Evidence Investing

 
 
It’s been said over and over again…mostly by financial advisors:

You must be in the market all the time to see your portfolio grow to its potential….If you miss the 10 best days, your returns will suffer greatly!

They usually show you something that looks like this:
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This quote from Charles Schwab and Company show what I mean: On "importance of being invested…just a few trading days each year…for the ten-year period from 1994 though 2003, only 10 days accounted for almost half of the gain during the period. That's 10 days out of about 2,600."

This is one of the biggest, if not THE all-time biggest, fallacy foisted on unsuspecting unsophisticated small-time investors.

This subject has been address else where on the net, but I really feel like it cant be said enough and it deserves a little more air time.

Let me ask you this:  if you missed your “10 best” job interviews, where would you be?  Not as well off, I would guess.  What if you missed your “10 best” dates?  Not married to the women of your dreams …or at least not as many memories, right?  What about your “10 best” investing plays?  Lower account balance now, maybe?  

Its not rocket science, right?  You miss the best, 10 best, or 50 best of anything and you will be less ‘well off.’  Yet another expensive useless piece of advice from and expert.

In reality, if we look at missing the 10 best days, we also have to look at missing the 10 worst days.   Unless you have some kind of system that makes you miss all the best and keeps you in for all the worst days…  And that means you have much bigger problems. J

In fact with no system at all, you have an equal probability of missing the best days and missing the worst days, right?  And with any kind of worthwhile system, you just tip those odds in your favor and miss a few more bad days than you do good days.
So we need to look at what happens if you miss both best and worst days.

But first a little DETOUR:  Lets just quickly clarify a basic idea in investing and finance ->  participating in percentage gains are not as valuable as avoiding equal percentage losses. [to a degree, of course…we all know you can’t make money without percentage gains]

Here is an illustration:
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So you can see that as you gain and loss and equal percentage, your portfolio value slips away.

Now let’s see what percentage we have to gain to stay even after a 25% loss
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So from this, we can see that equal losses have a much larger effect on your portfolio than do gains!  This is a basic risk management concept which becomes even more interesting when linked with the “10 Best/10 Worst” concept.

REMEMBER ->  participating in percentage gains are not as valuable as avoiding equal percentage losses, generally speaking.

Ok, keeping this in mind, back to our “10 Best/10 Worst” discussion.

Look at what happens if you miss both best and worst days.   Below are the results from essentially three studies each using different holding periods, for your viewing pleasure.
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Note that the return from “Both” is about 3% points HIGHER than the Buy and Hold return.

Here’s another example. During the period analyzed below, the S&P 500 Index yielded annualized return of 7.06% (buy and hold) over the same period of time: 
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Note that the return from “Missed Both” is about 1.5% points HIGHER than the Buy and Hold return.

Now look at this:
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This looks at a shorter period.  Note that missing the 10 Worst gives you more gain (+1.43% above buy and hold) than the loss you sustain if you miss the 10 Best (-0.84%).  This ties back in to my “Detour concept” above:  you need even MORE of a gain to offset an equal percentage loss…and here, you have LESS of a gain (i.e. even if the 10 Best days were worth +1.43% (instead of +0.84%), that STILL would not be enough to offset the 1.43% savings that occurs when you avoid the 10 Worst days.

I hope that’s clear.   If not, just remember that missing both the 10 Best and 10 Worst days beats buy and hold (as shown above).

Read these few pages for “in other words” look at it.

AND what’s more, I’ve just been looking at the return numbers here.  I haven’t taken into account the affect on psychology that missing some highly volatile days can have on an investor; neither have I addressed the chance that high volatility can totally wipe out your portfolio OR the fact that there are several systems (TAA) that can tilt the ‘missed days’ in your favor!

Keep reading folks, lots more to come!
 


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