Understanding Stock Market (A+++)

Investing: As Easy as Taking a Shower?

By Brian Stoffel 
November 9, 2011 

For the beginning investor, entering the stock market can be a confusing experience. Too often, a newbie dips his or her toe into the water, gets burned, and lets the "pros" take care of money matters from there on out.

It doesn't have to be this way; but first, we need to examine why investing can be such a difficult task.

Peter Senge in his best-seller The Fifth Discipline offers us a simple framework to explain the pitfalls of investing.

It's all about a feedback delayLet's pretend it's the morning, and you've jumped in the shower. Of course, the water temperature isn't going to be perfect right away; you need to adjust the knob. In the most basic sense, your feedback loop would look like this.

Now let's change things up: You have a defective shower. Instead of the water temperature adjusting almost immediately to a turn in the knob, it takes 10 seconds after turning the knob for any noticeable change to occur.

Now the feedback loop looks like this.

That delay is a pretty big deal, especially if you aren't used to dealing with it. Your first time in the shower might go like this: turn the knob to make it mildly hot, not feel a change, and turn the knob to scalding hot. Ten seconds later, while you're burning your skin off, you turn it to mildly cold. Not feeling a change, you adjust it to frigid cold, and then...

Well, you get the idea.

Applied to investingThe inclusion of a delay causes many a self-inflicted wound, and this explains why some beginners run into trouble.

Enticed into the stock market by opportunities for riches, investors may become frustrated when they don't see immediately results from their decisions. This leads them to constantly move money in and out of certain stocks, never allowing time for their thesis to play out.

In reality, an investor's feedback loop looks like this:

How long of a delay are we talking here?Fool founders Tom and David Gardner have always espoused the view that when investing, the average person should have a three-year time limit, minimum. That doesn't mean that you can't sell a stock before the three-year minimum. If it's crystal clear that your original thesis for investing in a company no longer holds true, then it's best to part ways sooner rather than later.

Being "crystal clear," however, isn't as easy as it sounds. Separating a company's performance as a business from its performance as a stock is essential. As Warren Buffett attributed to mentor Ben Graham in a letter to shareholders, "In the short run, the stock market is a voting machine, but in the long run, it's a weighing machine."

A few choice examples...To illustrate the importance of understanding this delay, I went back and looked at some well-known companies and how they've performed since three years ago, in November 2008. Here's a look:

Company	3-Year Return	Change at Lowest Close vs. Starting Price
Whole Foods (Nasdaq: WFM  )	612%	(15%)
Sirius XM (Nasdaq: SIRI  )	530%	(78%)
Green Mountain Coffee (Nasdaq:GMCR  )	1,200%	0%
Rosetta Stone (NYSE: RST  )	(72%)*	(72%)

Source: Yahoo! Finance. *Since going public in April 2009.

All four of these examples reveal a slightly different lesson for investors in how they should approach the market with a long-term time horizon.

When the Great Recession hit, investors behaved as if the organic food movement were dead. Adding to the negative sentiment, competition was coming from all sides: Even Wal-Mart (NYSE: WMT  ) began offering some organic food. Investors with a three-year horizon, however, realized that eventually, our economy would recover. And if they were following the broader move toward organic food, they knew the trend was undeniable.

Sirius XM, on the other hand, seemed to be on the brink of bankruptcy in early 2009. Believers in the company, however, were confident that the company wasn't going to be going anywhere, anytime soon. When they were bailed out by Liberty Media (Nasdaq: LCAPA  ) , life (and cash) was injected back into the company.

I included Green Mountain (maker of the ubiquitous Keurig coffeemakers) to show that there's really no telling how long a delay will be. Sometimes it will be a year, sometimes just one day. In this case, Green Mountain climbed immediately. The bigger point is that three years isgenerally long enough for any delay to work its way out of a system.

Finally, Rosetta Stone is an excellent example of the fact that it is OK to sell a stock before three years if your investment thesis changes dramatically. Just last month, I sold my sharesin this company because of the constant turnover in the executive suite.  

http://www.fool.com/investing/beginning/2011/11/09/investing-as-easy-as-taking-a-shower.aspx

Every investor who owns common stocks must expect to see them fluctuate in value over the years.

