Is It Possible to Beat the Market?

The following is a guest post from Paul Williams of Provident Planning.

The simple answer is yes - it is indeed possible to beat the market. People do it every day. I'm sure you've heard stories from friends or family members who have a market-beating stock broker or financial adviser. Maybe your uncle got a 150% return from his stock picks last year. There's no debating the fact that it is possible to beat the market.

The problem is that's the wrong question for investors to be asking. Yes, it's possible to beat the market. But the real question is this: is it possible to beat the market in the long run? When you're investing for retirement or other long-term goals it doesn't matter if you can beat the market for a day, a month, a year, or even five years. If you're going to try to beat the market, you need to be able to beat it for the entire time you'll be investing. If you aren't able to do that, you'll have wasted all the time, effort, and money you put in to trying to beat the market in the first place.

Why can I say that? Because one simple mistake can wipe away all those years of great returns and lucky stock picks.

My point is that long-term investors have to be focused on long-term results. I'm talking 20, 30, or 40 years - not 3, 5, or 10. If you're trying to beat the market, you need to know if it's possible over the long-term.

So here's my question for people who think they can beat the market. If 80% of professional mutual fund managers fail to beat their benchmarks, how do you expect to beat the market?

The pros spend every day studying their markets, screening stocks, and researching information. They have support teams and networks that you'll never be able to afford. They have inside contacts who can give them information just seconds after it has been released. Yet 80% of the pros still fail to beat their benchmarks (the market). How are you, with your limited time and resources, going to do better than they can?

It's clear that you'd be a fool to try to beat the market using your own strategy or ability to research stocks. But if you're not going to do it, you're left with two options.

1. Find someone else to do it for you.

2. Invest in a diversified portfolio of index funds.

So your first option is to find either a mutual fund manager, a stock broker or financial adviser, or an investment newsletter that will do all the work you can't do to help you beat the market. The problem is that finding someone to beat the market for you requires skill/luck on your part to identify that person in advance. Remember, you've got to find someone in that 20% group who's going to outperform the market. How are you going to do that? There is no reliable method to determine which professional is going to outperform the market.

Even after you overcome the hurdle of identifying the right person, you're still left wide open to the chance of underperformance. You're relying on humans to help you beat the market, but humans easily make mistakes. Consider Bill Miller (an often-used example) of the Legg Mason Value fund. Although he was able to beat the S&P 500 from 1991 to 2005, he lost to the market in 2006 and bombed in 2008. As of right now, the S&P 500 has outperformed the Legg Mason Value fund from 1991 to present (and the S&P 500 has handily outperformed the fund since 1986, the year the fund began). It's clear that even a pro with a good track record is susceptible to mistakes that will decimate the results of 15 years of effort.

Index funds remain the best choice for investors because of their simplicity, low-cost, and reliability. Picking a good index fund only requires you to compare a few key bits of information like the expense ratio, the underlying index, asset class, and any other costs. Because index funds don't require active trading, you get to enjoy lower costs and lower taxes - which will help improve your investment results. And finally, with index funds you know you will get results that match the index you're tracking minus your costs. You never have to worry about human mistakes erasing all the outperformance you may have received in the past.

They're not fun. They're not exciting. But index funds work and they'll give you consistent results compared to the market. I can't guarantee what the markets will do, but I can guarantee that a good index fund will match the performance of the markets very closely.

Comments

[Paul Williams]

Thanks for letting me guest post, FMF! I appreciate it.

[Eugene Krabs]

Well said!

Plenty of people win lots of money at the casinos too or with lottery tickets too. But hardly anyone ever considers that as a long term strategy. Over the long term, the odds really are against you. *rimshot*

Thank you! Try the buffet, it's great!

[Crystal]

Is investing in well known companies with high-paying dividends really that different than index funds? We've been getting slightly better results with that than the index funds we've looked into but have only been investing since 2006 (out of college). Obviously, we have not been in the game very long, and I'd like to know what y'all think.

