Investing has a whole new set of rules.

If we are to be successful, we need to play by these new rules.

Why the average equity fund investor underperforms the market?

From 1993 to 2012, the S&P Index 500 averaged a gain of 8.21% per year.

However, during that same 20 year period, the average equity fund investor had an average annual gain of only 4.25%.  

Had the average equity fund investor just bought a low-cost S&P 500 Index fund and held it, he/she would have almost doubled their rate of return.

The underperformance was due to investor behaviour such as market timing and chasing hot funds.

Had these investors been long-term, buy-and-hold investors, they would have earned close to the market's returns.

When the average investor underperforms the index by such a significant amount, it is clear that most are playing with a bad set of guidelines or none at all.

A one-time investment of $10,000 invested at 8% compounds to $46,610 in 20 years.

The same $10,000 invested over the same period at 4.25% compounds to only $22,989.

Short-run performance of the stock market is random, unpredictable and very volatile

The short-run performance of the stock market is random, unpredictable and for most people, nerve-racking.

The next time you hear someone saying that he/she knows how the stock market or any given stock is going to perform in the next few weeks, months, or years, you can be sure they are either lying or self-delusional.

The long-term trend of the stock market is up and its performance consistent

There is more than 200 years of U.S. stock market history and the long-term trend is up.  

Over the long term, stock market performance has been rather consistent.

During any 50-year period, it provided an average after-inflation return of between 5 and 7 percent per year.

If you invested in a well-diversified basket of stocks and left them alone, the purchasing power of your investment would have doubled roughly every 12 years.

Stocks over the long-run offer the greatest potentials return of any investment

Although long-term returns are fairly consistent, short-term returns are much volatile.  

Stocks over the long-run offer the greatest potential return of any investment, but the short-run roller-coaster rides can be a nightmare for those who don't understand the market and lack a sound investment plan to cope with it.  

The 1990s were stellar years for stocks but the 1930s were a disaster.

Warnings for calling your investment long term when they were meant to be short-term

Buffett warns against calling long-term those investments that were meant to be short-term but became long-term because the investors could not achieve the desired results quickly.

Buffett recommends being suspicious of those managers who fail to deliver in the short term and blame it on their long-term focus.

There are times when you should use other products besides stocks. When to avoid stocks?

Investing in stocks is not always the best answer for a financial goal.  There are times when you should use other products beside stocks.

Investing in stocks to meet short-term goals is usually not a good idea.  Do not use stocks for any goal that is fewer than five years from completion.  Any financial goal you need to achieve in fewer than five years is exposed to a risk that the stock market will swing to the downside just when you need the money.  The best plans can be sabotaged by a volatile stock market over the short term.

As you approach retirement, you will want to dial back your exposure to stocks and move into safer alternatives.

The stock market's obsession with the short term gives private investors an advantage.

Why The Stock Market Is Failing Britain

Published in Investing on 5 March 2012

A new report highlights fundamental failings.

Last year John Kay, a very accomplished economist who is a director of several companies, was asked by the government to see if the stock market is serving the needs of Britain's investors and companies. His interim findings were published last week and they make interesting reading.

Kay argues that today's stock market primarily serves the interests of the fund management industry, rather than those of companies and investors. He goes on to say that a culture of chasing short-term performance targets has developed, which is damaging the British economy and also harms investors' returns.

Secondary markets are good

The London Stock Exchange (LSE: LSE) consists of two markets. Companies come to the primary market to raise capital by selling shares and bonds through initial public offerings, but afterwards these are traded on the secondary market, which is where most of the action occurs.

Many investors would be reluctant to invest in the first place if they didn't have an easy way out via the secondary market. Since they do, this encourages them to buy shares and bonds, and it allows companies to charge a higher price for their shares and bonds in the primary market.

You can always sell your shares in BP (LSE: BP), HSBC (LSE: HSBA), or indeed most other quoted companies when the market is open, but if you couldn't access the secondary market, you'd have to find a willing buyer, which could take quite some time and would greatly increase your transaction costs.

Another well-known secondary market, one which has revolutionised the trade in second-hand goods, is the auction website eBay (NASDAQ: EBAY.US). Before eBay you had to rely on word-of-mouth, classified newspaper adverts and/or specialist dealers -- today eBay gives you access to a global marketplace.

