Sound Mind Investing profiled by MarketWatch

It's pretty rare for SMI to get national media attention, so we were pleasantly surprised to unexpectedly see this flattering profile by Peter Brimelow of Marketwatch recently. The author didn't talk with anyone here, so we had no idea it was coming.

Brimelow works with Mark Hulbert at the Hulbert Financial Digest. For those unfamiliar with Hulbert, they are sort of the third-party scorekeeper of investment newsletters. They subscribe to all the known investment letters and then monitor the performance of each one in real-time to provide an independent source of investment performance. Think Consumer Reports for investment letters. While we've had some issues with how they've calculated SMI's performance in the past (they average all our JtB and Upgrading portfolio allocations, then compare those to the stock market averages), they serve an important purpose and generally get things pretty much correct.

Brimelow correctly notes SMI's strong focus on asset allocation:

Sound Mind Investing takes an unusually comprehensive and disciplined financial-planning approach. It attempts to establish its reader’s “investment temperament” by means of an online quiz (“If you’re married, it’s a good idea to have your spouse take the quiz, too”) and focuses on tax-advantaged asset allocation, by far the most powerful decision for any investor, albeit one often neglected in favor of glamorous equity portfolios alone. Sound Mind also urges saving and getting out of debt.

Significantly, he also took the time to break out the performance of SMI's 100% stock Upgrading portfolio separately. (This has really been the sticking point with us regarding how they present our performance — this has tended to get buried.)

Its top-performing Fund Upgrading Strategy: 100% Stock Portfolio has appreciated an impressive 9.1% annualized since the HFD began following it in 1995, vs. just 6.7 % annualized for the Wilshire.

That type of outperformance is no surprise to readers who have been around long enough to experience those gains. But for newer readers, or prospective readers trying to decide whether to jump aboard, it's extremely helpful to see those long-term performance numbers confirmed and validated by a totally-independent third party source who has been accumulating that data month by month over the entire period.

Inflation History: The Rise and Fall of the U.S. Dollar

Posted by Mark at 9:34 AM | Comments (4) | TrackBack
Category(s): SMI General Announcements, SMI Model Portfolios
Tag(s): Model portfolio, performance, upgrading

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Hazards of confidence when investing

The field of behavioral economics studies why people make the financial decisions they do. We visit the topic occasionally, as in August's cover article, Why Smart People Make Big Money Mistakes—and How to Correct Them ( Members Only). This area of research has discovered a number of fascinating things about the way humans are wired, and how that wiring often works to our detriment in the financial arena.

Daniel Kahneman is one of the founders of this field. Last weekend, The New York Times Magazine ran an article titled Don’t Blink! The Hazards of Confidence, which is an excerpt from Kahneman's latest book. It's an interesting read if you're into this sort of thing.

I thought I'd pull a couple paragraphs where Kahneman tells about one of the most famous of all the behavioral economics experiments. It clearly highlights his theme that investors are typically overconfident and that overconfidence hurts their long-term returns,

Odean analyzed the trading records of 10,000 brokerage accounts of individual investors over a seven-year period, allowing him to identify all instances in which an investor sold one stock and soon afterward bought another stock. By these actions the investor revealed that he (most of the investors were men) had a definite idea about the future of two stocks: he expected the stock that he bought to do better than the one he sold.

To determine whether those appraisals were well founded, Odean compared the returns of the two stocks over the following year. The results were unequivocally bad. On average, the shares investors sold did better than those they bought, by a very substantial margin: 3.3 percentage points per year, in addition to the significant costs of executing the trades. Some individuals did much better, others did much worse, but the large majority of individual investors would have done better by taking a nap rather than by acting on their ideas. In a paper titled “Trading Is Hazardous to Your Wealth,” Odean and his colleague Brad Barber showed that, on average, the most active traders had the poorest results, while those who traded the least earned the highest returns. In another paper, “Boys Will Be Boys,” they reported that men act on their useless ideas significantly more often than women do, and that as a result women achieve better investment results than men.

This is why we emphasize having a long-term plan and sticking with it. This helps protect you from your own overconfidence. It's also why all of SMI's investing strategies are mechanically based; i.e., they don't rely on us to make lots of judgment calls or predictions. This helps protect you from our overconfidence!

None of this guarantees that you'll be optimally positioned when the market shoots up nearly 20% in 17 trading days, as it did this month. But it does stack the odds in your favor that over time, you're hopefully going to make more right calls than wrong ones. Hopefully, and again over time, that will lead to better results (and much more peace of mind along the journey). That's certainly how it has played out for those who have been investing according to SMI's strategies over the past decade or more.

Inflation History: The Rise and Fall of the U.S. Dollar

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Category(s): Investing Principles, SMI Model Portfolios
Tag(s): investing principles, market uncertainty, SMI model portfolios

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It's beaten the market by 185%: Fund Upgrading explained

In Upgrading, each month we rank more than 1,500 mutual funds by type and determine which ones have been delivering the best recent performance. We recommend the purchase of the top funds in each of five SMI risk categories. These funds will be held until they stop outperforming. At that point, we recommend replacement funds that are showing stronger recent performance.