We also have a pension, a 401k that's invested in a Vanguard Target Date Mututal Fund, and a Roth IRA that's invested in a Fidelity Target Date Mutual Fund (different date).

We're opening another Roth IRA this year and I'm trying to figure out what we should invest it in...my husband wants to invest it in stocks like our Scottrade account and I want to invest it in a different Target Date Mutual Fund or an Index fund. What do y'all think?

[Rick Francis@ponderingmoney]

I enjoyed the post, but I think your statistics are generous to the active fund! For much longer time periods far fewer funds beat the market. It gets even bleaker if you consider the performance after fees!

Even if you were able to beat the market yourself it isn't worth your time and effort unless you have at least $500,000.

-Rick Francis

[JoeTaxpayer]

I don't claim to beat the market, but I know, with certainty I will beat the average investor, long term.
The combination of the fees on managed funds and the tenancy to buy high/sell low means that anyone who indexes and stays in it long term will beat the average investor.
To put it another way, if the S&P runs 10% long term, data shows that the typical investor doesn't see anywhere near that, lucky to be at 5-6% (due to buying and selling at the wrong time). If I am willing to index and on the 10% get 9.9%, I am ahead of the average (investor, not market).

[Financial Samurai]

Statistics show that it is very hard to do over the long run. Sure, within 5 yrs, yes, but long run, it all comes close to center.

The Samurai Fund I've put together, based solely on the permutations of people's names and blog sites is proving this point.

It's all LUCK i say! The fund is up 0.2% YTD vs. the S&P500 -3.5%! Yeah baby yeah!

[Apex]

The advice is generally sound however something similiar to the following quote used in this article is often used as justification for why you can't beat the market:

"So here's my question for people who think they can beat the market. If 80% of professional mutual fund managers fail to beat their benchmarks, how do you expect to beat the market?"

This is a misleading comparison. Individuals have a huge advantage over professional fund managers. Namely, small dollar amounts. Fund managers are working with very large amounts of money. That means there are a whole swath of smaller stocks that are simply unavailable to them because taking any meaningful position in them at all would swamp the volume and move the price in such drastic swings that it the act of them investing would make the investment a money loser.

In addition it means that except for the very largest companies, it often takes a fund days to full take or unwind a position in a stock. And this action itself can have some price movement on some of the stocks. This gives fund managers an inherent disadvantages to the individual investor and the market as a whole.

They have other advantages too that were mentioned in the article, but it is worth pointing out the disadvantages too.

That is not to say that an individual doesn't have extreme hurdles to overcome and most would likely not succeed in doing so. But the comparison to the professionals while it sounds good is actually not a good argument.

[Paul Williams]

Apex, you make a good point, but the question is do those disadvantages the pros face actually explain their underperformance? If those disadvantages are why the pros are underperforming, then yes, my argument doesn't work there. But if there are other factors that contribute to why the pros are failing, then the argument can still hold water.

The biggest factor is time. Even if you have some kind of inherent (or learned skill), it's going to take up a bit of your time to be picking stocks you think will beat the market. Most of us are struggling for time as it is, so index funds are an easy solution that also have some great benefits.

[Apex]

@Paul,

I don't dispute your overall argument. It is sound.

The pros disadvantage may not explain all their underperformance.

It's just that some people who find a niche set of skills or information can outperform.

The number of people who possess that skill/information/ability is likely quite small (probably a lot smaller than the number of people who believe they possess that skill). And the skill/ability might be time bound too, they may lose their edge, or conditions may change, or they may lose their access to the information that made their outperformance possible.

I just wanted to point out that finding opportunity in the market is possible. (I believe a regular poster here "Old Limey" claims to have built his fortune doing it for about 15 years - and I only say claims because we have no way to verify what he has said, even though I believe it's likely true).

[RetirementInvestingToday]

Maybe I'm a fool but with my Retirement Investing strategy I'm going to try and beat the market by a little.

I have however adopted some key principles that I think match the principles above:
1. All my retirement forecasting and savings ratios are based on me just matching the market. Just in case.
2. I'm not paying fees for active management but wherever possible using index trackers and ETF's.