Market Fluctuations of the Investor’s Portfolio

Every investor who owns common stocks must expect to see them fluctuate in value over the years. 

The behavior of the DJIA since our last edition was written in 1964 probably reflects pretty well what has happened to the stock portfolio of a conservative investor who limited his stock holdings to those of large, prominent, and conservatively financed corporations.

• The overall value advanced from an average level of about 890 to a high of 995 in 1966 (and 985 again in 1968), fell to 631 in 1970, and made an almost full recovery to 940 in early 1971. 
• (Since the individual issues set their high and low marks at different times, the fluctuations in the Dow Jones group as a whole are less severe than those in the separate components.) 
• We have traced through the price fluctuations of other types of diversified and conservative common-stock portfolios and we find that the overall results are not likely to be markedly different from the above. 
• In general, the shares of second-line companies* fluctuate more widely than the major ones, but this does not necessarily mean that a group of well established but smaller companies will make a poorer showing over a fairly long period. 

In any case the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent one-third or more from their high point at various periods in the next five years.†




* Today’s equivalent of what Graham calls “second-line companies” would be any of the thousands of stocks not included in the Standard & Poor’s 500-stock index. A regularly revised list of the 500 stocks in the S & P index is available at www.standardandpoors.com.

† Note carefully what Graham is saying here. It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33% from their highest price—regardless of which stocks you own or whether the market as a whole goes up or down. 

• If you can’t live with that—or you think your portfolio is somehow magically exempt from it—then you are not yet entitled to call yourself an investor. 
• (Graham refers to a 33% decline as the “equivalent one-third” because a 50% gain takes a $10 stock to $15. From $15, a 33% loss [or $5 drop] takes it right back to $10, where it started.

Ref:  Intelligent Investor by Benjamin Graham

Volatility is not risk. Risk is the reasoned probability of that investment causing it's owner a loss of purchasing power over his contemplated holding period.

Investing is often described as the process of laying out money now in the expectation of receiving more money in the future.

At Berkshire we take a more demanding approach, defining investing as

•  the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. 
• More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. 

• Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. 
• And as we will see, a non-fluctuating asset can be laden with risk.

Investment possibilities are both many and varied.



http://www.berkshirehathaway.com/letters/2011ltr.pdf

Buffett: In my early days I, too, rejoiced when the market rose. Now, low prices became my friend.

Buffett highlights the irrational reaction of many investors to changes in stock prices.


Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%.  Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us.  Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?

I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years.

----



The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter:

• Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. 
• These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.

Charlie and I don’t expect to win many of you over to our way of thinking – we’ve observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus. And here
a confession is in order: In my early days I, too, rejoiced when the market rose. Then I read Chapter Eight of Ben Graham’s The Intelligent Investor, the chapter dealing with how investors should view fluctuations in stock prices. Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life.

In the end, the success of our IBM investment will be determined primarily by its future earnings. But an important secondary factor will be how many shares the company purchases with the substantial sums it is likely to devote to this activity. And if repurchases ever reduce the IBM shares outstanding to 63.9 million,  I will abandon my famed frugality and give Berkshire employees a paid holiday. 

-----


When Berkshire buys stock in a company that is repurchasing shares, we hope for two events:

• First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and 
• second, we also hope that the stock underperforms in the market for a long time as well. A corollary to this second point: “Talking our book” about a stock we own – were that to be effective – would actually be harmful to Berkshire, not helpful as commentators customarily assume.

http://www.berkshirehathaway.com/letters/2011ltr.pdf

Intrinsic Business Value - Look for the long term growth in the intrinsic values of your invested businesses.

Intrinsic Business Value


Charlie and I measure our performance by the rate of gain in Berkshire’s per-share intrinsic business value. If our gain over time outstrips the performance of the S&P 500, we have earned our paychecks. If it doesn’t, we are overpaid at any price.

