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November 08, 2010


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Anyone reading this using that method? How are you doing?

I am very grateful to you for posting this article, FMF. Yes, this is the method that I follow and advocate. It is called Valuation-Informed Indexing. At my site there are four unique calculators (which took years of effort and many thousands of dollars to develop) and 200 podcasts and 100 articles and scores of links to Guest Blog Entries describing the various aspects of how it works.

It greatly increases returns while also greatly reducing risk. It permits middle-class investors to retire five years sooner on average. If we could teach people about it, we would be unlikely to ever again see the sort of economic crisis we are living through today. I would need to write an entire book to describe all the benefits (I'm in the process of doing so -- it is called "Investing for Humans: How to Get What Works on Paper to Work in Real Life").

I know that you are widely respected in the personal finance blogosphere (and entirely properly so, in my assessment). I hope that some of the people who have been hostile to an examination of the pros and cons and VII and Buy-and-Hold will perhaps see your article and rethink whether as a community we have proceeded with our consideration of these topics in the best possible way. I can assure you that from my end I will do everything I can to make the discussions that I believe are going to begin soon a success for EVERY SINGLE PERSON involved in them.

Our discovery that long-term timing always works is a win/win/win/win/win. Do you know who gets the most credit for development of the VII strategy? A fellow named John Bogle. And of course the thousands of smart and good people who followed in his footsteps also deserve huge amounts of credit for their many positive and helpful and constructive contributions. Valuation-Informed Indexing would not exist if it were not for the many powerful insights developed by the Buy-and-Holders that form its foundation.

We all want the same thing. We are all in this together. Buy-and-Hold was a huge advance over what we had before it came along. VII is a huge advance over Buy-and-Hold. The Buy-and-Holders need to understand that no one ever expected them to get the data-based approach 100 percent right on the first try. We are learning new things all the time. We need to incorporate those new things into our investing strategies. The very first step is acknowledging that we do not already know it all and that it is silly even to imagine that we do.

Please let me know if there is ever anything that I can do to help things to get kicked off in the right way or to proceed in the right way. I admire and respect and like the Buy-and-Holders and I have long hated having been placed in circumstances in which I have come across to many as being critical of my friends who follow (and believe in) Buy-and-Hold strategies. I want to be working WITH my friends for our mutual benefit and for the benefit of all our readers.

Thanks again for showing the courage and love for your readers that I know it took for you to advance this post. There's wonderful, wonderful stuff on the other side of this black mountain. There's going to come a day when we all are going to look back at the past eight years and laugh that it took us so long to understand the importance of Learning Together all that we can about how stock investing works in the real world.


Market timing is easy...just be a contrarian. For example, today you should short gold - that's where all the money is flowing. How about bonds. They are easy to short via ETFs that short the bond market. Just be prepared to lose your shirt if you are wrong.
Mr. Greenspan talked about "irrational exuberance" 2 years before the market peaked.
Keynes said the market can stay irrational longer than you can stay solvent - worth remembering when you look at how easy it was in hindsight.

Timing can be done but most will fail at it.

As to the Greenspan comment, that was made on Dec 5, 1996, a full 3 and 1/2 years before the DOW peaked. The Dow was 6300 when it was made. It peaked at 11,700, almost 100% higher. It never again came down to 6,300. Shorting it at that point was a money loser no matter how long you waited (if you had the funds to wait that long).

It's not easy.

I have some shares of Fidelity Contrafund = which is a fund that tries to do what everyone else isn't. It's doing OK, but not as well as more traditional funds I own. I'm skeptical that anyone can effectively time the market.

I'm not a big "market timer" guy, but I generally keep at least a 5-10% cash position in the amount I am willing to invest in the market that I use in a small "timing" way. (I have other cash savings parked in my investment account, but don't invest that money because I'm looking to use that in less than a few years to buy a house.).

Basically, when the market is up over 1% in a day I try to sell a small amount of stock. And when the market is down over 1% in a day I try to buy a little bit. When the market was all over the place in 08 and the beginning of 09 I used 2% instead of 1%.

Generally this approach has helped me do well compared to the market with the funds invested (i.e. not including the house money, which obviously drags down the #s when the investments are going up).

I have no data to back it up, but like buying on down days and selling on up days.

Sounds like my approach is similar to Nicks. I guess I somewhat fit the the definition of a market timer, as I keep about 15% of my 401K in cash and will buy in as the market drops. All other bi-monthly contributions are made regardless of the market. I like having this blended approach more from a phsychological perspective. In makes me feel in control when the market corrects significantly as I am able to buy more. I am not bothered to watch the market fluctuate as I know that I can always buy more if it were to drop significantly.

