Most people focus far too much attention on an attempt to guess where the stock market will go in the upcoming months or even in the next year or so. This attempt to foresee the immediate future is an extension of people's typical belief that the market's current trends will most likely continue.
Investment advisors and journalists generally cater to our desire to be able to at least know something about the markets for sure - if the market is doing badly now, it is assumed the trend will probably continue. If, on the other hand, it has been doing well for a while, then this seems to indicate to many that it is probably a good time to invest.
Thus, both investors themselves and the people that advise them tend to put far too much focus on the possible short term direction of the market as a basis for making current decisions. By so doing, these same investors and advisors fail to pay enough attention to the longer term possibilities for the market.
This bias towards weighting investment decisions based on short-term considerations rather than long-term ones, unfortunately, has its focus well off the mark. Short-term trends come and go. The same investors or advisors who had one opinion say 3 to 6 months ago will often have a quite different one now. And often, once a year has elapsed, a great many of these original predictions will no longer even be remotely apparent by looking at the new predictions that take their place.
And unfortunately, following these short-term predictions can not only take one's focus off of good long term strategies, they can also lead to huge investing errors. More often then not, this bias compounds the tendency to invest in investments that are already past their best days. This is what actually happened for so many investors who jumped on the aggressive fund bandwagon in the late '90s. Sure, the funds contined to do well for a short time, but then were crunched before most people realized that these were yesterday's picks, not tomorrow's.
Our research over the last 15 or so years, however, has shown that most short-term predictions in the mutual fund arena, and perhaps in other areas of investing as well, are nearly without any usefulness. There is simply no way to know whether an existing trend (such as the current bear market) will continue over the short term or when exactly it will reverse. Longer term predictions, on the other hand, while obviously not infallible, when based on reliable estimates of under- and over-valuation as well as the recurring cyclicality of the markets can and usually are able to help you define excellent entry and exit points for your investing.
Although trends can continue for longer than expected, generally what is down will reliably go up and what is up will reliably come down. This is especially true when you are dealing with whole categories of investments such as broad fund categories; it may be true to a much lesser extent when dealing with individual issues, such as for example with Enron stock.
Many investors dont pay enough attention to fund categories. Rather, they tend to see the overall market as one single entity. So, they assume that if the overall market isnt doing well on a short-term basis, there are no opportunities. Nothing could be further from the truth as you will see below.
Let's look at how some fund categories have performed over the last 3 years, roughly the amount of time this newsletter has been publishing. During that period, we have been pretty consistently favorable to the following categories of funds: small, mid-cap, value, and foreign. Here are the latest 3 year average category returns for these general categories from morningstar.com as of 2-25-02:
Fund Category |
3 Yr. Return Annualized |
|---|---|
Small Cap Blend | +14.02% |
Mid Cap Blend | +5.41 |
Small Cap Value | +16.02 |
Mid Cap Value | +11.15 |
Small Cap Growth | +8.50 |
Mid Cap Growth | +3.75 |
Large Cap Value | +1.96 |
Foreign | -3.10 |
World | +0.47 |
Europe | -2.53 |
Pacific/Asia | +0.37 |
We also been recommending over the period that bond funds be included in many investors portfolios along with real estate funds. Our allocations have averaged around 30% for bonds and from 5 to 10% for real estate funds. Results:
Fund Category |
3 Yr. Return Annualized |
|---|---|
Short-Term Bond | +6.18 % |
Interm-Term Bond | +6.06 |
Long-Term Bond | +5.65 |
real estate | +12.17 |
During this period, we were generally not favorable to large cap growth funds and technology oriented funds. Thus, we were relatively light in recommending the major minefields that hurt the majority of other investors. Here are the results:
Fund Category |
3 Yr. Return Annualized |
|---|---|
Large Growth | -5.63% |
Technology | -7.74 |
In other words, in spite of the fact that the stock market over the last 3 years, as measured by several of the major indices, is below where it was in Feb '99, had you been following our general recommendations, your results would have still been quite decent. Even our not so well-timed recommendations on foreign funds outperformed - the average foreign fund, including all geographic areas, still did better than the average large cap domestic growth fund, as well as the S&P 500, the latter which was down -2.56% over the same period.
We believe these combined results show that the longer term trends in mutual fund investments can be successfully predicted, unlike the shorter trends, which are not much more than guesswork. It follows that while it isn't usually worth paying much attention to the average short-term advice you hear is, it does pay to listen to well-founded long-term advice. The outperformance that is shown above is not only huge in relative terms - it would have also prevented you from being one of the many people who are now so bitter, or at least very unhappy, about the prospects of meeting their future financial goals.
I realize that most people looking at this newsletter now werent aware of our existence in 1999 or early 2000 when we gave the above suggestions. (Note: many of our previous newsletters are still available on this site.) So you may be asking yourself what can this newsletter do for you now. Here are the categories of funds that we think 3 years from now you will have done reasonably well in, if they are in your portfolio over the full period:
Categories that should do well: Large Cap (Growth, Blend, and Value), Foreign (All regions), High Yield Bonds
Categories that will probably not do particularly well: Long-term govt. bonds
Categories to be on guard against chasing: Small Cap Value
See Newsletter 58 for our current allocations and some suggested funds.
Tom Madell, PhD