So how am I going to try and beat the market. Back testing that I have done suggests that over the very long term by using the Cyclically Adjusted PE (CAPE) which is the ratio of the Real Price to the Real Average 10 Year Earnings I might be able to squeeze a little more performance by being lighter equites when over valued and heavier equities when under valued.

[BillV]

@Crystal
My lay man's view of your first qx is that dividend paying stocks are different than an index fund. Because index funds usually have a mix of high, low, medium, and no dividend paying stocks. Having said that, if there is some index fund out there that is made up of only high dividend paying stocks--well that changes things. Based on your age, your other postings and your current mix of pension (defined benefit for both of you?) and other holdings I like the high dividend paying stocks over index for you now.

Your new money, well, let me ask. Do you both feel strongly regarding your choice? If yes, the easy way is to do both, I mean half in one and half in the other. Then track their records. But if you don't have strong feelings about your target fund, I'd say go with your husband's plan. Why? Again, because of your youth and your other assets. Honestly Crystal at this stage of your life I don't like the target date fund approach. And frankly I don't like them at all. You give up too much decision making to fund managers. A mix of index funds: small, medium, large, and in both value and growth plus an international or two gives you a better asset allocation. Oh yes, and maybe a small per cent in bond funds that you increase as get older.

One last thing and this also goes to the theme of today's article. Old Limey, our buddy, beat the market with well selected stocks. But if I have read his posts correctly it was not over a 30 to 40 year period. OL if I have mis-stated anything here I apologize. Also hope you don't mind me using your example here.

I wouldn't bet the retirement fund on beating the market. I think if one has the cash, it would be fun to take some smaller amount and invest it as though you were going to beat the market.
see how you end up over the next 30 years.

[Crystal]

@BillV
Thanks for your suggestions! My husband feels strongly about it...I'm just risk adverse. I chose target date funds because they force me to be riskier - 80%-90% stock allocations for my age group makes sense, but I cringe at trying to choose correctly.

My husband does not have this problem. I'll suggest putting half of the new Roth IRA into index funds and half into the high dividend stocks he likes. If he really wants to invest it all into individual stocks, I won't push back.

I'm just happy I convinced him that we needed another Roth IRA - he thought we were already saving enough and just recently looked at my long-term projections for all our accounts. We are fine now if we can get a 10% or better return over the next 25 years, but not if we only get an 8% return or less. Another Roth IRA will take up the slack and make me content with our retirement savings.

[mysticaltyger]

Actually, there are a fair number of good funds out there that have beat the market over long periods of time. The fund mentioned in this post just picked one good fund that blew it. Personally, that fund's expenses were too high from the get go. If you are someone who avoids funds with excessively high fees, you wouldn't have picked that fund, anyway.

Here is a partial list of funds off the top of my head that have beaten the S&P 500 over the last 10 AND 20 years:

T. Rowe Price Capital Appreciation PRWCX
T. Rowe Price Equity Income PRFDX
T. Rowe Price Balanced RPBAX
Dodge and Cox Stock DODGX
Dodge and Cox Balanced DODBX
Vanguard Wellington VWELX
Vanguard Wellesley Income VWINX
Vanguard Star VGSTX
Mairs and Power Growth MPGFX
Mairs and Power Balanced MAPOX
Fidelity Puritan FPURX
Fidelity Balanced FBALX
Berwyn Income BERIX
Sequoia SEQUX
Sound Shore SSHFX

Also, if you can buy the Class A or R5/R6 Shares of American Funds in your 401K without having to pay the sales load, most, if not all, of their stock or balanced funds have beaten the S&P 500 over the last 10 or 20 years by significant margins as well.

If the stock market ever goes into rip roaring mode again like it did in the 1980s and 1990s, then some of these funds won't beat it, but they'll likely match the S&P's performance or come close, and the balanced funds will have much less volatility.

