mutual funds

Timing Isn't Everything

Over the course of a summer, it’s not unusual for the stock market to be a topic of conversation at barbeques or other social gatherings.

A neighbor or relative might ask about which investments are good at the moment. The lure of getting in at the right time or avoiding the next downturn may tempt even disciplined, long-term investors. The reality of successfully timing markets, however, isn’t as straightforward as it sounds.

OUTGUESSING THE MARKET IS DIFFICULT

Attempting to buy individual stocks or make tactical asset allocation changes at exactly the “right” time presents investors with substantial challenges. First and foremost, markets are fiercely competitive and adept at processing information. During 2018, a daily average of $462.8 billion in equity trading took place around the world.[1] The combined effect of all this buying and selling is that available information, from economic data to investor preferences and so on, is quickly incorporated into market prices. Trying to time the market based on an article from this morning’s newspaper or a segment from financial television? It’s likely that information is already reflected in prices by the time an investor can react to it.

Dimensional recently studied the performance of actively managed mutual funds and found that even professional investors have difficulty beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs.[2]

[1]. In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.

[2]. Mutual Fund Landscape 2019.

Further complicating matters, for investors to have a shot at successfully timing the market, they must make the call to buy or sell stocks correctly not just once, but twice. Professor Robert Merton, a Nobel laureate, said it well in a recent interview with Dimensional:

“Timing markets is the dream of everybody. Suppose I could verify that I’m a .700 hitter in calling market turns. That’s pretty good; you’d hire me right away. But to be a good market timer, you’ve got to do it twice. What if the chances of me getting it right were independent each time? They’re not. But if they were, that’s 0.7 times 0.7. That’s less than 50-50. So, market timing is horribly difficult to do.”

TIME AND THE MARKET

The S&P 500 Index has logged an incredible decade. Should this result impact investors’ allocations to equities? Exhibit 1 suggests that new market highs have not been a harbinger of negative returns to come. The S&P 500 went on to provide positive average annualized returns over one, three, and five years following new market highs.

In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index,  Stocks, Bonds, Bills and Inflation Yearbook ™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.

In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.

CONCLUSION

Outguessing markets is more difficult than many investors might think. While favorable timing is theoretically possible, there isn’t much evidence that it can be done reliably, even by professional investors. The positive news is that investors don’t need to be able to time markets to have a good investment experience. Over time, capital markets have rewarded investors who have taken a long-term perspective and remained disciplined in the face of short-term noise. By focusing on the things they can control (like having an appropriate asset allocation, diversification, and managing expenses, turnover, and taxes) investors can better position themselves to make the most of what capital markets have to offer.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Making Billions With One Belief: The Markets Can’t Be Beat

Here is a nice article written by Jason Zweig of The Wall Street Journal: 


The fastest-growing major mutual-fund company in the U.S. isn’t strictly an active or passive investor. It’s both.

Dimensional Fund Advisors LP, or DFA, is the sixth-largest mutual-fund manager, up from eighth a year ago, according to Morningstar Inc., drawing nearly $2 billion in net assets per month at a time when investors are fleeing many other firms. Learn why DFA’s founders are pioneers of index funds here:

Making Billions With One Belief: The Markets Can’t Be Beat


Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.



The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

How Survivorship Bias Can Skew Your Views on Mutual Fund Performance

It’s important to avoid treating the market like a popularity contest by chasing out-performers or running away from the underdogs. But neither do most investors want to go into the market entirely blind. For that, there are database services that track and report on how various fund managers and their offerings have performed.

Besides ample evidence that past performance does not predict future returns, there is another reason we advise investors to proceed with caution when considering past performance: Many returns databases are weakened by survivorship bias. 

With respect to mutual funds and similar investment vehicles, survivorship bias creeps in when only the returns from surviving funds are included in the historical returns data you are viewing.

Here is what happens: As you might expect, there is a tendency for outperforming funds to survive, and for under-performers to disappear. When a fund is liquidated or merged out of existence, if its poor returns data disappears as well, overall historic returns tend to tick upward. 

As such, you may end up depending on past performance data that is optimistically inaccurate. 

Here is an article that further explains how survivorship bias works. In addition, consider the following illustration from Dimensional Fund Advisors’ report, The US Mutual Fund Landscape 2016. It illustrates how survivorship bias can skew your view on fund performance. 