We have no way to pinpoint intrinsic value. But we do have a useful, though considerably understated, proxy for it: per-share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values. That’s because the amount by which Berkshire’s intrinsic value exceeds book value does not swing wildly from year to year, though it increases in most years. Over time, the divergence will likely become ever more substantial in absolute terms, remaining reasonably steady, however, on a percentage basis as both the numerator and denominator of the business-value/book-value equation increase.

Comment:  It is not easy to determine intrinsic value.  The best PROXY for intrinsic value of Berkshire Hathaway is its book value.  Though this closely tracks the intrinsic value of Berkshire Hathaway,  it actually understates the intrinsic value of the company.  Nevertheless, Buffett opines that using book value to denote intrinsic value is meaningless for most other companies.


We’ve regularly emphasized that our book-value performance is almost certain to outpace the S&P 500 in a bad year for the stock market and just as certainly will fall short in a strong up-year. The test is how we do over time. Last year’s annual report included a table laying out results for the 42 five-year periods since we took over at Berkshire in 1965 (i.e., 1965-69, 1966-70, etc.). All showed our book value beating the S&P, and our string held for 2007-11. It will almost certainly snap, though, if the S&P 500 should put together a five-year winning streak (which it may well be on its way to doing as I write this)

Comment:  Psychological forces trump the fundamental forces in the short term.  In the long term, the fundamental forces always trump the psychological forces that affect the stock price of a company.  Buffett looks at long term performances.  He highlighted that in any given 5 year period, the percentage gains in book value of Berkshire Hathaway have beaten those offered by the S&P 500.

http://www.berkshirehathaway.com/letters/2011ltr.pdf

If you are buying sound value at a discount, do short-term price fluctuations matter?

In the long run, they do not matter much; value will ultimately be reflected in the price of a security.  

• Indeed, ironically, the long-term investment implication of price fluctuations is in the opposite direction from the near-term market impact.  
• For example, short-term price declines actually enhance the returns of long-term investors.  

There are, however several eventualities in which near-term price fluctuations do matter to investors. 

1.  Security holders who need to sell in a hurry are at the mercy of market prices.  The trick of successful investors is to sell when they want to, not when they have to.  Investors who may need to sell should not own marketable securities other than U.S. Treasury bills.

2.  Near-term security prices also matter to investors in a troubled company.  If a business must raise additional capital in the near term to survive, investors in its securities may have their fate determined, at least in part, by the prevailing market price of the company's stock and bonds.

3.  The third reason long-term-oriented investors are interested in short-term price fluctuations is that Mr. Market can create very attractive opportunities to buy and sell.

• If you hold cash, you are able to take advantage of such opportunities.  If you are fully invested when the market declines, your portfolio will likely drop in value, depriving you of the benefits arising from the opportunity to buy in at lower levels.  This creates an opportunity cost, the necessity to forego future opportunities that arise.  
• If what you hold is illiquid or unmarketable, the opportunity cost increases further; the illiquidity precludes your switching to better bargains.

Comparing equity yields with term deposits is lazy

Marcus Padley
December 3, 2011

I have been getting a little bit irritated by the constant comparisons between the yield on equities and the yield on a bond or term deposit.

The argument goes that equity yields are now higher than bond yields and also higher than term deposits, so you should switch.

But the truth is that a comparison of the returns on term deposits or bonds with equity yields is simply lazy and ridiculous and reckless, because it misses the point about why people are in term deposits in the first place.

Let me explain by taking a well-known income stock - the National Australia Bank, one of the highest-yielding and safest blue-chip stocks in the market. The yield on the NAB is 7.5 per cent - 10.7 per cent including franking. That, everyone will tell you, is cheap and the argument is that all you mugs holding term deposits earning just 5.5 per cent are idiots because you get a whole extra 2.2 per cent in the NAB or 5.2 per cent including franking.

Fair enough, until you consider this exercise.



Get a chart up of the NAB over the last year (one year will do). Now mark off the peaks and troughs since January and calculate how many and how big the variations have been. You will find that the NAB has had 10 fluctuations. Five rallies and five falls.

