On August 10, 2011, after a tumultuous day on Wall Street, I appeared on CNBC, along with another guest, Natalie Pace. According to her web site, Ms. Pace's vision is "to spread wealth by sharing wisdom and to add a splash of green (and pink) to Wall Street." Her mission is to "demystify the markets" and "...make investing as much fun as shopping."
This had potential.
You could feel the excitement in the CNBC studio, even from the satellite feed. There was a lot of ground to cover in under five minutes. The volatility of the markets had obviously rattled investors. We were there to make sense of it all.
Ms. Pace was asked to "please be a voice of wisdom and reason right now for us. We need it." Here was her advice:
1. Buy and hold doesn't work;
2. "America does work. Companies are doing well."
3. Add "hot industries" to your portfolio
4. Look at "modern portfolio theory which is as easy as a pie chart" and rebalance annually so you "capture any gains you have."
Buy and hold is not dead.
Proponents of the "buy and hold is dead" theory rely on the flat performance of the S&P 500 index over the last decade. This makes no sense. I know of no competent advisor who tells her clients to invest 100% of their portfolios in an S&P 500 fund. Investors in a globally diversified portfolio of three index funds (like those I recommended in 2006 in the Smartest Investment Book You'll Ever Read) had a fine decade. They invested in a domestic stock index fund that tracked the Wilshire 5000 (not the S&P 500), an international stock index fund and a domestic bond index fund. If they were in a typical asset allocation of 60% stocks and 40% bonds, they had an annualized rate of return of approximately 6% for the past decade. Allan Roth totally demolished the myth of the "lost decade" in this excellent blog.
America does "work", but that won't help investors
Maybe U.S. based companies are doing "well" (whatever that means), but we live in a global economy. Limiting investments to U.S. based companies deprives investors of opportunities in other countries and reduces their ability to diversify risk. Investors should have a globally diversified portfolio.
Adding "hot" industries to your portfolio is bad advice
Ms. Pace did not offer examples of industries she believes are "hot." There is no evidence anyone has the expertise to predict which industries will outperform in the future. Ms. Pace's "hot industry" picks (whatever they may be) may turn out to be good or bad, but relying on them is gambling and not investing. Her crystal ball was cloudy in January, 2011. She saw "a dismal January and February" (the S&P gained 41 points), a "spring rally" beginning in March, ending with the NASDAQ increasing in value by 20% year end and the DJIA increasing by 5% . These predictions may end up being accurate, but it will be a long haul. The NASDAQ is down 7.61% year-to-date and the DJIA has lost 5.16%. Relying on the predictions of Ms. Pace or any market "guru" is speculating.
Confusion over Modern Portfolio Theory and Rebalancing
Modern portfolio theory shows investors how to maximize expected return for a given level of market risk. It doesn't "work" to protect investors exposed to stock market risk against losses in all market conditions.
Nor does annual rebalancing permit you to "capture any gains you may have." The purpose of rebalancing is to ensure that a portfolio continues to reflect the level of risk an investor has the capacity to withstand.
The combination of MPT and rebalancing would not have "...kept your gains this year before this big market downturn" as Ms. Pace stated. All of the portfolios offered by Index Funds Advisors (with whom I am affiliated) follow MPT. In fact, Harry Markowitz, who is widely known as the father of MPT, and a 1990 Nobel Prize Winner, is an academic consultant to IFA. IFA regularly rebalances the portfolios it manages, which aggregate approximately $1.5 billion of assets. All of IFA's portfolios, from very conservative to aggressive, were impacted by the recent market declines.
Sound advice -- Lost in the hype
As I stated on CNBC, you should be in a portfolio with a suitable asset allocation. If you have less than a 3 year time horizon, you should have no stock market exposure. If you have a three-fifteen year time horizon, you should ignore the financial news and the current market volatility. No "expert" can "make sense" of the market, predict the future direction of the market, pick hot stocks, hot industries", or funds that will outperform. Stick to your guns. Invest in a risk-appropriate, globally diversified portfolio of low management fee index funds.
As one pundit said: Don't just stand there, do nothing!"
Dan Solin is a Senior Vice President of Index Funds Advisors (ifa.com). He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011. 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.
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