Upgrading works because, market leadership rotates among different investment approaches and companies of different sizes as economic conditions change. But even though market conditions are constantly changing, fund managers rarely do. Managers who excel under one set of market conditions often are only average (or worse) under a different set of conditions. So, rather than buy a fund and hold it through both the periods that favor the manager's approach and the periods that don't, Upgrading continually guides us to funds that are in favor right now.

This means we move in and out of funds more frequently than some people are used to, but it has helped us establish a track record of beating the market over an extended period of time, under both bullish and bearish market conditions.

The chart below shows the cumulative effect of this advantage, comparing the 11-year growth of a $25,000 Upgrading portfolio (dark shaded area) vs. the market return (light shaded area).

The $25,000 invested in Upgrading at the beginning of 1999 grew to $71,250 while the market portfolio (as measured by the Wilshire 5000) increased to only $35,250. In other words, the Upgrading portfolio was worth almost twice as much after 12 years than a portfolio that earned the market's return.

2. The asset allocation chart shows you exactly what percentage of your portfolio we suggest be invested in each category of mutual fund.

3. SMI's monthly Recommended Funds page shows which funds are currently recommended. Choose one (or more) funds from among the four recommendations in each category.

4. Each month, you simply review the new Recommended Funds page to see if any of the funds you own have been replaced. If any have, the new funds are clearly noted, and you just sell the old fund and buy the new recommendation.

Upgrading isn't complicated. It requires your attention only once per month, and its track record is exceptional. What are you waiting for? Order your subscription to Sound Mind Investing today!

Posted by Matthew at 1:08 PM | Comments (2) | TrackBack
Category(s): Investing Principles, SMI Model Portfolios
Tag(s): beat the market, investing principles, proven strategy, upgrading, Wilshire

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Funds you can own forever? Ha!

When you have a constant need to create financial content, you read a lot. And you file a lot of what you read. You never know when a well-done interview, bit of research, or historical review might come in handy. (I just know that a week after I throw it away, I'll need it and won't remember the author or source.) Over time, it piles up, creating something of an organizational nightmare, requiring a periodic purging of the older material.

This is something I'm not particularly good at. I hate going through old files, looking for what might still be useful. It's very time-consuming because you have to briefly read the material you're sorting through. After a few hours you have a thinner, better organized file (one down, several dozen to go), which doesn't seem an adequate reward for the somewhat boring, unpleasant time invested. So, you may not be surprised to learn, I don't do it very often. No, not often at all.

Yesterday, the chaos reached the tipping point and I forced myself to begin the process. Almost immediately I got distracted. I came across a 1993 article from Kiplinger's Personal Finance magazine titled "Funds to Hold Forever" (a laughable idea if I ever heard one — that must be why I kept it). The article named six funds — four actively managed stock funds, one bond fund, and one Wilshire 5000 index fund.

I couldn't resist checking up on the four stock funds to see how investors would have done taking Kiplinger's advice in the late summer of 1993 and holding them the past 18 years (through May 31, 2011).

At first, they seemed to have done better than I expected. First, all four are still in existence, which is no small thing. And second, while they trailed the market, they didn't do so dramatically — they collectively returned, on average, 6.9% annually during the period compared to 8.3% for the market.

But of course, compounding over almost 18 years makes that seemingly small 1.4%/year difference into a pretty significant gap. $100,000 invested in the Wilshire 5000 would have grown to $412,000 compared to only $324,000 for a portfolio equally divided among the four funds. Hmmm...not so great after all.

As SMI readers know, we believe that attempting to pick good funds that can be held for the long haul is a fool's errand. That's why we "upgrade" among the current performance leaders. During the same almost-18 year period, SMI's Fund Upgrading portfolio returned 10.4% per year, which would have grown a starting portfolio of $100,000 to $575,000. That's $251,000 more than the portfolio made up of "funds to hold forever."

Not yet an SMI subscriber or web member? Learn more about SMI and sign up today!

Posted by Austin at 2:35 PM | Comments (0) | TrackBack
Category(s): Mutual Funds, SMI Model Portfolios
Tag(s): long-term investing, mutual funds

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From first to worst

Bloomberg notes that three fund managers who used be at the top of their game are struggling mightily.

Bruce Berkowitz, Kenneth Heebner and Bill Miller, three of the best-known U.S. stock pickers, are competing for last place this year after their bets on an economic expansion backfired.

Funds run by Berkowitz of Fairholme Capital Management LLC, Heebner of Capital Growth Management LP and Miller of Legg Mason Inc. are the three worst performers among large diversified U.S. mutual funds in 2011, according to data from Chicago-based Morningstar Inc. The funds lost 11 percent to 12 percent through June 9, compared with a gain of 3.4 percent for the Standard & Poor's 500 Index.

Here is what reporters call the "money quote":

"People assume because certain managers have had good streaks that they are always going to be a step ahead of the market," Russel Kinnel, director of mutual fund research at Morningstar, said in a telephone interview. "It never works out that way."

Indeed. As much as we may wish that a winning fund will always be a winner, that's just not the way it is. This is why SMI offers a Fund Upgrading approach that identifies and recommends the funds — in various risk categories — that are the best performers at any given time. We care little that a fund was a top performer three years ago, or even last year. We want to know what it is doing now.

We've held funds managed by the above-mentioned managers in the past. All three of these guys are smart and capable, and we hope they'll have future success. But we're not going to hold the funds they manage unless those funds are currently outperforming others in their peer group. That's why Upgrading has strongly outperformed the market over time.