Mutual Fund Img 1.png

 

In the beginning – in this case January 1, 2001 – there were 2,758 US equity mutual funds. Now fast-forward 15 years to December 31, 2015. By then, only 43% of those funds (roughly 1,186 funds) had survived the period. Out of the survivors, only 17% (about 469 funds) had both survived and outperformed their benchmark over the 15-year time-frame.1

In the illustration above, you can readily see that the small blue box in the lower-right corner represents relatively low, less than 1:5 odds that any given fund in January 2001 went on to outperform its peers by the end of the 15 years. 

If a database instead eliminates the “disappeared” funds from its performance data, the larger gray box disappears from view as well, as in the illustration below. Without this critical larger context, you may conclude that those 469 outperforming funds only had to compete against the 1,186 survivors, versus the actual universe of 2,758 funds. While it may seem as if nearly half of the fund universe has done well, in reality, the less than 1:5 odds have remained unchanged.

You see 100% of what has survived and just over 40% outperforming!

You see 100% of what has survived and just over 40% outperforming!

But wait, maybe you could “take a look at the past performance, pick the funds that have outperformed after the first 10 years, and pile up on those seeming winners. Dimensional’s report also shares the results from that exercise:

The left-hand side of this diagram shows the funds that outperformed (in blue) and under-performed (in gray) during the first 10 years of the 15-year analysis.2 You can see that 20% outperformed their respective benchmark then. The right-hand side of the diagram shows what happened to that outperforming subset during the next five years. Only 37% of the initial “winners” continued to outperform. This demonstrates that is it is extremely hard to predict “winning” mutual funds based on past performance. Your odds are even worse than what you can expect from a basic coin toss! 

So let’s take a moment to reinforce our ongoing advice: Invest for the long-term. Instead of fixating on past performance, focus on capturing future available returns within your risk tolerances and according to the best available evidence. Aggressively manage the factors you can expect to control (such as managing expenses) and disregard the ones that you cannot (such as picking future winners based on recent past performance). 

These principles guide the actions we’ve advised all along. We will continue to embrace them unless compelling evidence were ever to inform us otherwise. They are the ones that serve your highest financial interests, which is our highest priority as your advisor.  


1.  Beginning sample includes funds as of the beginning of the 15-year period ending December 31, 2015. The number of beginners is indicated below the period label. Survivors are funds that were still in existence as of December 31, 2015. Non-survivors include funds that were either liquidated or merged. Out-performers (winners) are funds that survived and beat their respective benchmarks over the period. Past performance is no guarantee of future results. See Mutual Fund Landscape paper for more information. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago. 

2.  The graph shows the proportion of US equity mutual funds that outperformed and under-performed their respective benchmarks (i.e., winners and losers) during the initial 10-year period ending December 31, 2010. Winning funds were re-evaluated in the subsequent five-year period from 2011 through 2015, with the graph showing winners (out-performers) and losers (under-performers). The sample includes funds at the beginning of the 10-year period, ending in December 2010. The graph shows the proportion of funds that outperformed and under-performed their respective benchmarks (i.e., winners and losers) during the initial periods. Winning funds were re-evaluated in the subsequent period from 2011 through 2015, with the graph showing the proportion of out-performance and under-performance among past winners. (Fund counts and percentages may not correspond due to rounding.) Past performance is no guarantee of future results. See Data appendix for more information. US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago. 


Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.



The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Benchmarks Gauge Investment Markets

Just as a car salesperson uses the "blue book" to gauge the approximate price for a newly acquired vehicle, you can use market benchmarks to gauge the approximate performance of your mutual fund investments. Each market index tracks a representative sampling of stocks, bonds, or other securities that may be similar to the holdings in your investment portfolio.

Often tracked in financial websites and newspapers, benchmarks can be especially helpful to individual investors by offering a framework whereby they can evaluate the risk and return history of their own investments. The important consideration to keep in mind is that, when using benchmarks to compare to your investments, you should always compare apples to apples. In order to accurately do this, it helps to be familiar with a variety of benchmarks and the sectors and asset classes they track.

What Are Benchmarks and How Are They Used?

The dictionary defines a benchmark as "a point of reference for measurement." In investing, benchmarks are measurements used by investors, portfolio managers, and market watchers to track how a particular asset class or sector performs and to compare relevant investments to that measurement.

