ETFs let you avoid early trades

Anxiety Eh, Let me tell you a little story. I’ve done quite well in the last few years in the market but last year I noticed an anomaly. The accounts that I manage for my two Daughters had results that ran well ahead of my personal account results; it was a magnitude of plus 4 to 5 %.

My management training taught me that when you reflect on a problem it’s important to dig down deeply to determine the “root” cause; it’s the old “sit-in-a-dark-room” and thinks it through to a conclusion before you act. Without getting too deep into psychobabble I determined that my underperformance was due to me; I was the guilty party! Socrates said that people make themselves appear ridiculous when they are trying to know obscure things before they know themselves. Plato also alluded to the fact that understanding 'thyself,' would have a greater yielded factor of understanding the nature of a human being (it’s Human beings that think their stock-pickers BTW).

The cliff-note version of why I did better trading for my kids is that I worried about my holdings daily and I had structured those holdings to reflect my ego; I had a great many individual stocks. Looking a little deeper I saw that I was a pretty good stock picker. I had owned Netflix, Apple, Wells-Fargo, Facebook, Visa, MasterCard etc. at various times and traded in & out for small profits regularly. In KAS’s account things like a 50 share purchase of Visa eventually yielded a better that $7K profit. You get the picture; I was looking at my stuff way too often and trading way too much trying to react to every nuance that CNBC reported on.

It took me a while to work through it but here’s what I found. Individual stock holdings almost force you to review them very often so the daily-weekly market noise screams “do-something” to your detriment. I found that my Mutual Funds, being composed of a large basket of holdings made it impossible to react to day-to-day noise and I left them alone and they grew significantly in value over time. BTW, you’re young, always set your portfolio up to reinvest the dividend stream it furnishes you with automatic “Dollar-Cost-Averaging”.

As I looked more closely I couldn’t escape another troubling fact; Mutual Fund fees were expensive and it was a super rare manager that managed to beat his Funds comparable index. Whalla, the answer was inescapable, Buy that index. There are ETFs that sport an expense ratio low enough as to be a non-issue and while it’s less than 5% of Fund managers that can beat the S&P-500 benchmark almost all of the S&P ETF mirrors match it or beat it. It’s a simple premise that alluded me for a long time; an ETF holding somewhere between 35 and 500 equity holdings is not the kind if investment that you look at daily / hourly. If you eliminate the noise you’ll make more money with less anxiety and that’s all good.

In a nutshell that’s my version of why the “little-guy” usually has crappy returns. His single stock pick isn’t diversified and he’s scared to death that he’ll lose money on it so he frets, worries, trades trying to make his short-term bet a long term winner. Watching CNBC flacks can be detrimental to your portfolio returns!

So for the last 18 months I’ve been selling my mutual fund holdings on good market days and buying ETFs on market lows. I would estimate that I’m about half there to my goal. I got lucky since the market has essentially traded in about a 800 point range since the yearend; from a high of $18,000+ to a low of about $17,200.

A side benefit to all this is that it greatly simplifies my life because you just don’t worry and fret about a diversified basket of stocks like you would a single equity position. It also greatly aids my Estate Plan for now Wifey would inherit what I consider a balanced, diversified portfolio that would best be just left alone.

A related word on how the Experts predicted the 2007 market debacle. I’m ready to admit that I personally don’t really know when the market will swing or down. Okay, fine: I haven’t got an clue; there I’ve said it. Then again, neither does anyone else. I looked back at the financial media in the months before the market crash in 2007. The Lexis-Nexis database contains around 800 stock market stories for the three months immediately before the worst collapse in three-quarters of a century. By limiting the search to U.S. sources, I got it down to a nearly-manageable 400 or so which I proceeded to scan.

Here’s what I discovered: almost without exception, the public statements of major financial media outlets, mutual fund managers and hedge fund managers were stunningly clueless. Almost without exception, the story was that other than for one or two little puffy clouds in the distance, the skies were clear, you should have a song in your heart and a equity buy order in your hands.

Kiplinger’s led that parade in 2007 with “Why Stocks Will Keep Going Up” (July). BusinessWeek urged us, “Don’t Be Afraid of the Dark” (August 13). Money asked “Is This Bull Ready to Leave” (July) and concluded that the market was undervalued and that large cap growth stocks had “a strong outlook.” Fortune did some fortune-telling and found “A Sunny Second Half” (July 9); relying on “a hedge fund superstar,” they promised “This Bull Has Legs” (August 20). John Rogers of the Ariel Funds declared “Subprime Risks: Overblown … [it’s] time to buy” (September 17). Standard & Poor’s thought “equities could register nice gains by the end of the year” (September 20) as the result of a Fed-fueled breakout.

These are just a sample; remember the best-selling book, “Dow 20,000 this year”. In any event the market has rewarded the popular equity indexes with a very steady uptrend since 1900 even with the numerous short-term market breaks. Let us remember that the major market crash in 2008 was essentially erased in the next two years if you stayed in the market!

I think you can expect to make 12% on your investments over time based on the historical average annual return of the S&P 500. The S&P 500 gauges the performance of the stocks of the 500 largest, most stable companies in the Stock Exchange. It is often considered the most accurate measure of the stock market as a whole. The current average annual return from 1926, the year of the S&P’s inception, through 2011 is 11.69%. That’s a long look back, and most people aren’t interested in what happened in the market 80 years ago.

So let’s look at some numbers that are closer to today. From 1992–2011, the S&P’s average return is 9.07%. From 1987–2011, it’s 10.05%. In 2009, the market’s annual return was 23.46%. In 2010, it was 12.78%. In 2011, it was -1.12%. So yes the confluence of events triggered by the mortgage crisis in 2008 caused a market crash of 38.5% but look at 2009 and 2010 results. In those two years right after the famous 08 crash and you'll see that the market corrected by 23.46% in 09 and 12.78% in 2010. Morale of the story, stay invested; the trend is your friend.