All mutual funds — even the most successful over the long haul — go through periods of adversity. When they do, we move on, because that is in the best interest of those using our Upgrading strategy.

Not yet an SMI subscriber or web member? Learn more about SMI and sign up today!

Posted by Joseph at 10:55 AM | Comments (0) | TrackBack
Category(s): Current Market Events, SMI Model Portfolios
Tag(s): fund performance, Upgrading

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The "loser's game" approach to investing

In the April issue of the Sound Mind Investing newsletter, Austin Pryor and I explain why SMI's "passive" core strategy known as Just-the-Basics is both a simple and effective approach to investing.

No, JtB hasn't performed as well as our actively managed Upgrading strategy over the long term, but it has outdistanced most other actively managed approaches.

Our current article about Just-the-Basics is titled The Loser's Game That Can Make You A Winner — and I talked about it earlier this week with host Bob Crittenden on The Meeting House from Alabama's Faith Radio.

You can listen to a portion of that conversation by clicking the arrow on the player below (7 min.).

Not yet an SMI subscriber or web member? Learn more about SMI and sign up today!

Posted by Joseph at 10:50 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios
Tag(s): index funds, Just-the-Basics, Winning the Loser's Game

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The market is back where it was a dozen years ago — but...

The Big Picture website provides this illuminating chart of the S&P 500 Index over the past 12 years:

The site notes that the S&P 500 closed on Dec 31, 1998 at 1229.23. That's just 11 points below its close last Friday of 1240.40. Eleven points — in 12 years!

Naturally, a chart like this is quite persuasive in the hands of an advisor pushing market timing, or "tactical asset allocation," or any of the other nuances that seek to move investors in and out of the market. It seems so obvious that such an approach must be better than a buy-and-hold approach.

As the Big Picture's Barry Ritholtz explains:

Over the course of these dozen years, we have seen a 68% rally (to the 2000 top), a 50% sell off (March '03 lows), a 104% rally (October '07 top), a 58% drop (March '09), and an 83% move up (April 2010 highs).

The fee-driven industry continues to push buy & hold as the investing strategy of choice. I prefer to adjust my risk exposure relative to multiple inputs, one of the major aspects of which is Trend.

Of course, some academics will argue this point, but the chart above speaks volumes.

It is indeed difficult to defend a general buy-and-hold approach in light of the past dozen years. However, not all buy-and-hold approaches are created equal. I'm not criticizing Ritholtz here, but many people assume buy and hold equals a specific indexing approach or a strategy of buying certain "special" funds or stocks and holding them forever, come what may.

SMI's flagship strategy, Fund Upgrading, is different from either of these approaches. It is definitely buy-and-hold, and yet it is relentlessly active in its management of the underlying funds it recommends, requiring its adherents to check their holdings every month. Upgrading also makes no attempt to move investors in and out of the market.

Contrary to what the above chart might imply, Upgrading's version of buy-and-hold has been quite successful — despite the fact that the overall market has gone nowhere. Far from the 0% return implied by the chart, Upgrading has delivered a gain of roughly 165% over the past 12 years. That's approximately 8.5% annualized. In a perfectly flat market.

(You can review the 1999-2009 numbers yourself using this Performance History. This year, Upgrading is running about 3% ahead of the overall market, as measured by the Wilshire 5000.)

The next time you see or hear someone disparage buy-and-hold investing, keep in mind that there's more than one kind of buy-and-hold approach. Yes, if you had bought an S&P 500 index fund and held it for the past 12 years, you would have done poorly. However, that does NOT mean you necessarily have to subject yourself to the perils of market timing in order to succeed.

Someone who ignored the market's dramatic bull and bear markets over the past 12 years and simply kept on Upgrading would have done quite well — without the emotional roller coaster of constantly wondering if they needed to exit or re-enter the market.

Learn more about Upgrading by signing up for a FREE 30-day SMI Web Membership. This special end-of-the-year offer is good only through Dec. 31, so sign up today!

Posted by Mark at 9:55 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios
Tag(s): buy-and-hold, Upgrading

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"It's a five-star fund!" So what?

A five-star mutual fund isn't like a five-star movie. A great film from 2007 is still a great film. But a mutual fund that was stellar a few years ago may be a laggard today.

Even so, many investors select funds the way they select films. The look to the "star" system to make a decision. (The star system for mutual funds [PDF] was developed in the 1980s by Morningstar and revised in 2002.)

As Marketwatch reports, "looking to the stars" almost guarantees underperformance.

In meeting after meeting earlier this year, [Tim Courtney] and his colleagues at Burns Advisory Group had recommended mutual funds to prospective clients, only to be hit with the same response almost every time: Why are you telling me to invest in a three-star rated fund?

That sums up the way many investors allocate money to funds — look at products that have four- or five-star ratings from investment researcher Morningstar Inc., take that as a seal of quality, and hope for the best. Such decisions are perhaps even more common in volatile markets, when anxious investors view top-ranked funds as somehow better-equipped to handle adversity....

The trouble is that investors seem to forget that star ratings are backward-looking, based on a fund's past performance, and studies have shown the ratings have no predictive value....

Courtney and his colleagues went back to Dec. 31, 1999 and studied the subsequent 10-year performance of five-star rated funds. What he found might convince investors to kick their star-rating habit.