The size of the rallies has been +12.8 per cent, +17.8 per cent, +8.3 per cent, +23.2 per cent and +26.9 per cent. The falls have been -9.8 per cent, -15.3 per cent, -23.9 per cent, -13.5 per cent and -18.7 per cent and if we picked a smaller-income stock or took NAB out over a longer period, it would be even more dramatic.



Now tell me after 10 moves of more than 7.5 per cent in just a year that I should be worrying about the 7.5 per cent yield on the NAB. Now tell me, amid that volatility and instability, that I should mention the yield on the NAB and the yield on a risk-free term deposit or bond in the same breath. Now tell me the prudence behind selling my term deposit and buying the NAB.


The NAB and almost all other income stocks in the current market, are not stable low-risk investments; they are volatile trading stocks and the message is clear and let's make it clearer, once and for all. You cannot compare the yield on an equity to the yield on a bond because one includes no risk of a capital loss (no risk of a gain either) and the other contains a currently huge perceived risk of a capital loss (or gain).

Promoting income stocks because they yield more than a bond is ignoring that extra risk and misunderstanding why people are now in bonds and term deposits. They are there because they don't want to lose any more money. Because they don't want volatility.

The only way to compare equities to bonds or equities to term deposits is if the equities came with a price guarantee, which they don't, or if you compare risk-free yields with the expected total return from equities, which includes the extra volatility and risk and not just the dividends.

In the current market, equities are nothing like a bond or term deposit because share-price risk is dominating the investment decision not the yield. Do you really think people are in term deposits to make 5.5 per cent? No, they are in term deposits to avoid losing money. The focus is on the risk not the return. Risk rules.

But it's not all gloom. The good news is that this is not a normal state of affairs. The sharemarket is supposed to be about opportunity not risk and the fact that risk is so in focus means the opportunity side of the equation is being ignored.

Also, risk can change very quickly. Ahead of the last European Union summit the market jumped 11 per cent in four days on lower perceived equity risk. The banks jumped 19.2 per cent. If the GFC doesn't reignite, the focus is going to very rapidly swing back to yields and price-to-earnings (PE) ratios. If the GFC is behind us, how long do you think the NAB is going to trade on a 10.7 per cent yield and the market on a PE of 10.7 times against a long-term average of 14 times?

Not long. In which case the game now is not debating the marginal merits of term deposits versus equities but waiting for a chink of light in the outlook for risk, because that is all that matters and because when it appears, the herd is going to smash down the door to get to those yields and PEs.

At the moment they don't believe in them. Your job is to be on the ball on the day they do.

Marcus Padley is a stockbroker with Patersons Securities and the author of sharemarket newsletter Marcus Today. His views do not necessarily reflect those of Patersons.



Read more: http://www.smh.com.au/money/investing/comparing-equity-yields-with-term-deposits-is-lazy-20111202-1oakh.html#ixzz1jkzaigzd

Redefining Risk. Realistic definition of Risk.

Redefining Risk

Risk was the chance that you might not meet your long-term investment goals. 

And the greatest enemy of reaching those goals:  inflation. 

Nothing is safe from inflation. 

It's major victims are savings accounts, T-bills, bonds, and other types of fixed-income investments.

Investors usually use Treasury bills as their benchmark for risk. These are considered risk-free because their nominal value can't go down. However, T-bills and bonds are in fact highly risky because of their susceptibility to inflation.




Realistic definition of Risk

A realistic definition of risk recognizes the potential loss of capital through inflation and taxes, and includes:

1. The probability your investment will preserve your capital over your investment time horizon.

2. The probability your investments will outperform alternative investments during the period.

Short-term stock price volatility is not risk. Avoid investment advice based on volatility.

So if volatility is not risk, what is your major risk?

The major risk is not the short-term stock price volatility that many thousands of academic articles have been written about. 

Rather it is the possibility of not reaching your long-term investment goal through the growth of your funds in real terms. 