[mysticaltyger]

Oh, and another fund with a great 10 and 20 year track record is:

Fidelity Contrafund FCNTX

I'm sure there are other funds I don't know about. But I think it's definitely possible to beat the market with good funds. You do have to watch for manager changes, though. The team managed approach at Dodge and Cox or American funds would well serve those who are not interested in worrying about their funds when managers change.

[Paul Williams]

@mysticaltiger:

Finding funds that beat the S&P 500 is not as difficult as finding funds that beat their appropriate benchmark. The S&P 500 is not the appropriate benchmark for many (if any) of the funds you listed. Finding that information is very difficult (especially for the funds you noted) because they're continually changing strategies.

I'm not saying a single S&P 500 index fund is the best choice for investors. I'm saying a diversified portfolio of index funds is the best choice. Comparing that kind of portfolio to the S&P 500 would also be inappropriate.

[Old Limey]

@Paul
I am one of the few that has beaten the market by a significant margin over the last 17 years.
I have kept a daily log of the value of our portfolio since 12/28/92 when having recently retired from my job as an aerospace engineer at Lockheed Martin I took control of our IRAs and moved them and our other accounts to Fidelity Investments where they have been ever since.

..............................Compounded Annual Rate of Return%
Period ------------------ My Results ------------ Wilshire 5000
12/28/92 - 01/29/98 ------ +25.74% ---------------- +16.39%
01/29/98 - 03/22/00 ------ +64.57% ---------------- +22.99%
03/22/00 - 01/31/03 ------- +3.54% ----------------- -18.46%
01/31/03 - 11/07/07 ------- +12.51% ---------------- +13.61%
11/07/07 - 12/31/09 ------- +3.05% ----------------- -12.11%

12/28/92 - 12/31/09 ------- +19.04% ---------------- +5.87%

Now let me explain what it has taken to achieve these results.
Upon retiring I searched around for a comprehensive database of mutual funds and market indexes and saw one in Investor's Business Daily to which I started subscribing in early 1993. The database, which today has almost 10,000 funds and indexes with data going back to 9/1/88 also comes with a very comprehensive charting and analysis program, which has a steep learning curve because of its complexities and capabilities.
In the early days there was a Bulletin Board on the Internet whereby database users could chat and pass on useful information to others. I learned a lot from many of these older and more experienced investors and before long I decided to teach myself all about technical analysis. I bought many of the well known books and started programming many of the methods. I also designed a much simpler interface that helped less experienced users to use some of the techniques. There was lots of symbiosis between about 250 of these database users and I was kept busy for the first two years learning all I could and completing my own software. The company providing the database also had annual conferences at various cities and I also learned a lot from the guest speakers and 3 or 4 other developers like myself. In this community of gung ho investors the dirtiest of all dirty phrases was "Buy and Hold" - it was used very scornfully.

In the early days everyone was heavily into Sector Rotation using the Fidelity Select funds. Also, in those days, the Internet was still quite new and market data was nowhere near as widespread as it is today. Consequently investing in the sectors that were currently hot proved to be very lucrative. With time sectors started rotating at shorter intervals as more players entered the game and it became more and more difficult to hold a sector for 30 days so that one could avoid Fidelity's short term redemption fee. Eventually as Fidelity's funds network grew and grew and far more funds became available we shifted away from the Fidelity Selects and today we have the data for 39 sectors where each sector's data is now the average of all the available funds in each sector. Thus a quick ranking of the 39 sectors is very useful to know. I also programmed many technical indicators that were not readily available that helped to assess the health of the NYSE and the Nasdaq. These indicators included the Up/Down Volume, Advancing/Declining issues, and the McClellan oscillator and summation indexes as well as many more.
So finding the hot sectors and then finding the strongest funds in those sectors is a big help. The second major thing needed is a way of deciding when a fund should be sold, and there are many technical indicators that are very effective. After all is said and done there is no substitute for experience but all the experience in the world is of no help in a Bear market unless you want to sell short. I never did, I am content to sit out Bear Markets in a very conservative income fund. Likewise I never use Margin.
In November 2007 my indicators were all very negative and I decided then that I had made enough money to last a lot longer than I would so I decided to invest only in bonds. I was in High Yield bonds for a while and then in 2008 I decided to go completely into CDs and municipal bonds and coast along for the rest of my days.
If you look at my results you can see that the DOT.COM Bubble made all the difference in the world and I regard that as a once in a lifetime event. I know I will never live to see the Nasdaq 100 break its high of 4,704, it's currently at 1,779. The other main contributor to my success has been avoiding losing years. I also read complimentary market letters and articles by many experts - they all contribute valuable information.