Of the 248 stock funds with five-star ratings at the start of the period, just four still kept that rank after 10 years. And the 218 domestic stock funds with the rating typically lagged their category averages over the period — not just the benchmarks, but other mutual funds....

In other words, it's not just that five-star funds don't, on average, continue to lead their peers — they actually do worse in subsequent years.

At SMI, we don't let stars get in our eyes. Instead, our Fund Upgrading methodology gauges how a fund is performing now by looking at its most recent performance (within the past 12 months). This is fundamentally different from Morningstar's star system, which focuses on longer-term (3-, 5-, and 10-year past performance). Upgrading leads us to the best current performers, regardless of how many stars these particular funds have by their names in the Morningstar database.

Consider this overview of our current universe of 20 mutual-fund recommendations:

• Five-star funds: 3
• Four-star funds: 6
• Three-star funds: 4
• Two-star funds: 7

As you can see, 17 (85%) of our current Upgrading recommendations rate fewer than five stars — 11 of them (55%) rate fewer than four stars.

The star system is no doubt well-intended, but it leads far too many people to make decisions that yield inferior results. Research has shown that recent past performance tends to persist into the immediate future. It has also shown that longer-term past performance has little — if any — predictive value.

Those stars may be pretty, but they aren't likely to help you choose better funds. Upgrading, on the other hand, is likely to help you choose better funds. And SMI's approach has beaten the market in 10 out of the past 11 years.

Learn more about Fund Upgrading and SMI's other time-tested strategies. And for details on how to become a Sound Mind Investing print subscriber and/or web member, click the sign-up button below.

Posted by Joseph at 9:25 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios
Tag(s): five-star funds, investing strategies, mutual funds

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Fund investing: How the mighty have fallen — but that's OK

When a certain mutual fund does especially well for you during a particular market season, it's easy to fall in love and hold on to that fund forever (or at least much longer than you otherwise would, absent the initial success). That can be a big mistake.

One of the primary virtues of SMI's Fund Upgrading strategy is it helps keep us from getting enamored with the "winners of the last war."

I was reminded of this yesterday while reviewing our monthly "white pages." These are the data sheets we create each month that serve as the basis for our fund recommendations for SMI Upgraders.

In my review, two funds that performed exceptionally well during the past two "market seasons," respectively, caught my eye. One (a large-company value fund) was a leader during the 2007-2009 bear market; the other (a large-company growth fund) was an outperformer in the years before that. The reason they caught my eye is that each one is currently ranked dead last in its particular category.

Are these bad funds? Absolutely not. On the contrary, these are great funds. I say that because I believe these are two out of a relatively small handful of funds that an investor actually could buy and hold through multiple market cycles and do pretty well over time.

Despite that, we find them terribly out of synch with the market during this stretch, to the point where it is probably quite difficult for many investors in these funds to stay the course and continue to hold them. If you can't hold on through the worst periods for a particular fund or strategy, that's a recipe for trouble, because you're likely going to bail at the worst possible time — right before that strategy/fund starts to make up for that under-performance with a stretch of great returns.

To be sure, Upgrading occasionally gets out of synch with the market, typically at market turning points. But it's unusual for Upgrading to stay out of synch for an extended period of time. That would require the market switching back and forth between bullish and bearish conditions multiple times in a relatively short span of time. Possible, but rare.

Most of the time, Upgrading moves with the market's trend, grabbing an extra percentage point of performance here and an extra point there, in good markets and bad. While we occasionally wish Upgrading would have done better over some recent stretch, we rarely ever have to wonder if Upgrading has completely lost its way or stopped working as a result of it performing poorly relative to the broader market.

Another advantage of Upgrading is that we are able to own great funds (such as the two referenced above) when those funds are in their sweet spot. That's largely what helps Upgrading outpace the market over time. When these funds go into their slumps, Upgrading forces us to sell these old favorites (often kicking and screaming) and moves us to new recommendations that are performing more in synch with the market (and hopefully leading it) during that new market season.

This consistent buying/selling discipline is why Upgrading has beaten the market in 10 out of the past 11 years.

We invite you to learn more about Upgrading and SMI's other time-tested strategies. For details on how to become an SMI print subscriber and/or web member, click the sign-up button below.

Posted by Mark at 10:35 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios
Tag(s): fund upgrading, investing principles

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"Three questions to ask of a top-performing fund"

A few days ago, I asked if you were on the outside looking in as the market continues its long and steady advance. If so, you're not alone. MarketWatch writer Chuck Jaffe points out that while the S&P 500 is up about 50% over the past year (from 3/31/09 through 3/31/10), relatively few investors have been along for the ride.

Jaffe provides data to support the premise that too many investors wait until there's been a solid year of gains before they come to believe that the worst is over and muster the courage to re-establish their stock positions. Since we're at that point now, Jaffe offers a warning:

Any decision to come back after strong 12-month results may be too little and too late. Accordingly, investors should understand what makes some funds shoot to the top of their peer group over a one-year stretch, and why some of those 12-month numbers are particularly misleading and dangerous....

Here are three questions to ask when considering a fund that has vaulted to the top of the performance charts...