To measure monthly or quarterly volatility and call it risk - for investors who have time horizons 5, 10, 15 or even 30 years away - is a completely inappropriate definition. (David Dreman)


Take Home Lesson

Using Dreman's definition of risk, stocks are actually the safest investment out there over the long term. 

Investors who put some or most of their money into bonds and other investments on the assumption they are lowering their risk are, in fact, deluding themselves.

"Indeed, it goes against the principle we were taught from childhood - that the safest way to save was putting our money in the bank." 

Investing in volatile times

Investing in volatile times    

July 2010

When stock markets are volatile, what should unit trust investors do? Should they take on more risks and ride on the economic and market recovery? This article examines the issues that investors should look out for.

At the peak of the financial crisis in 2008, the FBM KLCI fell from an all-time high of 1,516 points in January 2008 to about 800 points in October 2008. With the index having rebounded to current levels of 1,361 points as at end July 2010, an investor would have made a handsome return of almost 70% if he had invested when the market was at its lowest point.





However, it is impossible to predict the bottom of the crash and therefore timing the market is virtually impossible for normal investors. With no crystal ball in hand, the ringgit-cost averaging method could provide retail investors with reasonable returns as markets recovered. This is provided that investors have a long-term perspective and are patient enough to ride through the market’s ups and downs.

Ringgit-cost averaging strategy is designed to reduce volatility by investing fixed dollar amounts at regular intervals, regardless of the market’s direction. Thus, as prices of securities rise, fewer units are bought, and as prices fall, more units are bought.

Depending on the risk profile and objectives of their funds, professional fund managers may capitalise on market volatility by bargain-hunting oversold stocks and divesting stocks that have become overvalued. By doing so, they seek to take advantage of mispricing of assets during volatile times. Given the sophistication of these investment strategies, unit trust investors should focus on a regular investment plan and let the fund managers deal with the volatility of markets.

How should unit trust investors respond to volatility?

Past performance of unit trust funds should be evaluated based on returns and volatility. Investors should try to assess whether a funds’ volatility is caused by market conditions which affect the performance of similar funds across the board or whether it is caused by the fund managers’ investment decisions to take on more risks.

It is quite clear that the primary reason for equity funds to be volatile in recent years is due to market volatility in various financial assets. As mentioned earlier, global stock markets sustained heavy losses as the US subprime crisis spread across the world in 2008, causing global financial institutions to write off US$1.7 trillion in debts. Subsequently, equities have rebounded in 2009 following signs of a recovery in economic activities in response to the fiscal and monetary stimulus measures undertaken by governments and central banks around the world.

The commodity bubble also burst in mid-2008, led by escalating crude oil prices which hit a high of US$147 per barrel in July 2008 before plunging to US$33 per barrel in December 2008. Volatility was also seen in the foreign exchange market as the financial meltdown forced U.S. investors to withdraw offshore funds to be repatriated back home, causing the US$ to strengthen in 2008. Subsequently with the recovery in equity markets, the US$ weakened in 2009 as investors were willing to take on more risks.

With volatility still in the current market, how can investors plan their investments before putting money into unit trusts?

Volatility is often viewed as negative as it is associated with risk and uncertainty. However, with a disciplined and consistent approach, investors can position themselves to achieve potential long-term returns from the market. In general, investors seeking above-average returns should be prepared to accept higher risks in their investments.

Before investing into a unit trust, investors should evaluate whether a fund’s volatility suits his or her risk appetite. They can start by reading the fund's prospectus and annual report, and compare its year-to-year performance figures. The figures can tell investors whether the fund earned most of its returns within a short period or whether its returns were achieved on a more consistent basis over time.

For example, over ten years, two funds may have gained 12% per year on average, but they may have taken drastically different routes to get there. One might have had a few years of spectacular performance and a few years of low or negative returns, while the performance of the other may have been much steadier from year to year.

Fund volatility factor

To assist investors in their fund selection, the Federation of Investment Managers Malaysia (FIMM), formerly known as the Federation of Malaysian Unit Trust Managers (FMUTM), introduced the fund volatility factor and fund volatility classification for funds with three years track record, which is assigned by Lipper.

