First Quarter Review: Volatility Returns
to the Stock Market

After climbing steadily higher through the second half of 2006, the market used the first quarter of 2007 to remind investors that it has a wild side. The fireworks kicked off on February 27 when the market dropped roughly 3.5% in a single gut-wrenching day. By the time it had quit falling, the market had lost 6% in a two-week span. From there, it turned on a dime and rallied through the end of March. While its overall gain of 1.5% for the quarter seems tame enough, the fear it induced along the way was intense for some investors.

How did Upgrading respond to this volatility? By remaining calm. You see, Upgrading is designed to tune out short-term market noise and only respond to long-term trends as they unfold. This recent flurry of market activity reversed itself so quickly that Upgrading didn't need to respond to it at all. Despite failing to "do something!" as stocks swooned, Upgrading's quarterly return of 2.6% topped the market, mainly by continuing to ride the strong performance of our foreign and small-company funds. Those categories solidly outperformed the large-company stocks that are more heavily weighted in the Wilshire 5000 and other indexes that measure "the market."

The long-term performance numbers in the table above offer two important lessons for investors:

1. Upgrading has provided a consistent and substantial margin of victory over the market (and, by extension, indexing strategies like Just-the-Basics). The indexing message became deeply ingrained during the 1990s. One expert after another advocated following an indexing strategy that settled for the market's return while paying as little in expenses as possible. Actively managed funds and strategies seemed so "unenlightened." Ten years later, Upgraders continue to take their superior "unenlightened" gains to the bank.

It's also interesting that Upgrading has turned in the exact same annualized gain over both the past five- and ten-year periods. The fact that both periods registered identical 13.7% annualized gains is coincidental, but it does show that Upgrading has continued to churn out surprisingly consistent gains despite the conventional wisdom saying stocks were due for an extended period of poor performance following the strong bull market of the 1980s and 1990s.

2. The benefits of compounding accrue to the long-term investor. This is critically important. At first glance, the fact that the 5- and 10-year annualized returns are the same might seem to suggest the 10-year total profits will be roughly double those of the 5-year period. However, because of compounding, the 10-year profits are significantly more than double the 5-year profits ($260,161 vs. $89,638). How can that be? Using the example in the table above of an Upgrader with 100% in stocks starting with $100,000, during the first five years this investor would have earned profits of $89,638. But instead of merely duplicating that experience in years 6-10 and thereby doubling the total profit, this long-term investor would have continued to earn 13.7% annual gains on both the original $100,000 investment as well as on the $89,638 profit already accumulated. By continuing to earn a high rate of return on all earlier profits, the total gains increase exponentially over time.

If you want great investment results, three ingredients are typically required: money to invest, a proven investing strategy that earns solid returns, and time to let your gains compound. Upgrading has provided outstanding returns in the past and seems likely to continue to do so. If you can supply an initial investment amount (or a steady steam of monthly deposits) and cultivate within yourself a long-term perspective, you've set in motion a process that can do great things for your financial security in retirement. If
you haven't already started, isn't it time you applied the power of Upgrading to your portfolio?

• Overview of SMI's Upgrading Strategy
• Overview of SMI's Just-the-Basics Strategy
• Performance History
• Volatility Returns to the Market - April 2007
• How to Take Market Turbulence in Stride
• How to Make Rational Investing Decisions 
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