22.68%, which is an annualized number. Sounds scary but keep in mind that it wouldn’t take much of a rise in the price of VFINX for that number to become positive. I was playing around with the numbers and figured out that if VFINX went up to $125, you would actually have a positive personal ROR even though the fund would still be down over 7.51% for year.

So, even though it stinks to watch your periodic investments drop in value, in the long run, it’s a good thing if you’re dollar-cost averaging.

John Bogle, founder of the nation’s second largest mutual fund company, dismisses many of products hawked these days by financial companies as largely self-serving. His advice for investors seems to square with one popular marketing pitch: Set it and forget it.

The phrase serves as a delightfully short to-do list for those who don’t want to juggle many investment decisions. And the idea of making an investment decision and sticking with it has helped the retired chief executive of the Vanguard Group and creator of the index mutual fund accumulate a healthy savings account of his own and to look past many of Wall Street’s gyrations.

Bogle said investors too often chase returns rather than adopt a long-term investment strategy that prizes broad diversity and low fees.

I think chasing returns and timing the market (due to chasing returns?) are the two biggest investing mistakes people make.

It’s not easy to walk the straight and narrow when it comes to investing. Especially when your brother-in-law and postal delivery man are making money hand-over-fist day trading internet stocks. It’s also not easy to stick to the course when the world seems to be falling apart (like right now). Here’s what I tell myself during the bad times:

1. They’re usually short run and I’m a long-run investor. In other words, the bad times usually end up looking like bumps in the road over the long run.

2. If things get really bad, not having money is going to be the least of my worries.