While historical performance may not predict future returns, it can tell you how volatile a fund has been and reflect a fund manager’s track record. In using the fund volatility factor, unit trust investors should keep in mind to compare the volatility of funds against their annualised returns. In addition, they should evaluate the returns and volatility of funds within the same peer fund category and not across different categories of funds.

Apart from the fund managers’ investing style, the volatility of unit trusts differs depending on the assets that the funds are invested in. Commodities and equities are seen as more volatile compared to bonds and fixed deposits.

For equities, industry and sector factors can cause increased market volatility. For example, in the plantation sector, a major weather storm in an important plantation area can cause prices of crude palm oil to jump up. As a result, the price of palm oil-related stocks will rise accordingly.  This increased volatility affects overall markets as well as individual stocks.

There are unit trusts that invest in specific countries or regions such as China, Australia, Vietnam, and the emerging markets such as BRIC (Brazil, Russia, India and China). These funds are prone to country risks such as political risk and financial events in the country. Investors have to be aware of the volatility of foreign stocks and bonds. Regional and country-specific economic factors, such as tax and interest rate policies, also contribute to the directional change of the market and thus volatility.

Investors of a commodity fund would normally look at demand and supply conditions to access the outlook for the commodity market. In 2008, the rally in commodity prices was partly due to growing demand from energy-hungry China and other emerging countries. However, a sharp increase in speculative demand among hedge funds for selected commodities helped to drive up these commodity prices to record levels that were out of line with their fundamentals.

Following the financial crisis, hedge funds were scrutinised for their role in the speculation. Meanwhile, global demand of commodities is expected to increase in line with the economic recovery but there is no guarantee that the hedge funds will not return and create speculative demand.

In response to the financial crisis, central banks around the world have slashed interest rates to record lows to spur economic growth. However, selected regional central banks had started raising interest rates in the first half of 2010 to curb potential inflation as economic conditions improve.

In conclusion, unit trust investors can apply the ringgit-cost averaging method in a volatile market environment. This strategy would effectively reduce volatility risks as it does not time the market. Ringgit-cost averaging is most suitable for long-term investors as it requires investors to stay invested regardless of the market’s direction. For investors with higher risk appetite, they would need to understand specific factors that affect volatility in different asset classes and geographical areas and select their funds accordingly.


www.publicmutual.com.my

http://www.publicmutual.com.my/LinkClick.aspx?fileticket=KIgoaupKUnU%3d&tabid=86

The Average Investor Is Better Off Trading Long-Term

By Arthur, The Stock Investor Home
Investor are often reminded by the stockmarket that their shares value can go up (the bull) as well as down (the bear).  That is why people who tried to time the market can never beat it.  It is also the number one reason why people who tried to time the market will only end up losing money again and again.
 
One of the best time study was to "sell in May" and keep away from the market.  This is a method which was once used by traders and coined by the Hirch organization who publish the Stock Traders Almanac.  What they published was a fascinating stat that says that since 1950, if you invested $10,000 in the market at the beginning of November and held it to April of every year, you would have $536,000 currently. If you had done the same thing but invested from May to October, you would actually have a loss of $236.  You might want to give this time study investing method a tried but at your own risk.
 
Study have shown that for the average investor who have a full-time job on hand, they are better off investing for the long-term and ignore the short-term volatility of the share market.  Remember, short-term volatility is only importance to short-term investor.  As long you as you keep your long-term financial goal in mind and average the number of shares in good and bad time, the average long-term investor are going to perform much better than any short-term trader.
 
The secrets to consistently outperform any stock market indices no matter where you lived is very simple.  Since 1925, common stocks have generated an average annual rate of return of around 9-10 percent versus 3-5 percent for government bonds.  In addition, stocks have been one of the only investments that have consistently outpaced inflation over time.
 