Obsessed with the short-term

Kay and his team say that the stock market tail now wags the economic dog to such an extent that it damages Britain's interests. Many contributors to the report consider that the combination of quarterly reporting and institutional fund management has caused the investing community to obsess about the next set of figures at the expense of everything else.

As a result, many companies focus on meeting the institutions' short-term expectations, often by "managing" their quarterly earnings, to such an extent that they take their eye off the long term.

Another problem is that chasing short-term targets and concentrating on beating the forecasts can encourage excessive risk-taking. This can reduce your long-term returns, as well as having some serious consequences for the economy.

We saw this happen in a big way several years ago when Royal Bank of Scotland (LSE: RBS) collapsed during the credit crunch, due to a reckless expansion programme, and it had to be bailed out by the long-suffering taxpayer.

Take advantage of the short termers

I believe that the stock market's obsession with the short term gives private investors an advantage. Unlike the typical fund manager, you won't be sacked if you have a bad quarter, so you should be able to take a long-term view.

This can pay off handsomely when the stock market is having one of its hissy fits, because when this happens, there are bargains to be had. Benjamin Graham summed this up nicely when he said; "In the short run, the market is a voting machine, but in the long run it is a weighing machine."

Separation of owner and manager

Another of Kay's concerns is that because most people nowadays invest through funds, rather than by directly owning shares, the economic interest of share ownership has been separated from the decision-making process. The choice of whether to buy, sell and exercise the voting rights attaching to shares is now overwhelmingly concentrated in the hands of the institutions.

This is nothing new; separating the control over property from its ownership has been a cornerstone of English trust law ever since the 11th century, when the King's Knights left their lands under stewardship before they went off to fight in the Crusades.

But it has mushroomed with the growth of the fund management industry during the last few decades, and the result is that most shareholders are absentee landlords with little interest in how their companies are run. The industry encourages this by offering nominee accounts, and making it very hard (and often expensive) for shareholders to exercise their votes.

The paradox of voting your shares

The difficulty that private investors have in voting shares held in nominee accounts is a bone of contention for some people. Personally I couldn't care less about exercising my voting rights unless my stake is large enough that that it might actually have an effect. If I don't like what I see, I "vote" by selling my shares.

When it comes to voting I'm a big fan of Downs Paradox, named after the public policy expert Anthony Downs who described it in his 1957 book An Economic Theory of Democracy. Downs says that if a rational self-interested person has just one vote in a very large electorate, then they should not bother to vote because this will not influence the outcome.

So, if you own 1% of the company, your vote is substantial and is thus worth exercising. The same goes if you are a constituent in a parliamentary election, which was won last time by just a few hundred votes. In both of these instances, your vote is very valuable.

But if you own 0.0005% of a company's shares, Downs Paradox says that a much better use of your time is to do something else, such as reading its report and accounts! Even though I attended Diageo's (LSE: DGE) annual general meeting last October, I didn't bother to vote -- my stake, whilst fairly substantial, is but one vote amongst more than a million others.

Kay's full report will be published this summer along with his recommendations. If you want to read his interim report you can find it at this webpage.

http://www.fool.co.uk/news/investing/2012/03/05/why-the-stock-market-is-failing-britain.aspx?source=ufwflwlnk0000001

The short-term and long-term perspectives on an investment can diverge.

In a rising market, many people feel wealthy in the short run due to unrealized capital gains, but they are likely to be worse off over the long run than if security prices had remained lower and the returns to incremental investment higher.

A 5% return may end up being a better deal than a 20% return!!!!!

The time it takes to realise a gain, plays a huge part in determining our annual rate of return and the overall attractiveness of the investment.

If one is able to get a 5% return in a month, can we argue that it is a better investment than one that earns us a 20% return over a two-year period?

The Reasoning:
5% rate of return in a month
= yearly rate of return of 60% (0.05 x 12 months = 0.6).

20% return at the end of two years
= yearly rate of return of 10% (0.2 / 2 years = 0.1)

Premise:
The above argument is premised on being able to re-allocate the capital that you had out at 5% for a month, at attractive rates in the preceding months.