[Old Limey]

@Mysticaltyger
I just ranked all the funds that are in Fidelity's Funds Network that were available over the last ten and the last twenty years and available to retail investors.
The database that I use adjusts the share prices of all funds for all dividends and distributions and assumes that all dividends are reinvested.
Having shares prices adjusted is absolutely crucial for income funds since they have monthly or quarterly dividends.
Many other databases only show the published net asset value (NAV) for each market day.
Since the S&P 500 doesn't have dividends or distributions this may account for erroneous conclusions by others.

Last 20 Years
==========
276 beat the S&P 500
83 did not beat the S&P 500

Last 10 Years
==========
972 beat the S&P 500
295 did not beat the S&P 500

[Old Limey]

@Crystal and BillV
I first started investing on my own in 1960 when I had little money to work with. Things were very different in those days, long before the Internet. For mutual funds you dealt with the company primarily by mail and for stocks you had a broker that would call you at work when you were very busy and pester you to buy something or make a trade. The broker offered a phone number that you could call to hear an automated recording that gave the price of the Dow and the Nasdaq, that and the newspaper was all I had until I started subscribing to newsletters and newspapers like the WSJ and IBD. If I wanted to research a stock I had to visit my local reference library and check out the latest S&P Report for that company.
The brokers were only out for themselves and I had far more losers than winners with them. Fortunately I had one stock that tripled, and that produced the downpayment for our first home.
I had one mutual fund company where a salesman came to our door and talked us into investing in a fund with an 8% sales load.
Boy! was I wet behind the ears in those days.
For a short period I subscribed to two experts, highly acclaimed by the Hulbert Digest. I tried trading stocks that they recommended but by the time I got the Buy or Sell information in the mail it was usually too late and the stock had made a big move already. Eventually one stock recommendation that I bought went to zero and was delisted. With that incident and a number of "Disasters de Jour" when bad earnings reports came out I gave up on stocks once and for all. One thing I bet you have never heard of - some days during lunch we would go into a nearby brokerage where they had a seating area facing a big chalk board. As stock prices changed they would use erasers and update the chalk board prices. Old retired guys would stay there during market hours, watching the board, and making trades. Your stockbroker tried to be your Buddy back then and take you out to lunch 2 or 3 times/year, as long as you kept investing in his picks.
I also tried newsletters for a while but never found one that I liked for very long.
In those days my 401K was growing nicely - I could change allocations twice/year and I had about four choices which were just different ratios of a stock index and a bond index. It was just as well since I was far too busy at work to get involved in investing the way I did after I retired.
Investing as we all know it today didn't really get going until the Internet came of age. The volume on the NYSE in those days was a tiny fraction of what it is today when nearly everyone is in the market.

[Paul Williams]

@Old Limey:

Thank you for taking the time to comment. You know I enjoy hearing your views.

I know you have done quite well for yourself doing exactly what I've recommended against, but as you've admitted many times before (1) there aren't too many people who can successfully do what you did, and (2) you were lucky enough to ride the .com bubble on the way up. In many ways you were also more conservative than many people who try to beat the market, since you didn't use margin and you didn't short sell.

Your performance is impressive, but the bigger question is whether it would have been sustainable over a longer period OR is it replicable?

My question for you is this: given your experience and successful performance, what course of action would you recommend for the average investor? To follow your methods, or to invest in a diversified portfolio of low-cost index funds with an appropriate asset allocation?

[Mike Hunt]

Hi Old limey,

What does your model tell you right now? Any flashing red warning lights we should be aware of?