Time is the best way to ride out any volatility.  Time have repeatedly show you that the stock market share value will recover and your share prices will once rise again.  That is why Warren Buffett favourite holding period for stock is FOREVER.  To benefits from the test of time, you must select your company stock carefully for investment.  Go for large companies such as Coca-Cola which you know that it will be around for many centuries.  Diversify your stock investment to not more than 10 companies.  Diversification works only if your don't OVER diversify.
 
No one in the stock investment world can consistently out-perform or beat the market.  Successful investor DO NOT tried to beat the market.  What they do is to keep their long-term financial goal in mind and invest using Fixed Cost Averaging, Time Diversification, and Investment Fund Diversification in Large Companies listed on stock exchange.
 
Don't bother to listen to any financial news, all they do is to constantly keep you in fear.  They are in the business of providing the financial buzz, they are not in the business to educate you to become a better stock investor.
 
To conclude, always keep your investing method simple.  Make used of the time tested formula and invested a fixed amount monthly.  Let the power of time and compound interest do it magic tricks for you.

http://www.sap-basis-abap.com/shares/the-average-investor-is-better-off-trading-long-term.htm

Buy-and-Hold: Golden Strategy That Takes an Iron Will

Buy-and-Hold: Golden Strategy That Takes an Iron Will

August 10, 1997|TOM PETRUNO

http://articles.latimes.com/1997/aug/10/business/fi-21077/2

Anne Scheiber's life was no happy tale. Embittered after the federal government failed to promote her from her IRS auditing job at the end of 1944, she retired and spent the next 51 years mostly alone, living on the Westside of Manhattan.

Her only hobby was investing. She apparently put every penny she had into stocks, rarely selling, her broker would later explain.

By the time she died in 1995, Scheiber had amassed a $22-million fortune in about 100 stocks--all of which she left to a stunned, but grateful, Yeshiva University.

If Scheiber's story is something of a cliche--"aged, frugal recluse buys and holds stocks, leaves millions to charity"--it's too bad we all can't be beneficiaries of such cliches.

But then, many investors have in fact benefited handsomely in the 1990s from the same basic investment philosophy: Just buy stocks and don't sell them. Period.

The proven long-term success of buy-and-hold is the basis for the retirement savings plan boom of the past decade, of course. Americans are encouraged to invest regularly in the market, avoid the temptation to sell when stocks suddenly sink, and trust that when retirement happens in 10, 20 or 30 years, a hefty nest egg will be there to fund it.

And why doubt that? Since Dec. 31, 1989, the Dow Jones industrial average has risen 192%, from 2,753.20 to 8,031.22 at Friday's close.

Even better: Measured from the start of the 1980s bull market on Aug. 13, 1982, the Dow has increased a spectacular tenfold.

What's more, if buy-and-hold still is good enough for Warren Buffett--perhaps the greatest living spokesmodel for that investment style--it still should be good enough for the rest of us, right?

Yet as stock prices have zoomed this year, adding to the huge gains of 1995 and 1996, many investors have understandably grown uneasy. The nagging worry is that stocks might have reached such historically high levels that buying and holding at these prices may never pay off.

On days like Friday--when the Dow sank 156.78 points, or 1.9%, as bond yields surged on concerns about the economy's growth rate--investors' darkest concerns about the market's future can surface.

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Is there a danger in trusting buy-and-hold at this point?


Certainly not if you have 51 years, like Anne Scheiber did. Academic studies show that the longer your time horizon, the lower the possibility of losing money in stocks.

That's not terribly surprising: Over time, the economy's natural tendency is to grow, because humankind's tendency is to strive to achieve more. If you own stocks, you own a piece of the economy--so you participate in its growth.

But over shorter periods--and that includes periods as long as a decade--it is indeed possible to lose money in stocks. Consider: The Dow index was at 890 on Dec. 31, 1971. Ten years later, on Dec. 31, 1981, the Dow was at 875. Your return after a decade of buy-and-hold was a negative 1.7%.

True, the 1970s were a miserable time for financial assets overall, as inflation soared with rocketing oil prices, sending interest rates soaring as well. But we don't even have to look back that far to discover just how difficult it can be to stick with a buy-and-hold strategy.