Market booms occur because demand out paces supply of an asset class. If people did not over invest in stocks during a boom, there wouldn’t be a boom in stocks. If a majority of money didn’t sell their positions in a panic, there wouldn’t be a panic. Booms and panics don’t occur in a vacuum.

The Morningstar report: Wait, let me get this straight, Morningstar, a provider of fund data, found that people should use their service to buy funds instead of stocks. Very interesting indeed :)

My thoughts: everyone is different. People should find a strategy that fits them. There is no right answer. One should be cautious however of an extreme strategy that wont allow for flexibility. Investment strategies that work for me, probably wont work for you.

Can people gain an edge by market timing? Absolutely. Can most people gain an edge by market timing? Not enough to be worth their time. This being said, I think everyone should reduce risk when they believe the asset class or their life requires it.

I follow Nick's approach. Market timing isn't putting more equities in your portfolio as the market rises, then selling on panic, as described by Morningstar. It's about nibbling in and out when the market drops or rises more than 1% in a day, all while holding the vast majority of one's account in fixed income or cash. Timing is designed to enhance the measly returns of 3-5% per year in fixed income investments, while keeping the risk low in cases of big market drops. You may not make as much money temporarily is a surging market, but you don't lose anything until you sell. Even in a bull market, there are significant corrections that allow you to nibble back in with 5-10% of your cash, then sell the last lot to make a profit or adjust your cost basis of prior lots downward.

The goal is to maintain returns of 7-10% over the long term, year after year, regardless of what the overall market is doing. This has worked for me consistently since 1999. The difficultly is in selecting equity funds without trading restrictions, typically a 7-day hold after selling to buy them back again. It just means you have to be more careful and trade a higher percentage of your fund or cash when the market makes unjustifiable swings on panic or irrational exuberance.

I think some limited amount of market timing based on broad market valuations can work. e.g. If average P/E's are 25 then you may want to take profit.
But with any timing theres risks that you time it wrong. For most people I think that buy and hold is the easiest, sure fire way to succeed over a long term period of decades.

OF COURSE market timing works. If you time it right. Despite the many, many tools developed to attempt to identify what the masses are doing, these often give conflicting indications. Thus, basing the strategy soley on what others are doing is very difficult.

The key, as it points out at the end, is to invest in low P/E ratio stocks - and sell high P/E ratio ones. This isn't market timing per se, but it has the same effect.

I use market timing to an extent, but it's really only part of a longer term strategy. I am a buy and hold kind of guy, and believe that the best investment strategy is simply to diversify and have a long time horizon. But I do have latitude, for example, in what time of year I make my $10k of Roth contributions each calendar year. If I feel stocks are undervalued (which I have the past two years), I make my contribution in January. If I feels stocks are overvalued, I make my contribution later in the year. Waiting until October saved me a lot of money in 2008, for instance. I am young enough that stocks are the right investment for me, for the most part, so most of my contributions are buying stock-based mutual funds.

A better approach is to set a target asset allocation and rebalance as necessary. If stocks go up relative to bonds, you sell the stocks because you are overweighted in them. Likewise, if stocks go down,you buy more stocks because you are underweighted in them. Market timing is chasing ghosts. Nobody has any clue ahead of time what the market is going to do. Read Burt Malkiel's A Random Walk Down Wall Street for a more academic debunking of market timing.

If you you have a diversified portfolio and direct additional investment away from inflating categories and into weaker categories to maintain your portfolio balance, wouldn't that effectively be buying assets that most are selling and selling (or at least not buying) assets that are generally on the upswing?

The idea that regular rebalancing is essential for good long-term performance is not really new. Or am I missing something?

Anyway, my self-directed accounts are up 18% year-to-date using that method. My 401(k), which is fairly conservatively invested, is up 14% year to date. I'm sure many do better, but I'm not disappointed.

I do not worry one bit about what the market is doing. I didn't get out of the market during the '08 crash and getting closer to where we left off. I've also add new funds when the market was around 8500 and updated my allocation to meet the realities of this market. I know people who went to cash, but I don't know when they got back in, if at all. If not, they have lost out on the market's recovery. I'm up 18% this year so far. I'll take that and I'll just keep adding to what I have and hope for an 8% avg return over the next 20 years.

Market timing can be very successful when used to time a mutual fund that represents a sector of the market that traditionally has a low volatility. One such sector that I have used very successfully a lot in the past is the junk bond sector. The timing is based upon a moving average, with the value of the moving average being based upon the fund's past performance. The lower the fund's volatilty, the greater the value of the moving average.