But in theory, if you could reallocate your capital five times over a two-year period and each time earn 5% a month, it would still produce better results than getting a 20% return at the end of a two-year period.

The year is the base time standard by which one compares different investment returns.

Rules to remember:
1. The time it takes to achieve the projected profit ultimately determines a great deal of the investment's attractiveness.
2. Always adjust the return to put it into a yearly perspective.

Long Term Investing Vs Short Term Trading

Long Term Investing Vs Short Term Trading

Jun.10, 2010

Investing into stocks over the long term and trading stocks are two conflicting points of view. So, which one is better? Well this really depends; each strategy has its advantages and disadvantages.

Long term investing is simply the process of buying strong companies and holding onto them for the long term. Because the companies are fundamentally strong they are unlikely to go out of business any time soon and in fact they are very likely to increase in price as time goes by.

Trading stocks in the short term is actually a completely different strategy. Instead of holding onto stocks for the long term short term traders tend to use things such as chart patterns and technical indicators to attempt to catch the short term movements of stocks and hopefully make a larger profit then if they were to simply buy and hold the stock.

Which strategy is best? There are defiantly advantages and disadvantages to each method. The best strategy for you really depends on you and where you are at.

Trading stocks in the short term does have a lot more potential then buying and holding. If you can make short term gains relatively consistent over the long term then you can do pretty well for yourself. However it does take a lot of work and there are no guarantees that you will make any money. It is like starting a business most people will fail their first time around, but those who can keep getting back up and learning from their mistakes will likely do well eventually.

If you are willing to put all of the time and energy into short term trading the rewards can be pretty nice.
However if you just want something that is considered to be safe yet does have some potential then you can take a look at long term investing. The main advantages of long term investing are that it is passive and it is a relatively secure way of making a decent return over the span of a couple decades.

Basically it comes down to this, if you want to earn a relatively safe return passively then investing in the stock market can be a great idea. If however you want to attempt to increase your returns and put some extra time into it then trading stock might be better suited for you.

Diary of a Private Investor: how the pros make money from turbulence

Diary of a Private Investor: how the pros make money from turbulence

Unfortunately there is no foolproof system to deal with these sort of situations. When a panic occurs, it is usually right to buy.

By James Bartholomew
Published: 9:49AM BST 27 May 2010


What a daunting few weeks this has been in the stock market. In normal times, one or two worries present themselves. Recently they have had to form a queue.

It was bad enough when we were just worrying about Greece and its budget deficit. One of the scary numbers I came across was that German financial institutions hold $37bn in Greek bonds. That, I presume, is not counting money lent in forms other than bonds. If Greece defaulted, some major German banks would take a big hit. Think through all the consequences of that and you get to higher lending costs around Europe and renewed recession.

My shares quoted in Hong Kong were probably not too worried about that but they spiralled down for a different reason. China has tightened lending to quieten down property prices. And what are my biggest holdings in that area? Why, property companies of course.

Back home, growing anguish about the coalition government's apparent aim to tax capital gains more heavily in future is encouraging people to sell sooner rather than later. On Friday last week, I myself sold some Healthcare Locums (at 223p) held by one of my children to use up the tax free allowance under the current rules. The fear must be that many people will decide not to reinvest after selling if the new regime is harsh.

Then came news that the North Korean dictator has taken it into his head to prepare for war. Next came a crisis among Spanish banks. For those of us who are pretty fully invested, the bad news has been relentless. It has been like the charge of the light brigade: "Cannon to the right of them, cannon to the left of them, cannon in front of them … into the mouth of hell rode the six hundred"

Unfortunately there is no foolproof system to deal with these sort of situations. When a panic occurs, it is usually right to buy. But sometimes it is better to get out because the fears will turn out to be justified. As concerns about an uprising in Russia increased in 1917, I expect prices of Tsarist bonds fell back. It probably looked clever to buy on the dip. Unfortunately, as it turned out, when the communists took over, the bonds lost all their value except as wallpaper. So it all depends on how things actually turn out. Right now, if Greece and Spain do not default and if North Korea thinks better of starting a war, shares are cheap. On the other hand …

Investment obliges you to take a view on how things will turn out in politics and all sorts of other things. That is one of the things that makes it so interesting. Another aspect of investment is the influence of personality. I tend to be optimistic and that is probably key to why I think that we will probably muddle along. In any case, it occurs to me that even if North Korea attacks, this will probably not stop people going to have a drink at the pubs owned by one of my companies, Enterprise Inns. Some things you can rely on.