Jaffe's questions and his related comments (in italics below) are worth thinking about — and I want to respond to them from the point of view of SMI's Upgrading strategy, which has a long and successful track record of investing in funds that have "vaulted to the top of the performance charts."

1. Is performance repeatable? You can't buy into what the fund did yesterday, so all that matters is what happens next.

Upgraders agree. The question then becomes: What clues do we have as to what will happen next? There's a significant body of research that shows there is a short-term tendency for recent winning performance among mutual funds to persist — that is, performance leaders of the recent past tend to be the performance leaders of the near-term future. SMI's performance-momentum rankings (available to our subscribers and web members) are our attempt to take advantage of this tendency.

2. How did the fund rise to the top? ...Whenever a fund tops its peer group, make sure its investment strategy and style is truly reflective of the larger group; the easiest way to top the short-term charts is to game the system.

Upgraders agree. That's why we separate mutual funds into the various risk categories — to compare, as best we can, apples to apples in terms of manager strategy and style. However, it's also true that as long as a fund continues to do well, we don't mind a little style drift. That might matter to an investor looking to own a fund for years, but is not a concern to Upgraders who own our recommended funds, on average, for less than one year.

3. Are you chasing returns? Investors typically wait to buy until the investment has proven itself with a stretch of good performance. Then the hot run comes to an end, the fund cools, and the investor never gets the stellar performance that drew them in the first place.

Upgraders agree there's a risk here, but one that's manageable. Note that Jaffe says, "the hot run comes to an end." In other words, the investor typically enjoys some degree of success initially. The idea that "the investor never gets the stellar performance that drew them in the first place" reflects the view that the investor has no selling discipline and will be a long-term holder of the fund. We rely on our strict selling guidelines to help prevent holding a fund too long once "the fund cools."

This is why Upgrading has beaten the market in 10 out of the past 11 years.

Learn more about Upgrading and SMI's other time-tested strategies. And for details on how to become an SMI print subscriber and/or web member, click sign-up button below.

Posted by Austin at 8:50 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios

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On the outside looking in?

With the first quarter of 2010 continuing the market's solid uptrend, here are the approximate results Sound Mind Investing readers who use our Upgrading strategy or Just-the-Basics indexing approach have experienced since the March 2009 low (through 3/31/2010):

• +80% SMI Upgrading
• +74% S&P 500 Index (large companies)
• +98% Russell 2000 Index (small companies)
• +74% EAFE Index (foreign companies)

This is exceptionally good news for those who stayed the course, but a bit of heartburn for those who headed for the exits during the dark days of the bear. A friend (who knew better and shall remain nameless) sold his stock holdings until a more promising investment climate took shape. The problem has been (and will always be) that the market begins heading up many months before a "promising investment climate" becomes evident.

So, what to do? I suggested he figure out how much of his money should be invested in stocks (based on his season of life and other factors we explain in our publications), divide that amount into four parts, and invest the first 25% immediately. I suggested this, not because I have a particular view as to what the market will do in the short-term, but because my friend needs to overcome his paralysis. If his goal is to get back into the market, then the only way I know to do that is to start getting back into the market.

Now, whether he takes this first step with 20%, 25%, 33%, or 50% of his total stock allocation is a matter of personal preference. I chose 25% because that didn't seem too bold a step, given his current fear that he's waited too long and may well be investing at the end of the rally. But you've got to start somewhere, and this approach still left 75% safely on the sidelines.

I suggested he wait 6-8 weeks and see if he felt comfortable putting another 25% in at that time. It would be nice if he had a little profit by that time to encourage him, but there's certainly no guarantee of that.

I don't know what his decision will be, but thought I'd pass along our discussion in case there are others like my friend — on the outside looking in.

If you're not investing effectively for your financial future, take a few minutes to learn more about SMI's time-tested strategies. For details on how to become an SMI print subscriber and/or web member, just click sign-up button below.

Posted by Austin at 9:10 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios

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"A changing landscape"

This simple observation serves as the basis for Sound Mind Investing's highly successful Fund Upgrading strategy: even though market conditions are always changing, fund managers rarely change their investing approach.

That explains why a manager who is hugely successful under one set of conditions can seem dreadfully inept under another. If the game the manager knows how to play (let's say he or she is an expert in small-cap growth companies) is the same game the market is playing, success occurs. But if the market changes to a different game (a preference for large value companies, for example), it's difficult for that manager's fund to compete effectively.

The always-morphing nature of the market is underscored by last week's USA Today article headlined, "Top 10 S&P 500 Stocks Change From 2007 Peak." (Because all the stocks mentioned are near the top of the S&P 500, there is a rough commonality of company size in these comparisons; but, as the article makes plain, even within the general area of large companies, relative performance is by no means static.)

Beneath the surface of the market's steady advance, a dramatic race is taking place among leaders vying to become the USA's most-valuable company.

The Standard & Poor's 500 index hangs near bull market highs, having risen 4% this year and 66% from its 2009 bear market low. Four of its most 10 most-valuable companies — Wal-Mart, Apple, JPMorgan Chase and Berkshire Hathaway — weren't among the top 10 at the market's peak in 2007, according to data from S&P's Capital IQ....

"It's a changing landscape," says Jack Ablin of Harris Private Bank. "It's amazing."...

The biggest gainer among the top ranks is Apple, which appeared close to collapse 10 years ago but is now the fourth-most-valuable company in the S&P 500, beating out Warren Buffett's Berkshire Hathaway and General Electric....

