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4 strategies that beat 'buy and hold'
Not making money on your investments these days? If you got buy-and-hold religion in the 1990s, it's time to update your strategy to cope with what could be a long bear market.
By Timothy Middleton
Ive been peppered with e-mails lately from readers complaining they are not making any money on their investments these days.
Heres one possible reason: Youre using out-of-date investment approaches. You were brainwashed in the 1990s to buy and hold a thoroughly diversified portfolio. That is so 20th century. If you actually did that from the markets peak in March, 2000, through the end of last year, you eked out annual gains of 3.9%. No wonder youre unhappy.
My source for this performance datum is Michael E. Kitces, director of financial planning for Pinnacle Advisory Group in Columbia, Md. He has a better idea for improving portfolio returns -- four of them, in fact.
Its a scheme he outlined in an article for the Journal of Financial Planning last month. It rests on the premise that the bad market were suffering through is going to last a while, and if you want to make money, youve got to forget what worked in the 1990s and learn whats working now.
Kitcess keys to change: - Buy a few stocks rather than a bunch; only the best will do.
- Shun weak industries.
- Use alternative investments, like commodities.
- Violate the biggest taboo of all, and start market timing.
I like his ideas because I share them. So here Ive fleshed them out with some concrete suggestions on how you can fit these innovations into your portfolio.
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Why make the moves? Markets tend to move in very broad trends, says Kitces, who wrote the article "Understanding Secular Bear Markets: Concerns and Strategies for Financial Planners" with Kenneth R. Solow, Pinnacles chief investment officer. When markets get up to excesses, as they did in the late 1990s, they dont merely regress to the mean (the average). They regress to their lows.
This is what economists call a secular bear market, a period during which stock prices contract from their exuberant peak by as much as 65% to 75%. That happened between 1901 and 1920; 1929 and 1932; and from 1966 through 1981.
This time around, the Standard & Poors 500 Index ($INX) declined 45% between March 2000 and October 2002, and then rebounded. If the past is any guide, this market hasnt bottomed: What lies ahead are lower, not higher, prices for stocks.
So if your favorite mutual fund is Vanguard 500 Index (VFINX) -- and it has assets of $110 billion, making it the second-largest mutual fund -- you are going to be very, very unhappy 10 years from now. To avoid that dolorous fate, dump it and do one or more of the following things:
Concentrate on the few and the cheap
The more stocks a mutual fund owns, the more it is likely to resemble the Vanguard 500 -- the market average. To avoid that, own fewer stocks. The best stock-pickers own portfolios concentrated in just a few names. And in a bear market, the best stock-pickers follow the cheap, or value, style of investing because it is less risky.
My pick is Oakmark Select I (OAKLX), which owns just 20 names and packs more than 60% of assets into just 10 of them, including Washington Mutual (WM, news, msgs), Yum! Brands (YUM, news, msgs), H&R Block (HRB, news, msgs), First Data (FDC, news, msgs) and Time Warner (TWX, news, msgs).
Oakmark Select has posted average annual gains of 8.9% over the last five years, as of April 11 -- double the markets return. This year, however, its actually trailing the market with a gain of 3%. Concentrated funds are streaky; thats the dark side of a good force.
But value stocks by definition have already been beaten down, so they lose less in tough times. We consider avoiding significant losses to be the most important requirement for achieving long-term financial goals, and we believe our approach is well-suited for that, lead manager William C. Nygren wrote to shareholders at the end of the first quarter.
Find the right industries
There are always some sectors that are outperforming, notes Jack Bowers, editor of Fidelity Monitor newsletter, which maintains a model portfolio of Fidelity Select sector funds. If you can be in at least some of those, you set yourself up for success.
In the 10 years ended March 31, his sector portfolio delivered annual returns of 11.1% -- 2.1 percentage points more than the S&P 500.
Bowers tunes his model several times a year. Yesterday he adjusted it to look like this:
| Best sectors | | Fidelity Select Fund | % of assets | | Fidelity Select Brokerage & Investment (FSLBX) | 20 | | Fidelity Select Energy (FSENX) | 17 | | Fidelity Select Telecommunications (FSTCX) | 17 | | Fidelity Select Wireless (FWRLX) | 14 | | Fidelity Select Technology (FSPTX) | 14 | | Fidelity Select Biotechnology (FBIOX) | 13 |
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Source: Fidelity Monitor.
Bowerss system looks at good relative performance and low relative volatility, which together he hopes will lead him to at least two outstanding groups and no more than one turkey. Nobody can be in the top sector year in and year out -- those are lottery-style odds, he says. He only needs the odds to shift more toward than away from him.
Fidelity has the best array of sector funds in the business, but not the only large stable: Another sector expert is Rydex Investments.
Buy alternative investments
I have been recommending non-traditional investments for years. In January I talked about currency hedges and other alternatives in "Build your own hedge fund."
The ultimate alternative of the moment is gold. I hate the shiny stuff, except for adornment, but one of the markets most reliable pieces of advice is dont fight the tape. Gold is at a 25-year-high and recently pierced the $600-per-ounce mark. You can buy gold bullion in the form of StreetTracks Gold Trust (GLD, news, msgs). Most mutual funds companies offer funds that invest in gold-mining stocks.
Feel free to roam
Market timing was an expletive in the 1990s, when the straight-line increase in the S&P 500 made autopilot the preferred form of flight. In bear markets, market timing excels. Since November of 2003 Ive been maintaining a model portfolio of exchange-traded funds (Read "Defend your portfolio with ETFs.") that is adjusted quarterly -- that is, timed -- and has gone up at an annual rate of 13%.
Contrast that with the 3.9% return of the classic buy-and-hold portfolio cited by Kitces in his article. That portfolio is 10% cash, 30% bonds, 43% U.S. equities, 12% foreign stocks and 5% real estate. The fact is, U.S. stocks have been a big drag on performance for most of the last five-plus years, and bonds have been a drag much of that time. My model has a much greater allocation to foreign stocks, a much smaller one to bonds and a few other tweaks as well.
Unless you were away on Enceladus, youve added value funds to your portfolio in recent years, and possibly energy funds as well. Those steps, even if they were just chasing performance, were in the right direction. But you need to continue such moves, because todays bear market could last another decade.
The length of a bear isnt predestined: Those of 1929-1932 and 1937-1941 lasted only four and five years, respectively. But more commonly, they last between 16 and 20 years. If that history repeats itself, this bear wont go back into hibernation for a long, long time.
At the time of publication Timothy Middleton didnt own any securities mentioned in this article.
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