Last week I was even sanguine enough to buy more shares in Paragon, a mortgage lender, which came out with good results and made hopeful noises about restarting active lending. The purchase turned out to be horribly timed. I bought at 151p and, after the market falls, they are licking their wounds, as I write, at 133p. On Monday, my fears about Greece increased, and I wanted to reduce my exposure to further market weakness without selling any of my favoured companies. So I tried something I have never done before. I bought a few shares in an Exchange Traded Fund (ETF) designed to go up if the stock market goes down. It has the strange name, DB X-trackers FTSE 100 Short, and I bought at 938p.

Incidentally, I was astonished to see how big this fund is. The market capitalisation is an amazing £1.4bn. I had not realised just how big the business of being bearish on shares has become. This is just one of a number of such funds. But on Tuesday, the market fell so far and so fast – with Enterprise Inns down 10pc for example – that I decided the bearish trend had gone too far. I sold my bearish ETF for a little profit at 981p.

Unfortunately this bit of good timing was with only a tiny amount of money. Overall, I have been nearly fully invested and my portfolio had taken a bit of a battering.


-----

Some comments:

Thank you Jo.
Padraig, I am sorry but you are wrong in so many ways. Long term 'investing' is just as risky as short term trading. It's all a 'gamble' as you put it, I prefer the term 'bet' as it is all about calculated risk. You're right in that gambling loses in the long run but proper trading is not gambling. You are also right that it is impossible to pick market movements correctly all the time. One does not need to and I am often wrong, but I manage my risk effectively and ensure I capitalise on the times when I am right so that I make money. I do this over and over and over. The stock market is not the only thing to money on and markets do not go up all the time. How can you say that the only way to make money is in a strong bull market,just sell futures!

And yes as you have all pointed out Warren Buffet is succesful, but he not the only one in the world. Please measure your success your own way. Mr Buffett is not the only succesful investor in the world. There are thousands. Mr Buffet has done extrememely well but I could not replicate his success with his style as my personality is not suited for the long term approach. In reality I will not be as rich as him because the volumes in the market will not accommodate my short term approach and that is fine by me. I make money and so do many others.

---

Don't see your point, Paul. Stock or currency, bull or bear, you can make money. Day trading is fine if you're after 5% gains here and there, but most of us are here for 5 years or so, therefore long positions on shares are a much better idea.

I too am mostly all-in, James. It’s been a pretty stressful year or two, hasn't it? I've gone from 50% up to 35% down since Xmas, crazy times.

I agree entirely with you on the topic of your post, probably one of the most important lessons for any new PI for that matter.

Confident in Sarkozy talking tosh, I managed to pull out a blinding FTSE short (a proper CFD short, not an ETF) following the brief rally last week. It's shooting up today, but that was a lot of resistance on the 5k line it broke through on Tuesday, so I'm not too confident s/term - any any ideas for next week??!

http://www.telegraph.co.uk/finance/personalfinance/investing/shares-and-stock-tips/7767939/Diary-of-a-Private-Investor-how-the-pros-make-money-from-turbulence.html

Stock Market Strategy: "One-day trade, Swing trade or Long-term trade"

Stock Market Strategy
Stock market is a risky place to make a profit.

Who are these players generating all this trade -speculating or investing - in the stock market?

There are many types of trades in the stock market.  However, essentially the three most popular of them are:

1.  One-day trade

2.  Swing trade

3.  Long-time trade.

It is common to think that the swing trade has a time horizon between the one-day trade and the long-time trade.  The time horizon of a swing trade is dependent on the event(s) influencing the player to terminate the trade.

The more astute would notice that all these types are characterized by a single factor (risk tolerance profile) of the players:  their ability to hold onto their position in the stock market for various investing time frames.