AT&T and Citigroup have consistently been among the most-valuable companies. Both were in the top 10 at the 2007 peak. Now, though, Citigroup is ranked No. 21...and AT&T is No. 14.

Time passes, things change. By leading you to funds that are performing well across several risk categories, our Upgrading strategy can help you stay on top of changing conditions. Indeed, change becomes your ally in growing the value of your holdings.

This is why Upgrading experienced a total gain of 142% over the past 11 years (1999 though 2009), while the overall market (as measured by the Wilshire 5000) gained only 21.5%.

Not an SMI subscriber yet? Today's a great day to sign up and learn more about how Upgrading can help you make the most of your investment money.

Posted by Joseph at 9:30 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios

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How important are mutual fund expenses really?

You've probably seen articles explaining that mutual fund investors pay higher costs than they realize due to funds incurring "hidden" costs that aren't reflected in the published "expense ratio." Such articles (here's a recent example from Morningstar) usually disparage funds that do a lot of trading because they tend to incur higher levels of these "hidden" costs.

The argument is true to a point: Any investor who selects funds primarily based on their stated expense ratios probably isn't aware of potentially expensive trading costs or 12b-1 fees (i.e., marketing expenses) that aren't reflected in those ratios.

But is that the best way to select funds in the first place?

At Sound Mind Investing, we take a different approach to the issue of expenses. Brace yourself — we're not all that concerned about them. It's not that they don't matter — they certainly do. It's just that we're much more concerned about overall performance. If we wind up paying higher expenses as part of the price of obtaining better overall performance, that's a trade we're willing to make.

The types of articles mentioned above usually don't present it that way. They argue that if Fund A has high trading costs, Fund B has a high 12b-1 fee, and Fund C has neither, then you should invest in Fund C. That would be true if A, B, and C all generated the same performance. But if A and B strongly outperform C — so that you come out ahead even after expenses are subtracted — then, relatively speaking, the expense levels of A and B weren't all that important.

Fundamentally, this issue boils down to two competing belief systems. On one side, you have those who say it's virtually impossible to determine in advance which funds will outperform in the future. Therefore, the only approach that makes sense is to diversify and minimize expenses. This is the basic essential argument for indexing.

On the other side, there are people like us who say you can predict which funds will outperform in the future. Not every time. And trying to do so doesn't afford you the luxury of buying a fund and holding it for years or decades at a time. But over time, we do believe it's possible to get a market-beating result if you're willing to stick rigorously to a specific discipline of buying and selling funds. We call this discipline our Fund Upgrading strategy.

So how can you know in advance that A and B will perform better than C? You can't know for sure, not on any single fund choice. But research has shown that recent mutual fund performance tends to persist into the short-term future. In other words, superior recent performance tends to translate into superior near-term future performance. That's the basis of Upgrading.

It certainly doesn't work on every single fund selection. That's why we have to follow a vigorous selling discipline as well, to cut our losing trades short. But over time, the Upgrading process steers us towards enough funds that outperform their peer group.

That's how our Upgrading has been able to beat the market in 10 out of the past 11 years (in the graph below the light-shaded bars represent the performance of the overall market as measured by the Wilshire 5000; the dark-shaded bars represent Upgrading's performance).

Further, as noted in the current issue of SMI, Upgrading is a strategy that works remarkably well even when implemented on limited scale.

At the end of the day, our emphasis is not on expenses and costs, but rather on the final returns a fund produces after already accounting for all the costs of ownership. It's not that we don't care about expenses, it's that all of a fund's costs are already baked into the performance numbers we use as the basis of Upgrading. So if a fund can outperform in spite of higher costs, we're willing to overlook them.

Posted by Mark at 10:10 AM
Category(s): Investing Principles, Mutual Funds, SMI Model Portfolios

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Why SMI's Upgrading strategy works

You never know when inspiration will strike. I was recently skimming this Morningstar article — which explains how several of the top foreign value managers are drawing opposite conclusions regarding Japan as an investment opportunity — when I realized, "This article is explaining why SMI's Upgrading strategy works!"

The article reports on how six specific foreign large-cap value managers disagree over the prospects for a Japanese stock market recovery. This would normally merit a giant "who cares?" reaction, except for the fact that these particular managers are the absolute elite of their peer group. Six Morningstar Manager of the Year awards between them, and great long-term results from all six funds. And they happen to be split right down the middle in their opinions regarding Japan.

So how does this explain why Upgrading works? Because in this disparity of outlooks, and the resulting differences between these funds portfolios, we see how the Upgrading process can move us between winning ideas even within relatively narrow peer groups, while steering us clear of losing ideas.

If half this group is in Japanese stocks and the other isn't, it stands to reason that half of this group will do well and half will do poorly, regardless of which path Japanese stocks take. And Upgrading will pick up on whichever group is correct and steer us towards those funds.

In other words, we don't have to figure out which group is right and which is wrong (which is good, because I don't have the foggiest idea). Instead, we can simply follow our mechanical guidelines and the correct answer will play itself out in our fund rankings. We get the benefit of whichever group has this issue figured out correctly, even though right now we don't have any idea which side has the winning argument.

