A sound mental approach towards stock fluctuations (3): Market Price Fluctuations

Market Price Fluctuations

When the general market declines or advances substantially, nearly all investors will have somewhat similar changes in their portfolio values.

The investor should not pay serious attention to such price developments unless they fit into a previously established program of buying at low levels and selling at high levels.

A sound mental approach towards stock fluctuations (2) Measuring Investment Results

Price Changes as Measuring Investment Results

The success of your investment program in common stocks must depend in great part on what happens ultimately to their prices.

• How far must you commit yourself to concern with the market's price fluctuation or conduct?
• By what market tests should you consider that you have been successful or not?

Yet, focusing on short-term or minor fluctuations will make you indistinguishable from the stock trader.

The experienced investors lean toward using a combination of dividend return and market-price change over a suitable period of time as the measure of investment success.  

• These calculations are made preferably between dates, several years apart, on which the general market level has not changed appreciably.
• The inclusion of the dividend income make this method a highly satisfactory one for testing investment results.
• It may be employed: 

1. (1) to measure the overall performance of an investor's portfolio, or 
2. (2) to compare one investment fund with another, or 
3. (3) to assess the merits of alternative principles of investment - for example, buying "growth stocks" versus buying undervalued securities.

Market Price Fluctuations

When the general market declines or advances substantially, nearly all investors will have somewhat similar changes in their portfolio values.

The investor should not pay serious attention to such price developments unless they fit into a previously established program of buying at low levels and selling at high levels.

A sound mental approach towards stock fluctuations (1)

Intelligent investment is more a matter of mental approach than it is of technique.

A sound mental approach towards stock fluctuations is the touchstone of all successful investment under present-day conditions.

Your portfolio should consist of:

(a)  Savings Bonds, which have no price fluctuations, and,

(b)  Common Stocks, which are likely to fluctuate widely in their market price.

Such changes in quoted prices may be significant to the investor in two possible directions:

(A)  As a measure of the success of your investment program.

(B)  As a guide to the selection of your securities and the timing of your transactions.

Berkshire Hathaway: A Safe, High-Quality, Growing Company

The Basics

• Stock price (5/4/17): $249,540
  • $166.34 for B shares
• Shares outstanding: 1.64 million
• Market cap: $409 billion
• Total assets (Q4 '16): $621 billion
• Total equity (Q4 '16): $286 billion
• Book value per share (Q4 '16): $172,108
• Repurchase maximum price (1.2x book): $206,530
• Downside to the Buffett repurchase put: 17%
• P/B: 1.45x
• Float (Q4 '16): $92 billion
• Revenue: $224 billion
• Berkshire Hathaway today is the 11th largest company in the world (and 4th largest in the U.S.) by revenues

History

• Berkshire Hathaway today does not resemble the company that Buffett bought into during the 1960s
• It was a leading New England-based textile company, with investment appeal as a classic Ben Graham-style "net-net"
• Buffett took control of Berkshire on May 10, 1965
• At that time, the company had a market value of about $18 million and shareholder's equity of about $22 million

• Buffett is doing a good job investing – the latest examples being Precision Castparts, Kraft and Duracell– but the cash is coming in so fast (a high-class problem)!
  • Berkshire will generate free cash flow equal to the $32.7 billion paid for PCP in ~2 years
• Markets have a way of presenting big opportunities on short notice
  • Junk bonds in 2002, chaos in 2008
  • Buffett has reduced the average maturity of Berkshire’s bond portfolio so he can act quickly

Valuing Berkshire

"Over the years we've…attempt[ed] to increase our marketable investments in wonderful businesses, while simultaneously trying to buy similar businesses in their entirety." – 1995 Annual Letter

"In our last two annual reports, we furnished you a table that Charlie and I believe is central to estimating Berkshire's intrinsic value. In the updated version of that table, which follows, we trace our two key components of value. The first column lists our per-share ownership of investments (including cash and equivalents) and the second column shows our per-share earnings from Berkshire's operating businesses before taxes and purchase-accounting adjustments, but after all interest and corporate expenses. The second column excludes all dividends, interest and capital gains that we realized from the investments presented in the first column." – 1997 Annual Letter

"In effect, the columns show what Berkshire would look like were it split into two parts, with one entity holding our investments and the other operating all of our businesses and bearing all corporate costs." – 1997 Annual Letter

Buffett's Comments on Berkshire's Valuation Lead to an Implied Historical Multiplier of ~12x

• 1996 Annual Letter: "Today's price/value relationship is both much different from what it was a year ago and, as Charlie and I see it, more appropriate."
• 1997 Annual Letter: "Berkshire's intrinsic value grew at nearly the same pace as book value" (book +34.1%)
• 1998 Annual Letter: "Though Berkshire's intrinsic value grew very substantially in 1998, the gain fell well short of the 48.3% recorded for book value." (Assume a 15-20% increase in intrinsic value.)
• 1999 Annual Letter: "A repurchase of, say, 2% of a company's shares at a 25% discount from per-share intrinsic value...We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated...Recently, when the A shares fell below $45,000, we considered making repurchases."