The beauty of the stock market is that it can be used for various purposes by different investors.


http://www.assetinvesting.com/?p=4473

****3 Steps To Profitable Stock Picking

3 Steps To Profitable Stock Picking

Stock picking is a very complicated process and investors have different approaches. However, it is wise to follow general steps to minimize the risk of the investments. This article will outline these basic steps for picking high performance stocks.

Step 1. Decide on the time frame and the general strategy of the investment. This step is very important because it will dictate the type of stocks you buy.

Suppose you decide to be a long term investor, you would want to find stocks that have sustainable competitive advantages along with stable growth. The key for finding these stocks is by looking at the historical performance of each stock over the past decades and do a simple business S.W.O.T. (Strength-weakness-opportunity-threat) analysis on the company.

If you decide to be a short term investor, you would like to adhere to one of the following strategies:

a. Momentum Trading. This strategy is to look for stocks that increase in both price and volume over the recent past. Most technical analyses support this trading strategy. My advice on this strategy is to look for stocks that have demonstrated stable and smooth rises in their prices. The idea is that when the stocks are not volatile, you can simply ride the up-trend until the trend breaks.

b. Contrarian Strategy. This strategy is to look for over-reactions in the stock market. Researches show that stock market is not always efficient, which means prices do not always accurately represent the values of the stocks. When a company announces a bad news, people panic and price often drops below the stock's fair value. To decide whether a stock over-reacted to a news, you should look at the possibility of recovery from the impact of the bad news. For example, if the stock drops 20% after the company loses a legal case that has no permanent damage to the business's brand and product, you can be confident that the market over-reacted. My advice on this strategy is to find a list of stocks that have recent drops in prices, analyze the potential for a reversal (through candlestick analysis). If the stocks demonstrate candlestick reversal patterns, I will go through the recent news to analyze the causes of the recent price drops to determine the existence of over-sold opportunities.

Step 2. Conduct researches that give you a selection of stocks that is consistent to your investment time frame and strategy. There are numerous stock screeners on the web that can help you find stocks according to your needs.

Step 3. Once you have a list of stocks to buy, you would need to diversify them in a way that gives the greatest reward/risk ratio. One way to do this is conduct a Markowitz analysis for your portfolio. The analysis will give you the proportions of money you should allocate to each stock. This step is crucial because diversification is one of the free-lunches in the investment world.

These three steps should get you started in your quest to consistently make money in the stock market. They will deepen your knowledge about the financial markets, and would provide a of confidence that helps you to make better trading decisions.

http://tradingindicator.blogspot.com/2010/01/3-steps-to-profitable-stock-picking.html

Comment:  There are many ways to make money.  Investing for the long term is profitable for many investors.  Some of those who employ other strategies can also be profitable too.

Short-term investments: Savings Accounts, Money-Market Funds, Treasury Bills and Certificate of Deposits

The Pros and Cons of some Basic Investments

Savings Accounts, Money-Market Funds, Treasury Bills and Certificate of Deposits

All of the above are known as short-term investments.

They pay you interest.  You get your money back in a relatively short time.

In savings accounts, Treasury bills, and CDs, your money is insured against losses, so you're guaranteed to get it back.

Money markets lack the guarantee, bu the chances of losing money in a money market are remote.

One big disadvantage:  They pay you a low rate of interest.

Sometimes, the interest rate you get in a money-market account or a savings account can't even keep up with inflation.  Looking at it that way, a savings account may be a losing proposition.

Inflation is a fancy way of saying that prices of things are going up.  Another way to look at inflation is that the buying power of the dollar is going down.

The first goal of saving and investing is to keep ahead of inflation.  Your money's on a threadmill that's constantly going backward.  In recent years, you had to make 3 % on your investments just to stay even.

That's the problem with leaving money in a bank or a savings and loan.  The money is safe in the short run, because it's insured against loss, but in the long run, it is likely to lose ground against taxes and inflation. 

Here's a tip - when the inflation rate is higher than the interest rate you're getting from a CD, Treasury bill, money-market account, or savings account, you're investing in a lost cause.

• Savings accounts are great places to park money so you can get at it quickly, whenever you need to pay bills. 
• They are great places to store cash until you've got a big enough pile to invest elsewhere. 
• But over long periods of time, they won't do you much good.