This example also helps illustrate why conventional funds go through periods where they put up phenomenal returns, only to stumble badly over the next few years. It's easy to get big-picture predictions like this wrong from time to time, and suffer for a year or two (or three) because the fund's portfolio was positioned incorrectly as a result. Upgrading helps us side-step those periods of poor performance, while steering us towards those managers who were the most accurate in positioning their portfolios to take advantage of the issues that matter most to the market right now.

Naturally, Upgrading isn't perfect and carries its own set of challenges. Nonetheless, it is a strategy that has beaten the market in 10 out of the past 11 years. It works not only because it steers us clear of certain challenges inherent to most "normal" funds, Upgrading actually uses those very challenges as the basis for its success.

Posted by Mark at 9:10 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios

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Will gold keep rising against major currencies?

The answer, of course, is "no one knows." But the prospects for gold seem good — or, put another way, the prospects for currencies appear to be not-so good.

Reporter Tom Sullivan offers details in Barron's.

The dollar is not as good as gold. Neither are 22 other currencies.

A recent study by GoldMoney.com, which enables online cross-border transactions using gold as a currency, found that from 2000 through 2009, gold rose an average 10.1% a year versus the Swiss franc...14.9% against the U.S. dollar... [and] 20.0% for the Sri Lankan rupee.

"Gold isn't going up, currencies are going down," says James Turk, GoldMoney.com's founder. "The purchasing power of gold remains basically unchanged against commodities. In contrast, the purchasing power of national currencies is being constantly eroded."...

That's because governments are debasing currencies, he says, destroying their citizens' purchasing power by spending beyond their means and using debt to stay afloat. The U.S., as one example, is trying to goose its economic recovery through massive deficit spending, but it may worsen the situation should the dollar tank, Turk asserts.

As always, there are those who see things a different way. The Barron's article quotes Ashraf Laidi, chief strategist at CMC Markets, who predicts gold will fall against the dollar.

Laidi could be right. But for any weaker gold/stronger dollar scenario to extend to the longer term would require the reversal of a pronounced nearly decade-long trend (see table).

A more extensive version of the table is here (PDF).

Posted by Joseph at 8:35 AM | Comments (0) | TrackBack
Category(s): Inflation Watch, SMI Model Portfolios

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Author: Even rich would come out ahead by using simple index funds

The New York Times' "Wealth Matters" column — targeted to wealthier readers — has served up a profile of Princeton economics professor, Burton G. Malkiel, author of the long-time bestseller, A Random Walk Down Wall Street, and now (with Charles Ellis), The Elements of Investing (Wiley, 2009).

Dr. Malkiel is a strong proponent of investing via no-frills, low-cost index funds. He argues that even the wealthy are more apt to come out ahead by using simple indexes, rather than hiring advisers to help them try to find outperforming stocks, hedge funds, and/or alternative investments.

From the Times:

For the wealthy, index funds have an image problem. They are considered the economy cars of the investing world: they'll get you there but not in style and you're always worried they may break down. Anyone at a serious level of wealth, the thinking goes, needs the equivalent of a luxury sedan, with strategic stock choices, hedge funds, private equity, real estate.

Burton G. Malkiel says this is all hogwash....

[He argues that the wealthy] would have fine returns without the volatility and high fees if they simply used indexes to diversify their money across asset classes. "This is still a strategy that is good for people of all income levels," he said.

Malkiel says many wealthy people waste money by paying for advice that doesn't improve their investment performance beyond what they would experience with index funds.

While the old adage says you get what you pay for, Mr. Malkiel argues the opposite. "The one thing I'm absolutely sure about is the less I pay to the purveyor of the service, the more that will be left for me," he said....

This makes sense for the modest investor with a straightforward portfolio. But the counterargument is that the wealthy need more advice because of the complexity of their assets, and that the advice is worth the fees. (Mr. Malkiel would say the rich just need more tax-planning advice.)...

"You don't need a commodities fund if you're really well diversified and into emerging markets," he said. "You’re going to have some investments in Brazil, which is natural resource rich. It's simple."

We agree with Dr. Malkiel that many investors — including many wealthy investors — overcomplicate matters, thereby increasing expenses without any significant increase in performance. That's why we developed our simple Just-the-Basics strategy.

Although SMI's Upgrading strategy clearly offers superior performance to indexing over the long haul, if the simplicity of indexing strikes your fancy, you won't get any argument from us. Indexing is a solid approach that (as Dr. Malkiel says) "is good for people of all income levels."

Not an SMI member yet? Today's a great day to join and gain access to all of our investing strategies and online tools!

Posted by Joseph at 1:45 PM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios
Tag(s): christian investing, index funds, investing principles, IRAs & 401ks, stock market, upgrading

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"Yesterday's winners, tomorrow's losers"

In an article on passive vs. active approaches to mutual-fund investing, the Wall Street Journal quotes Vanguard founder (and passive indexing guru) John Bogle on what is perhaps the biggest challenge facing active investors: "Yesterday's winners," said Bogle, "are far more likely to be tomorrow's losers."

In other words, many actively managed funds are loaded up with stocks that did well in the past (that's why managers bought them) but that are in the process of becoming underperformers. Active managers are constantly playing a game of "move ahead, then fall behind" — which generates expenses, but not much to show in terms of actual profits in comparison with low-cost indexing.