-Mike

[BillV]

@old Limey,
Seriously,with no pander intended, you need to write two books. One regarding investing/savings/preparing for the future; one sort of autobiographical. I hope you saved all your posts. You have an interseting storyand you write well.(Especially well for an engineer. I'm teasing of course.)

There is an old adage that applies to the market but it can be expanded to other aspects: Bulls make money, bears make money, pigs get slaughtered. Had you been piggish someone in your situation back in 07/08 might have choosen to let the money ride. You decided you had plenty, paid attention to the warning signs and moved your money to the sidelines. I wonder if all your online friends were as shrewd.

Keep posting.

[Old Limey]

@Mike Hunt
This is a free newsletter that was recommended to me about a year ago. The author is very well connected as you will find out if you subscribe. His letter covers world economics, it doesn't give tips on what to do, what to buy/sell etc. but I find it very well done and very educational and enlightening. Many of the articles he provides are written by experts that he associates with. The articles are about Reality not about Hope. If you want Hope, listen to the politicians or watch TV.
http://www.frontlinethoughts.com/

[Tyler]

Why is delivering excess returns over a short period of time a bad thing? I’d rather have excess returns over a five year period and then have market returns over then next 20 years, than have 25 years of market returns. If one can find a market inefficiency, it is unlikely to last for a long period of time- length of time here is simply irrelevant. John Paulson made a few billion for himself with one year of market beating returns.

Apex is absolutely correct- a fat wallet is not the friend of returns. As funds grow, their returns tend to hug the benchmarks. This being said, if the fund can make the leap into the ‘super size’ realm, their information advantage grows (this is less and less true as technology improves.) For a fundamental manager this means access to senior management and for others it could mean faster data lines.

I hate the logic, “if most so called professionals cant beat the market, how can you expect the beat the market”. Most so called professionals look great on paper but are completely incompetent. Most are incentivized to match their benchmark and have zero incentive to even attempt to ‘beat the market’.

I am a professional money manager. I grew up in this business. I no longer manage outside money. I have delivered returns that far exceed market returns; even adjusted for volatility. If a money manager is good, you wont hear about him (why spend any money on marketing?). If a fund manager is good, they will very quickly stop taking investors. There is zero incentive for the above average fund manager to work at a fund open to the general public.

The advantages held by ‘professionals’ are diminishing everyday as barriers to entry are knocked down. This being said, I still hold a huge advantage over an average investor. I live and breath the markets, I’ve seen thousands of trades, experience with opm (this education costs millions… literally), costs of execution, data speeds, news, networks, risk profile, leverage costs, structural advantages, etc. The odds of an average investor beating me over any period of time are very low.

The average investor at home, should focus on asset allocation. ETF’s are a cheap way to accomplish a diversified portfolio. If you have a special knowledge, use that to your advantage- a biology PhD investing in biotech, Old Limey using his math skills, etc.

[PDubbs]

There are two sides to every trade: a buyer and a seller, a winner and a loser. That's what makes a market. Of course, over the short term one investor (or speculator) can be on the winning side of most of those trades. The longer the investor is in the market making those trades, the more opportunities there are to also be on the losing side, thus bring the overall returns back to "market average." Also, the more trades the investor makes, the more commissions s/he has to overcome. I believe it was Warren Buffett who said something like, "The key to investing is never losing money."

For the average person index funds are best, especially if they don't have time to do research on fundamentals, technical analysis, etc. Much safer and more "out of sight, out of mind." Sure, people can make a huge returns picking and trying to time the market, but these people are speculators (for the most part).

[Old Limey]

@Paul
The methods that I used worked well for me from 1993 until the beginning of the debacle in which we now find ourselves. You must have read articles describing how the big players like Goldman Sachs, Morgan Stanley, Bank of America and others are able to borrow all the money they want for almost nothing from the Federal Reserve and then use their trading floors, supercomputers, proprietary trading systems, top computer experts, and insider knowledge of pending trades to manipulate the market at will while making tiny profits on massive numbers of shares traded. These are the players that can make the market move a lot in the last 10-15 minutes whenever they want. They have to be the greediest people in the world, and with their huge bonuses, also some of the wealthiest.

