How to Profit Better Than 85% of All Fund ManagersWednesday, January 6, 2010 | Teeka Tiwari |
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Even the very best fund managers can experience losses for 50% of their clients, because those clients pull money from the fund manager at the worst-possible time.
Back to the 'Drawing' Board? Not So Fast...
Almost any investment approach will experience periods of losses otherwise known as "drawdowns."
If you believe in the long-term validity of the methods used to govern your long-term investments, then the worst thing you can do is sell into a drawdown or withdraw money from a fund manager while they are in drawdown mode.
This is especially true for fund managers who have a 15-year record of strong compound annual growth rates. Over time, those types of fund managers will invariably pull themselves out of drawdown.
The same is true for index investing -- over time, all the major indexes make higher highs.
It's true that, in many cases, several years can go by before the index in question fully recovers. But if you are investing with a long-enough time horizon, then it really doesn't matter.
Use Drawdown Periods to Perk Up Your Portfolio. Here's How
One way to make drawdowns work for you is to use dollar-cost averaging.
Dollar-cost averaging simply consists of investing equal amounts of money at specific periods of time into a financial instrument (such as the S&P 500).
Dollar-cost averaging means that sometimes you'll be overpaying for the market, like many did in 2008. But you'll also be buying the market on the cheap, such as in March 2009 when the Dow Industrials fell below 7,000.
If you have absolutely no interest in investing in the market, but the idea of only getting a 1% return on your money at the bank makes you nauseous, then dollar-cost averaging may be for you.
How to Compound Your Returns With This Technique
The process is simple: Pick a specific series of time periods to add money to an S&P 500 index fund.
It could be annually, quarterly or monthly. Just make sure that you pick an index fund that does not charge you a commission every time you buy into it ... one that also has very low management fees.
If you do that for 20 years (as well as re-investing your dividends back into the index), you'll have about an 11% compound annual growth rate (CAGR).
While that return sounds low, an 11% CAGR will have you beating more than 85% of professional fund managers!
So, why doesn't everybody manage to at least make 11% on their money?
That's a good question, and there are a number of reasons why. The most important has to do with psychology.
Most folks come to the markets looking to sate psychological needs for validation, market action and excitement, just to name a few.
Of course, most people are completely unaware that they are being driven by these baser desires ... and that those desires are ruining their investing results.
Most self-directed investors have to hit some kind of a bottom before they start to re-evaluate their investment decision-making process. These individuals have the will and the smarts to be terrific investors.
You Have the Smarts to Become a Great Investor
Once they make the conscious decision to rid themselves of their market illusions and grandiose fantasies, they can go on to make a lot of money.
However, very few can make it through the fog of their own ego.
Admitting that one is wrong is not easy to do, and letting go of old ideas and preconceived notions is even harder.
If the prospect of having to slay your own inner demons is too much to think about, then there is a simpler way! It's not the most profitable, but it is one of the simplest and least-stressful ways to make money in the stock market.
An Easy Million or Two ... or More!
If you save just $5,000 per year for 30 years at a CAGR of 11%, you'll have $1.1 million.
Many people will say, well, what's $1.1 million worth 30 years from now?
And my reply is that it's worth a darn sight more than if you have nothing in your savings account 30 years from now!
If you want to accelerate your retirement earnings, there are just two options: either invest more or generate a higher return.
But if you are looking for a completely autopilot solution for beating 85% of all money managers, then this may be the approach for you.
Round Out Your Retirement With This Edge
If you want to do a little bit more work, you can create a performance edge for your retirement account by timing your entries into the S&P 500.
However, the process that you use to time your entries cannot be discretionary -- i.e., it can't be you waking up one morning and saying, "Today I am going to buy the S&P."
You can create an entry edge, but I do not suggest ever attempting to sell your existing position and then re-attempting to buy back cheaper. When you are investing for 20 years or more, it's just not worth trying to sell and then buy back in. Your biggest long-term edge can come from timing your entries, though.
The key is to buy into the index during a drawdown period. The magnitude of the drawdown will be different for each investment period. In some years, you may see 50% drawdowns; in others, just a 12% drawdown.
So, you want to have an entry tool that is not so much dependent upon the size of the drawdown because, on a year-to-year basis, we simply cannot predict that.
Rather, we want to employ a tool that tells us when the index is experiencing an oversold period based upon its long-term trading history.
A Sharp Way to Cultivate Your Investing Edge
You need to use specific technical tools that have a long proven track record of getting you into the S&P at historically cheap prices. I cannot emphasize enough that, in order for this approach to work, you must take "YOU" and your opinion out of the equation.
One tool that can be very helpful for timing entries into major indexes like the S&P 500 are Bullish Percent charts.
Bullish Percent charts measure the amount of stocks in an index that are on a Point & Figure (P&F is a form of technical analysis) buy signal vs. a P&F sell signal.
By timing your purchases through buying into an index when its BP chart is exhibiting an oversold reading, you put the drawdown recovery component inherent in every major index to work for you in your favor.
Buy and Hold on for Long-term Success
Remember, this is no silver bullet. You might buy into the S&P when it's down 30% ... only to watch it fall another 30%.
However, over a 20-year period, it won't matter. And by specifically buying the index when it's in drawdown, your overall rate of return could be far greater as the index recovers all of its lost value (and then some).
I recommend looking at some long-term charts of the S&P 500 and applying some different technical tools against the chart. Try to find some other technical indicators that you can use to time your long-term investments into the S&P 500.
Compare your results to a dollar-cost averaging schedule that invests specific amounts on specific dates, and see which method holds up better over the historical testing period.
This is very basic quantitative work that could boost your retirement investment returns dramatically.
Your Dream Retirement is Closer to Reality
I already shared with you that, if you can save $5,000 a year for 30 years at 11%, you'll have $1.1 million.
But if you can grind out an entry edge that yields just an extra 3% per year, or a CAGR of 14%, the same $5,000 per year will turn into more than $2 million.
Even with inflation, a $2 million nest egg that's growing at 14% per year will fund a dignified retirement.
 Teeka Tiwari Chief Investment Officer ETF Master Trader |
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