A Variety of Measures

Some of the more popular and widely used indexes include:

•  IBC's Money Fund Report Averages®: These benchmarks track the averages of taxable and tax-free money market fund yields on a 7- and 30-day basis.1

•  Barclays Aggregate Bond Index: A combination of several bond indexes, Barclays indexes are among the most widely used benchmarks of bond market total returns.

•  10-Year U.S. Treasury Bond: The yield on this long-term U.S. government bond is often looked to as the standard bond yield for long-term bond investments.

•  Standard & Poor's Composite Index of 500 Stocks (S&P 500): A broad-based, unmanaged index of the average performance of 500 widely held industrial, transportation, financial, and utility stocks. Many people believe that this, one of the most often-cited indexes, includes the 500 largest stocks on the New York Stock Exchange. Not true: In fact, it includes the stocks of companies that are or have been leaders in their respective industries and that are listed in the New York Stock Exchange and the NASDAQ Market System. The industry weightings in the S&P 500 are selected to reflect components of the Gross Domestic Product (GDP).

•  Dow Jones Industrial Average: Following the returns of 30 well-established American companies, the Dow is among the most renowned of the stock market indexes. However, the S&P 500 can be considered a broader indicator of the stock market. The Dow has usurped much of the focus of the newspapers' investment pages because of its unprecedented string of double-digit gains in the late 1990s.

•  The Nasdaq Composite Index: This index was created in 1971 and measures all domestic and non-U.S.-based common stocks listed on the NASDAQ market. It contains many new-economy companies and is widely acknowledged as a benchmark for technology stocks.

•  Morgan Stanley Capital International's Europe, Australasia, Far East (EAFE) Index: The most prominent of the indexes that track international stock markets, the EAFE is composed of companies considered representative of 20 European and Pacific Basin countries.

In addition to the above, there are many others including the Value Line Composite Index (stocks); the Russell 2000 Index (small-cap stocks); the Citi 3-Month T-bill (money markets); the Dow Jones World Stock Market Index (major international markets, including U.S.); and the Barclays Global Aggregate Bond Index (global bond index).

Many benchmarks, including those listed above, are reported regularly on major financial websites and in the business section of local newspapers; national publications such as The Wall Street Journal and Investor's Business Daily; and, internationally, in The Financial Times.

investment benchmarks.png

Using Benchmarks to Target Expected Return

Benchmarks can be used to assess what types of investments may be most suitable to an investor's goals and investment time frame. By looking at the past performance of a market index, you can gauge the relative return potential of a particular asset class, as well as its risk characteristics. Keep in mind, however, that past performance is not a guarantee of future results. Also, be careful to use the right benchmark. For example, you wouldn't want to invest in corporate bonds maturing in five years based on the benchmark performance of 10-year U.S. Treasury bonds. Your financial advisor can help you assess which benchmarks to use in evaluating the performance and risk of a given market.

In mutual fund investing, market indexes can be used as a benchmark to evaluate how a given fund has performed in relation to the overall market. Be careful to look at the fund's performance relative to the benchmark over time. Keep in mind that a fund that outperforms the benchmark some of the time and underperforms it in others can still be a good addition to your portfolio if it offers opportunities to diversify.

You may also want to look at indexes of specific types of mutual funds when assessing their performance.

Don't Rely Solely on the Blue Book

The short-term, stellar performance of a particular benchmark may spark your interest in a specific investment class or sector; but remember, you shouldn't buy the car based solely on the blue book price.

In other words, research the investment opportunity, your personal objectives, and risk tolerance before investing. And use the benchmark as just one more resource to keep tabs on your investment performance.


Source:

1.  An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.


Required Attribution


Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content. 

© 2016 DST Systems, Inc. Reproduction in whole or in part prohibited, except by permission. All rights reserved. Not responsible for any errors or omissions.


Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.
 


The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Funds’ survivorship bias worse than you think

We wanted to share with our readers an article posted on BizWest, a website that covers the dynamic business community of the Boulder Valley and Northern Colorado, including Boulder, Broomfield, Larimer and Weld counties.


The article, Funds’ survivorship bias worse than you think, is written by our very own Robert Pyle.
 

Here is a preview of what you will find:

 
"Survivorship bias is a problem with the way mutual-fund returns are reported. Funds that are liquidated or merged into other funds are eliminated from the averages. Only the surviving funds are included when the aggregate returns are reported by the mutual-fund reporting services or the newspapers. Understanding survivorship bias is important because…”  To read more go to:  http://bizwest.com/funds-survivorship-bias-worse-than-you-think/  


Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.