Archive for February, 2015

Investing and Emotions Don’t Mix

For many people, investing can be very emotional.  In declining markets, fear takes over and the natural reaction is to sell to prevent further losses.  In advancing markets, greed is in control and produces a desire to buy more.  These emotions are extremely dangerous to the health of your portfolio and if followed through, will inevitably lead to regrets later.  Emotions do not belong at all in investing, only hard logic and reasoning does. For Star Trek fans, you should always be Mr. Spock as far as your portfolio is concerned.  Live long and prosper!

February 25, 2015 at 5:22 am Leave a comment

A Common Misconception of Index Funds

It is now a well known fact that 80% to 90% (depending on the study) of actively managed funds underperform S&P 500 index funds.  The reason for that is two-fold.  First, active fund managers charge higher fees.  Second, they tend to trade often which results in commission costs, unfavorable capital gains tax treatment, and most importantly, underperformance due to continued attempts to time the market  stemming from frequent trading.  Index funds, on the other hand, change composition very rarely and thus almost never trade.

As a result, there is a flow of cash from actively managed funds to index funds.  Many prominent investors, including Warren Buffett, advocate to consider only index funds for individuals.

However, many investors don’t understand exactly how index funds are structured.  Most indices, including S&P 500 index, are not equal weighted, but instead market capitalization weighted.  This means that dollar amount of each fund holding is proportional to its market cap.  So if you invest $1,000 into S&P 500 index fund, you will not put $2 into each of 500 companies.  Instead, you will own approximately $50 worth of Apple, $30 each of Microsoft, Google and ExxonMobil, etc. — because these are highest market cap companies in the index.  And you will invest only $10 combined into hundreds of mid-cap and smaller companies with less than $5 billion market cap.

While market capitalization is appropriate to measure performance of the overall market, no reasonable investor will construct his or hers individual portfolio in the above manner.  The best way is to select high quality companies with excellent management teams and own these companies for a long time, selling only if business fundamentals deteriorate.  That way, you can have your own properly constructed “index fund”, and without market timing, it will have a good chance of beating the venerable S&P 500.  This is exactly the strategy I use for my clients’ and my personal portfolios.

February 22, 2015 at 1:58 am Leave a comment

Market Timing Doesn’t Work

Since 2011, investors have been waiting for a correction, which has not yet materialized.  Meanwhile, the market has been climbing steadily and hitting new highs.  I am sure a correction will happen sooner or later, but trying to time the market this way never works.  Watch this one minute video for details.

February 16, 2015 at 9:49 am 1 comment

Market Update

We are well into the first quarter earnings season, and the results are not quite as robust as they used to be.  Many prominent mega-cap multinational corporations, like Caterpillar, Dupont, ExxonMobil, Pfizer, etc. either missed earnings estimates or provided cautious guidance going forward.  There is nothing wrong with these businesses — the reason is our strong currency which reduced dollar-denominated sales overseas.  This affects all companies with significant business abroad.  Thus, we may witness a shift in market leadership toward domestic companies, which tend to be smaller.  It is about time — large cap stocks outperformed smaller companies last year.

Meanwhile, in addition to never-ending “Grexit” concerns, deflation is a new market bogeyman.  Indeed, deflation would be bad news for worldwide economies, and in order to prevent it, several European countries now sport negative interest rates (which causes weakness in Euro and other currencies and leads to dollar strength — see paragraph above).  With no inflation in sight, I don’t think Fed will raise interest rates anytime soon — doing so will only strengthen the dollar even more.

As a result of this very low interest rates environment, S&P 500 dividend yield is now higher than 10 year U.S. Treasury rate.  There is always a possibility that one or several multinational companies chooses to cut its dividend, and that may well trigger that long-awaited correction.  However, at this time, equities remain essentially the only game in town for investors expecting a reasonable return.

February 10, 2015 at 10:58 pm Leave a comment


Blog Author

Leon Shirman's long-term investment philosophy is summarized in his book, “42 Rules for Sensible Investing”, also available from Amazon.

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