You asked about what I would do if I were still investing in equities. I would still look for hot sectors that are in a nice smooth uptrend, ride them up as long as they were going up and then sell them when they headed down. The absolute best sector last year for what I used to do (and my favorite) was the Hi-Yield Bond sector - they had their best year in a long time last year and it was an unbelievable, low volatility, steep uptrend that ended at the end of the year. One newsletter that I receive for nothing because I have known the writer a long time was in it from March 2009 until January 2010, which is quite unusual. One fund in that sector you probably know well because it's an adviser fund is Fidelity's FAHCX, it was up 125% in that period, another retail fund was NTHEX, it was up 100%. These low volatility funds are easily timed using an exponential moving average. You find the best value of moving average by backtesting and keep the trades/year down to about 3 at the most. It happened because the stock of the companies whose bonds the funds held hit bottom in March '09 and the yield on the bonds went up to unprecedented values. Then as the market recovered and the yield on the bonds returned to normal levels, the bonds had a great ride up. Picking the very best low volatility sector that's in an uptrend and riding it up as long as it lasts still works and many of the people I know follow that newsletter even though it costs $1500/year. The guy who writes it also has a hedge fund for which his investors pay him a nice cut of their profits. I believe you need to invest $1M minimum to invest in the hedge fund, but he uses margin and short positions as needed to do well above average.

[Mike Hunt]

Old Limey,

I've been getting John Maudlin's newsletter for some time- it's pretty good. I also read The Automatic Earth, it's a great collection of news that gets assembled twice a week.

I really need to learn how to do proper TA, although with the number of people in the market it probably provides less returns than it used to.

In the mean time, it's spending most of my time focused on work like the 95% of the rest of the population.

-Mike

[Old Limey]

I was curious about the reluctance of people to want to time the market so I just ran the simplest possible case I could think of. I ran VFINX which is Vanguard's index fund that tracks the S&P 500 but it also earns dividends so it does better than the index.
I then used a 260 day moving average, that's as simple a way to time as there is.
A large moving average such as this only creates about one switch per year between the fund and the money market.

For the last ten years the results were:
Buy and Hold VFINX -0.64%
Timed With/260 day average VFINX +6.41%

For the last twenty years the results were:
Buy and Hold VFINX +8.32%
Timed With/260 day average VFINX +10.94%

The last two trades were a Sell on 5/23/08 and a Buy on 7/23/09
Over twenty years Buy and Hold increased 495% whereas simple timing increased 797% - That's worth having.

[FMF]

Old Limey --

Ok, I'll bite. If it's so easy, then why isn't everyone doing it? Or a more realistic question -- why aren't at least the pros (people who should know how to do this easily) doing so?

My guesses as to why:

1. It's not as easy to select timing dates as you might think. It's easy to you because you've built up skill in it, but for the average person, it may be a stretch.

2. Even if they know what to do, the actual "doing" part (the execution, if you will) keeps potential investors from actually doing it.

3. The time and effort that you have to put into this sort of plan is not something most people will want to commit to. You've said that you spent many, many hours working the system you developed. Those returns didn't come without a cost -- in your case the cost was time, and you gave up significant portions of your life in order to get higher investment returns. When you look at the total costs -- money AND time invested -- your path was not as inexpensive as it appears to be on the surface.

4. While it's easy to look backwards and see which plan would have been better, it's impossible to tell the future -- and if one plan or the other will pan out as the winner. Given that, it's best to go with a low-cost indexing strategy the delivers decent returns and low expenses. I think this is why Buffett recommends index funds for all but the most serious investors.

[Old Limey]

@FMF
You are correct that very few people have the software and the data (adjusted for all distributions) on their computer to be able to check whether a fund is above or below a particular value of moving average.

With my software I can actually set it up so that every night when I update my database I just have to press one key to generate the status of any timing signals I have set up and a signal that has just gone to a SELL will show up in RED and will be blinking. Since I stopped trading I never use it. The only trades I ever submit are to reinvest income as soon as it appears in my account.

