10/05/2010 08:54 pm ET | Updated May 25, 2011

A Novel Investing Strategy From the WSJ

Many investors take the Wall Street Journal seriously. So when I read a column by Brett Arends entitled, "You Should Have Timed the Market," it caught my attention.

I knew I was off to a bad start with the first sentence: "Everyone knows the last decade on Wall Street was a poor one for investors."

"Everyone" does not include Allan Roth, a respected journalist for MoneyWatch. Roth notes that U.S. stocks broke even, international stocks increased 26% and bonds increased by a whopping 83%. Investors who had a globally diversified portfolio of stock and bond index funds in an asset allocation appropriate for them, did just fine.

Arends did get one thing right. Investors lost billions of dollars by buying and selling at the wrong times. For obvious reasons, he omits the cause of this bad investor behavior. The financial media and "market beating brokers" who encourage this conduct.

Here's the astounding part. Arends' suggestion to investors is to cure this behavior by timing the markets. He states: "All you had to do was buy when the public was selling, and sell when the public was buying."

He tells investors precisely how to do this. "All you had to do was look at the latest numbers from the Investment Company Institute, showing whether the public was putting money into their stock-market funds or taking it out. And then do the opposite."

That's precisely what I did. I looked at Investment Company Institute numbers from January 28, 2007 through August 31, 2010. I tried to figure out how I would implement this strategy. Should I go short when the equity flows are positive, or stay in cash? How positive do these flows have to be for me to be a seller? Positive flows in domestic equity funds ranged from a low of $883 million to a high of more than $13 billion. How much negativity do I need to see before I decide it's time to buy?

For the month ending January 31, 2009, there was a net positive inflow into domestic equity funds of almost $7 billion. I guess I should have sold. But the next month, ending February 28, 2009, there was an outflow from these funds of more than $14 billion. I guess I should buy back in. Boy, this is confusing!

Then Arends extrapolates this strategy and tells an anecdotal story of "one of the best investors I have known". He "shuns publicity" so his name could not be used. This anonymous investor is investing in Japan because "your typical fund manager would rather suck a lemon than invest in Japan."

It's sad this kind of musing passes for financial advice in a prominent financial newspaper. I was struck by the lack of any hard data justifying these recommendations. -- even assuming it was possible to figure out how to implement them. It's not because the data doesn't exist.

For the 10 year period from 1997-2006, investors who missed the 20 days with the biggest gains lost the entire 8.4% annualized return of the S&P 500. There are legions of studies demonstrating that market timing simply does not work.

There is also ample data indicating precisely what does work. Buying and holding an appropriate allocation of index portfolios. Here are the annualized returns investors could have achieved with such a portfolio, consisting of 60% stocks and 40% bonds:

January 1, 2000-September 30, 2010: 5.79%
January 1, 1990-September 30, 2010: 7.60%
January 1, 1980-September 30, 2010: 10.40%

You can find details of this portfolio here. Please note the sources and disclosures.

This is information the financial media does not want you to know. It's bad for business. Novel investment ideas with vague parameters encourages trading. That's good for business.

There's nothing novel about that!

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

Here is the trailer for my new book, Timeless Investment Advice.