Two observations: 1) Bogle is right — this is the general case with active management; 2) Nonetheless, many actively managed funds have runs of outperformance that can stretch for many months (even years in rare cases).

Identifying these outperforming funds and investing in them until their success begins to falter is the essence of our Upgrading strategy. Upgrading isn't perfect, but that's okay. There is no perfect strategy. What Upgrading has been able to do is generate annual returns that have strongly outperformed indexing in recent years (although not every year; as noted in our just-released February issue, indexing eclipsed Upgrading ever-so-slightly in 2009).

We're all for indexing for those investors who want to follow that approach — and we're thankful that Mr. Bogle's Vanguard firm offers a terrific mix of index funds that we use for our Just-the-Basics indexing strategy. But we're also glad that Upgrading offers a way to meet the "yesterday's winners, tomorrow's losers" challenge and (usually) come out ahead.

Posted by Matthew at 11:52 AM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios
Tag(s): christian financial, christian investing, investing principles, stock market, upgrading

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Decade in review

One of the things I've been working on for this month's upcoming November newsletter is the report card we include every quarter on the performance of SMI's model portfolios. As I've been analyzing the data, one thing that has stood out to me is how different the experience of the past decade has been for "the market" vs. SMI's Upgrading strategy.

Over the past month, there have been quite a few "decade in review" type articles written. They've been spurred by a couple of recent events: the Dow re-claiming the 10,000 level (which first happened in March 1999), and last month's 10-year anniversary of "Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market" being published. Not surprisingly, as in this example, the main idea seems to be to point out what a waste of time the past decade has been for investors, since the market is stuck right back where it started a decade ago.

While that may be largely true for indexers and others who earned roughly the market's rate of return over the past decade, it's decidedly not true for those who followed SMI's Upgrading strategy. Over the 10 years ended 9/30/09, SMI's Upgrading model portfolio earned a total gain of 116.5%.

The media line is the past decade was a waste, that you're flat over the past decade.

The truth for Upgraders is that you've more than doubled your money over the past decade.

Quite a difference.

If you weren't following SMI's Upgrading strategy and find yourself with meager investment gains (or even overall losses) over the past decade, take hope. There is a better way to invest. You don't have to repeat the mistakes of the last 10 years in the decade to come.

Posted by Mark at 4:49 PM | Comments (0) | TrackBack
Category(s): SMI Model Portfolios

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Gimme shelter

After my rather lengthy (and financially depressing) post on Friday, one member commented: "I already knew it was bad and getting worse. What I keep hoping to see in my financial newsletter are a variety of protection strategies." I thought an answer was worth its own post.

First, I will point out, as always, that the Four Levels process, if followed faithfully, is the best "protection strategy" for the average SMI member. Being debt-free and having sufficient emergency savings will go a long way to seeing anyone through the present crisis.

Second, following our allocation recommendations, based on one's age and risk tolerance, would also have protected those who test out as being risk-averse from major damage. Here are the 2008 results for various age/risk combinations (keeping in mind the market was off -37% last year):

5-10 years until retirement / Researcher temperament / 60/40 = ~21% loss
5-10 years until retirement / Preserver temperament / 50/50 = ~17% loss
5 years until retirement / Researcher temperament / 50/50 = ~17% loss
5 years until retirement / Preserver temperament / 40/60 = ~13% loss
Early retirement years / Researcher temperament / 40/60 = ~13% loss
Early retirement years / Preserver temperament / 20/80 = ~4% loss
Later retirement years / Researcher temperament / 20/80 = ~4% loss
Later retirement years / Preserver temperament / 0/100 = ~5% gain

If you have more than 10 years before retirement, it remains our belief that you have sufficient time to recover your losses. But if you don't necessarily buy that and want to brace for further market weakness, that brings us to...

Third, the cover article in the April issue, due out for web members this afternoon, will discuss Protecting Yourself Against "The Big One." In it, Mark offers age-based suggestions for those wishing to take further defensive steps.

Posted by Austin at 1:42 PM | Comments (0)
Category(s): SMI Model Portfolios

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Cash levels of funds

On Monday, I noted that the cash level of our currently recommended Sector Rotation fund had soared during the 4th quarter of 2008. As this Morningstar article reports, several currently recommended Upgrading funds have also been beneficiaries of large cash holdings in recent months.

Some financial advisors don't like using funds that let their cash levels rise when conditions seem inopportune to the manager. That's understandable, as the advisor is trying to allocate investment capital between asset classes, and doesn't want to be left wondering if his 60% stock allocation is truly only 50% because of cash sitting around in his stock funds (an issue we discussed a bit recently in the comments of this post).

However, as Upgraders, we're not particularly concerned if a given fund has a high cash holding or not. That's because the performance impact of holding that cash is going to be reflected in the fund's momentum score. If the manager was just lucky to be holding cash when the market downturn occurred, that will likely be revealed when the market eventually rises and the fund lags due to the cash holding. But if raising cash was a result of skillful management, we benefit by avoiding damage as the market declines, and then potentially benefit again as that cash is intelligently deployed before the market rises again (as funds holding cash will lag in a rising market).

Upgraders can relax and simply focus on the MOM scores - the manager's cash management or lack of will show up there.

Posted by Mark at 3:35 PM | Comments (0)
Category(s): SMI Model Portfolios

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