CLE Course Review

Beating the S&P 500 with Stock Market Timing

Beating the S&P 500 with Stock Market Timing

Copyright 2006 Equitrend, Inc.

Approximately 75% of fund managers do not beat the S&P 500 year in and year out. How can a basket of 500 hundred stocks beat the majority of actively managed mutual funds? The people who manage these funds are, for the most part, brilliant people. They are highly educated and have access to the most advanced information and decision support systems in the world. So why is it that they do not outperform the S&P 500?

A Quick Test:

Here’s a very crude test of management performance: Let’s compare the domestic-equity mutual fund performance supplied by Morningstar against the S&P 500 index for one, three, five and ten-year periods, looking back from April 30, 1995. The S&P 500 index is a fair comparison for large, domestic companies.

Our results:

Of the 1,097 funds Morningstar covered for the one-year period, 110 beat the S&P 500, while 987 fell short. Results ranged from 46.84% to -32.26%, while the S&P 500 attained a 17.44% return.

During the three-year period, the S&P 500 returned 10.54%, while results in the funds varied from 29.28% to -15.02% compounded annually. Of the total 609 funds, only 266 beat the S&P 500.

Shifting to the five-year period, of 470 funds, 204 beat the S&P 500. Results ranged from 27.35% to -8.51%, while the index racked up 12.62%.

At ten years, only 56 of 262 funds managed to beat the index, and results varied from 24.77% to -4.06% compounded annually against 14.78% for the S&P 500.

The fact that most funds do not beat the overall stock market should not be surprising. Since the majority of money invested in the stock market comes from mutual funds, it would be mathematically impossible for the majority all of these funds to out perform the market.

The implied promise held out to investors in actively managed mutual funds is that in exchange for higher fees (relative to index funds), the actively managed fund will deliver superior market performance. There are a host of barriers to fulfilling this implied promise.

Some of the problems are:

The larger a mutual fund gets, the more difficult it becomes to deliver exceptional performance.

Although fund size runs counter to performance, fund managers have a strong motivation to let the fund grow as big as possible because the bigger the fund gets, the more money the fund managers make.

Most skillful mutual fund managers are hired away by hedge funds, where their financial rewards are greater and there are few restrictions on investment techniques.

By law mutual funds are supposed to be conservative, which in theory limits their potential losses. This conservative stance generally limits their ability to use arbitrage, options, or shorting stocks.

Can You Do Better?

Because of the general inflexibility and restrictions of most mutual funds, your investment capital is not properly hedged against market fluctuations. In most cases, if you compared the beta of the equity exposure held in actively managed mutual funds to an equal equity exposure to the S&P 500 index, your reward/risk ratio would be less rewarding than purchasing an identical equity exposure to the S&P 500 index. So, the answer is, you can do better and beat the S & P 500 by using an effective stock market timing system.

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Beyond the Brink

Beyond the Brink

Penny stocks represent an excellent investment vehicle for producing gains, while the risks are equally as high. When you finally decide to get involved in penny stocks, to go ‘Beyond the Brink,’ there are some things you need to know.

In fact, whether you have been burned by penny stocks in the past, or have never even invested, the following theories are designed to give you an instant and significant advantage over all those inexperienced and uninformed traders. After all, to make money in stocks someone usually has to be losing money. Which side of the fence do you want to fall on?

Glass Jaw

Lots of people have made lots of money from trading penny stocks. Lots of people have lost plenty, as well. What is the difference between a successful micro-cap trader, and one who continually takes it on the chin?

Uses professional stock picks and research. Does their own due diligence. Observes patience. Takes lessons from past trades and stock activity. Takes lessons from other traders. Decides between 10 stocks at a time.

Uses tips at work, rumors, and so-called ‘inside scoops’ to pick stocks. Doesn’t investigate financials and corporate position. Falls victim to negative emotions like greed, anger, and desperation. Makes the same mistakes more than once. Looks at one stock alone on its own situation.

So Let’s Learn

The fact that you have taken the time to review this feature demonstrates that you have the characteristics of a successful trader, specifically the willingness to learn from experts and the experiences of other traders.
So let’s learn. As mentioned above, you should always examine groups of stocks together when looking for a new issue to invest in. For example, make a chart and write down the revenues of each. In the next column list the earnings. Follow this by each of the subsequent criteria you think are important. With all of the data on one table and available at a glance, you can easily get a clear picture of which are the one or two strongest companies from your pool of potential investments.

However, understand that stock prices do not necessarily act in concert with the underlying fundamentals of a company. For example, there is nothing saying that the stock of the worst company on your list won’t out perform the top ranked one.

For that reason you should also include factors such as trading volatility, your opinion of a potential break-through due to some new product, potential positive press releases, etc… This method is not intended to reveal the best stock, but instead to give you additional clarity about which are the best few and worst few according to your own weighting of the various factors you have chosen.

Available Advantages

Get a discount broker. Monitor your portfolio online, do your research online (and offline), and place your trades online. Embrace the technology, because it provides superior advantages all across the board. You can screen stocks, put those into comparative charts, instantly access the corporate press releases, check the latest industry news, and then place your trade… all for about $20.
Then you can monitor your trade order fulfillment, verify that the money and shares traded hands, track the progress of the stocks, get instant alerts for press releases… It is truly endless and complete, and each step that you take full advantage of leaves other traders one step behind you.

Keep small amounts of money in each stock, and only ‘risk’ money for penny stocks. While these low-priced, volatile investments can produce some truly incredible gains, they usually bounce among all sorts of price ranges.
On a related note, if you get ‘freaked out’ or worried about a stock you hold, you should consider selling your position. Try to invest in solid penny stock companies that have a low share price because they are small or undiscovered, not because they are having business troubles.

Be sure to read our related articles Falling in Hate, Fools Rush In, and Trading Myths, and our tools section on Choosing a Broker.

Beyond… And After That

Some of the most successful traders have a few things in common. Firstly, they have made some major trading mistakes in their day. However, they learned more from these mistakes than they ever did from any of their great trades. Don’t squander your failures by trying to put them behind you.

Secondly, keep a journal with dates, specific trade amounts and prices, and even the stocks you were thinking of investing in but didn’t. You can use this for a hundred different purposes as you become a more advanced trader, such as seeing opportunities you missed, or learning that your strategies are valid, or just to monitor your improvement as you become more experienced from month to month.

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