Market timing of a broad market index is very difficult and unreliable. Some years ago I programmed several such market timing signals that were periodically published in the "Technical Analysis of Stocks and Commodities" magazine. These signals were based upon the author's work which optimized several parameters based upon the longterm performance of the broad market index. As such the signals naturally each had a fantastic performance as of the date they were published in the magazine. The problem was that going forward in time using new data the signals did quite poorly to the point where they soon became worthless. The reason being that past history is no indication of future performance or to state it in another way - history does not repeat itself where a broad market average is concerned.

On another occasion I used an optimization program to develop a timing system that switched between several Fidelity Select funds based upon their track record. When I had finished optimizing the results the result were quite amazing. I never invested any money in this timing system but kept track of it going forward in time. Sure enough within less than a year the results had deteriorated a lot and not long after that I realized again that optimizing past history is no great predictor of future performance.

Soon after that I gave up on timing signals completely and adopted a method that has worked well for me for a long time. That method is to use "Fund Selection" to locate funds that are in nice, low volatility uptrends, take a position in them and hold them as long as the uptrend stays intact. Once I become convinced that the uptrend has deteriorated I sell that fund and start searching for a replacement. If I cannot find a replacement to my liking then I stay out until I can find one that I like. There are so many different market sectors that with the right fund selection software you can usually find a sector to your liking and continue the ride upwards. It's analagous to jumping from a horse that is starting to slow down and tire, onto another horse that has a nice upwards momentum.
It's not "Buy Low, Sell High", it's "Buy High, Sell Higher".

Old Limey- "The lower the fund's volatilty, the greater the value of the moving average." This statement doesnt make sense. The value of a price MA and price volatility shouldnt have any relationship.

Buy low, sell high- mean revert.

Buy high, sell higher- momentum.

Anyone disagree with these conclusions:

Market timing can deliver above market returns, but most are not successful at pure market timing for one reason or another. (it can also deliver below average returns- like anything else)

Most people use some kind of market timing strategy to allocate their personal portfolios. Many use mean revert- (this surprises me). Its a small, but real factor in their decision making process.

Because most use some form of market timing (whether they realize it or not), most believe market timing can add alpha.

Simply because most believe market timing adds alpha does not mean it translates into real returns. Because there are so many different ways to manage money, it is almost imposable to develop a test that yields definitive results. Thus we are stuck in a never ending debate :)

In the software that I wrote myself and marketed successfully for many years I constructed modules that enables the user to use backtesting to determine the parameters that worked the best for several types of analysis.
In the case of a filtered exponential moving average there are just two parameters, the value of the moving average and the value of a small filter to control the sensitivity of when a Buy or Sell signal is generated.
The user would input the two funds involved in the trade, a range of values for the moving average and a range of values for the filter. He would also specify the time period for the backtesting and an increment for each of the input variables. One issue is the fund to be timed and the other issue is generally, but not necessarily, a money market fund into which you move upon receiving a Sell signal.

The output for each combination of parameters tested (of which there could be thousands) consists of ANN (the annual rate of return), MDD (the maximum drawdown), and S/Y (the number of switches per year).

What the user seeks is the value of the moving average and the filter that produces the highest ANN, the lowest MDD, and the lowest number of switches/year. If you trade some mutual funds too frequently they will ban you from trading with them. Over the last 18 years I have been banned from several fund companies, including Vanguard. They don't like frequent traders, especially very successful ones like I used to be before I stopped trading and went into fixed income investments, they love Buy and Hold investors.

This is where volatility comes in. The more volatile a fund is, the lower the moving average has to be in order to move in and out of the fund more frequently to minimize losses. The less volatile a fund is means that you can use a higher value of the moving average, keep the number of trades down to the minimum, usually no more than three of maybe four per year and time the fund much more successfully.
This is again why a bond fund is much easier to time with a moving average, it doesn't jump up and down like a yo-yo the way a great many stock funds do. Compare an income fund like PIMIX with a regional bank fund like FSRBX and you will see what I mean.
The huge advantage of low volatility in investing is that a low volatility fund gives you a lot more time to arrive at your Sell decision with the result that you get to keep a lot more of your profit before you finally feel forced into getting out.
The "Find the Best Values" modules were some of the most popular with my customers. Unfortunately my software runs unde MS-DOS and now that the funds database I use has grown so large they no longer have enough DOS memory to run. I took my software off the market over two years ago and it is now on "life support" with its total demise a year or two away.

I buy both during times of high market values and low market values, but when the markets are down, I save double than I normally would.

I had cash on the sidelines that I used, in addition to VII, to buy back into my mutual fund picks between Jan - March '09. By the end of November '09, I was up 70+% from the March 9th low and had doubled the value of my account from it's pre-crash high. Total return for 2009, which includes the lousy first quarter, was 42%.

Valuation informed indexing WORKS.

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