The number of users of my software is in the low four figures and I had an e-mail from one of them yesterday that ordered a CD for a new computer, she said "What I am ever going to do without you". Over the years I have had many e-mails from users thanking me for enabling them to beat the market and keep them out of the big dips. My software, being an MS-DOS program is on life support because DOS is limited to 640K of memory, which is nothing these days. I took my software off the market in July 2008 when the database had another 5 years added to it, and then in 2013 when it expands again all of my users will be out of luck because it will die for lack of memory.

You are correct that I spent the better part of two years developing and debugging 130,000 lines of computer code but I was amply rewarded by my customers as well as with my success in using it for managing my family's investments. I also thoroughly enjoyed it, just as you enjoy being a referee. The reason I never converted it to Windows is that it would have taken a whole year because I don't know how to program in Visual Basic and I heard horror stories from two guys that went through what I would have had to go through.

There are a great many investors that time a major index using a 200 day moving average, the reason for this is that it's easy to find results on some websites for such a popular number such as 200 days. To get the best results though you have to backtest for all the data you have over a wide band of moving averages and then decide which value for a moving average gives you the best compromise between the number of trades, the maximum drawdown, and the annual rate of return. If you want to go better than that, instead of switching into a money market fund when you get a Sell you could switch into an interest bearing fund such as short term bond fund or a total return bond fund, which both outperform a money market fund over a long period.

Submitting Buy and Sell orders is a trivial task these days if you are using a software package provided by the company that handles your money. I use Fidelity's Active Trader Pro, not only is it a wonderful portfolio manager, it's the easiest thing in the world to submit a trade.

[tyler]

1. As soon as everyone 'does it' it wont work (or it will work REALLY well, then not work). You would be amazed at some of the stupid things that have worked in the past. (We once ran a very profitable strategy that used 7 and 13 min simple moving avg crosses.)
2. Many professionals use 200 sma as an indicator- and if the pm doesn't, his traders do. (the difference between 200 and 260 should be near zero. 252 is the number of trading days a year so I assume 260 is an approximation for 1 year.)
3. Your portfolio asset allocation adjustments should cause the difference between Old Limey's tests to diminish.
4. Don't underestimate the power of group think and the emotional aspects of managing money when asking yourself why don't people do this if it's so good. There are a ton of factors that keep people from actively managing their money.
5. Not that we are trying to analysis Old Limey's results with this quick and simple test (he was clearly trying to make a general point), but standard deviation, max drawdown, transaction costs, frequency of 'bad' signals, etc. are all important factors. People simply don't have the skills, resources, or desire to do this work/analysis. People would rather give up a few % every year than pay attention to their finances. Over 20 years, a few % adds up.

[tyler]

Data and alerts on that data are easy to get these days. A simple subscription to Esignal can do this. Now there are a number of products on the market that can do what Old Limey has described so there is really no excuse if this is a strategy one truly wants to pursue.

[Old Limey]

Tyler
To confirm your 1st. point, a group of us on the Bulletin Board where I could chat with lots of other database users decided to use a trading program that one of the other developers had written.
We based our system upon a limited group of the Fidelity Select funds.
Basically, FSVLX was our MMF and a 5 other Select HiTech and Healthcare funds made up the family.
We optimized and optimized it until we just couldn't get it any better.
We named it the "Winner" system and I wrote an article descibing it in the newsletter that the database company put out.
We had 7 years of data at the time.
The system had an ANN=59.4%/year, a 77% winning percentage of trades and about 6 trades/year.

I never put any of my money on it but as good as it was in the backtesting it was really bad in real time.

I also programmed several timing signals that were described in 'Technical Analysis of Stocks & Commodities". They were likewise optimized to the hilt and they also didn't work well in real time.

I believe that the markets were easier to trade mechanically in the 90's than they are today. Now there are too many players and too much proliferation of data. The playing field used to be slanted now it's pretty level.