From the late 1980s through 1991, major drug stocks such as Merck & Co. and Pfizer Inc. were among Wall Street's favorites. They were well-run businesses, and the long-term demand for their products seemed assured.

By December 1991, Merck was trading at $56 a share, or a lofty 31 times its earnings per share that year.

Then came the Clinton administration's push for national health care. Suddenly, the drug companies found their pricing policies under attack. The stellar long-term earnings growth that Wall Street anticipated seemed very much in doubt. And the stocks fell into a decline that lasted more than two years and which shaved 40% to 50% from their peak 1991 prices.

Merck, for example, bottomed at $28.13 in 1994, which meant a paper loss of 50% for someone who bought at the peak in 1991.

If that had been you, could you have held through that horrendous decline? You should have: Today, Merck is at $98.81 a share, or 76% above its 1991 year-end level. After restructuring its business, Merck's earnings began to surge again in 1995 and 1996.

And this year, the drug stocks have once again become market darlings. But therein lies the problem: Merck is again trading for a high price-to-earnings ratio--26 times estimated 1997 results.

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That doesn't necessarily mean that Merck is primed to drop 50%, as it did in 1992-94. But it does mean that if you own that stock--any stock, for that matter--you must allow for the possibility of a deep decline from these current high levels, something much worse than the just-short-of-10% pullbacks the market has experienced twice in the last 14 months.

Anne Scheiber, angry recluse that she was said to be, somehow managed to show no emotion at all about the stock market's many ups and downs in her 51 years of investing. A cynic might say she had nothing on which to spend her money, anyway. But the point is, she managed to remain true to buy-and-hold, when many other investors were probably selling out at the market's lows.

Mark Hulbert, editor of the Hulbert Financial Digest newsletter in Alexandria, Va., and a student of market history, worries that too few investors will have Scheiber's iron stomach when the tide eventually turns for the market overall, as it did for the drug stocks in 1992.

"I am cynical about all of these people genuflecting at the altar of buy-and-hold," Hulbert says. "They're not buy-and-hold--that's just what is working now," so investors are happy to go with the flow, he says.

Most investors, Hulbert maintains, are too new to the market to imagine how psychologically painful a major and sustained loss in their portfolio would be.

What is key to judging how much of your assets should be in stocks is your tolerance for risk, your tolerance for loss and, of course, your time horizon. But as a simple rule of thumb, many Warren Buffett disciples like to use this line: If, for whatever reason, you can't take a temporary, 50% loss in your portfolio, then you don't belong in the stock market.

For the relative handful of pros who really invest like Buffett, what the market does on a short-term basis isn't important. Their faith in buying and holding stocks derives from their long-term faith in the underlying businesses.

George Mairs, the 69-year-old manager of the $324-million Mairs & Power growth stock fund in St. Paul, Minn., owns just 33 stocks in the fund. He is among the least active traders in the fund business--he almost never sells. And his results speak for themselves: Mairs & Power Growth has beaten the Standard & Poor's 500 index every year in this decade.

Does Mairs fear that buy-and-hold isn't a great idea at these market levels? Hardly. High-quality stocks aren't cheap, he says, but neither does he find them to be drastically overpriced. "It's the long-term earnings stream that we look at," he says. "If the earnings are going to be there, we don't worry too much.

"What we want to do is own businesses," Mairs says. "If we like a business for the long term, we don't worry about what the stock value is on a week-to-week basis."

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How Patient Can You Be?

"Buy and hold" sounds great on paper, but it can require enormous patience. Major drug stocks, for example, soared 94% between March, 1990 and December, 1991, as measured by the Standard & Poor's index of five major drug companies. But when the threat of federalized health care surfaced in 1992, drug stocks began a sustained decline that lasted more than two years--and slashed the S&P drug index by 42%. With the stocks again rocketing this year, 1992-1994 stands as a sobering reminder of how bad things can get. S&P drug stock index, quarterly closes and latest



Source: Bloomberg News