/2017/05/tilson-berkshire-hathaway-safe-high-quality-growing-company-30-upside/

Estimating Berkshire's Value: 2001 – 2016

1. Unlike Buffett, we included a conservative estimate of normalized earnings from Berkshire's insurance businesses: half of the $2 billion of average annual profit over the 12 years prior to 2014, equal to $600/share prior. Starting in the 2015 AR, Buffett began to include all insurance earnings, so this is reflected in 2014 and 2015 earnings. Both we and Buffett exclude investment income.
2. Historically we believe Buffett used a 12 multiple, but given compressed multiples during the downturn, we used an 8 in 2008-2010 and 10 since then.

Berkshire Is Trading 16% Below Its Intrinsic Value

* Investments per share plus 12x pre-tax earnings per share through 2007, then an 8x multiple from 2008-2010, and a 10x multiple thereafter.



12-Month Investment Return 

• Current intrinsic value: $296,000/share 
• Plus 6% annual growth of intrinsic value of the business 
• Plus ~$10,000/share cash build over next 12 months 
• Equals intrinsic value in one year of $324,000 
• 30% above today's price 


Catalysts 

• Continued earnings growth of operating businesses 
• Likelihood of meaningful acquisitions 
• New stock investments 
• Additional cash build 
• Share repurchases (if the stock drops to 1.2x book or below; it’s currently at 1.45x)


Conclusion: 

Berkshire Has Everything I Look for in a Stock: It's Safe, Cheap and Growing at a Healthy Rate 

• Extremely safe: Berkshire's huge hoard of liquid assets, the quality and diversity of its businesses, the fact that much of its earnings (primarily insurance and utilities) aren't tied to the economic cycle, and the conservative way in which it's managed all protect Berkshire's intrinsic value, while the share repurchase program provides downside protection to the stock 
• Upside: trading 16% below intrinsic value (without giving any credit to immense optionality), with 30% upside over the next year 
• Downside: Only 17% downside to 1.2x book value, which is where Buffett it will to buy the stock, thereby putting a floor on it. 
• Growing: Intrinsic value is growing at roughly 6-8% annually

Buffett: The stock market's casino-like characteristic can be agonizing for investors

Iconic investor Warren Buffett says Berkshire Hathaway (BRK.A) (BRK.B) thinks that investors will do reasonably well when speculators in the market get fearful.

During the Berkshire Hathaway’s annual shareholders’ meeting, a value investor from China asked Buffett and his right-hand man Charlie Munger for advice on how to spread the value investing philosophy in a market system where so many are speculating.

“There’s always some speculations, always some value investors in the market,” Buffett said.

The problem arises when people start to see others benefitting from playing the market.

“When speculation gets rampant and when you’re getting what I guess Charlie [Munger] would call ‘social proof’ that it’s worked recently, people can get very excited about speculating in markets. And, we will have it from time-to-time in the market,” Buffett said, adding, “There’s nothing more agonizing than to see your neighbor, who you think has an IQ 30 points below you, getting richer than you are by buying stocks, whether it’s internet stocks or whatever. And people succumb to it. They’ll succumb to it in this economy and elsewhere.”

Buffett noted that in developing markets, there’s probably a tendency to be more speculative than already established markets.

“Markets have a casino characteristic that has a lot of appeal to people, particularly when they see people getting rich around them,” Buffett said. “And those who haven’t been through cycles before are probably a little more prone to speculate than people who have experienced the outcome of wild speculations.”

Munger added that China will probably have more trouble.

“They’re very bright people. They have a lot of action. Sure, they are going to be more speculative, but it’s a dumb idea. And to the extent that you’re working on it, why you’re on the side of angels. Lots of luck.”

Buffett noted that there will be “more opportunities” for investors if they can “keep their wits about them.”

“Fear spreads like you cannot believe until you’ve seen a few examples of it,” Buffett said, pointing to the panic in U.S. money market funds in 2008 as an example.

“The way the public can react is really extreme in markets and that actually offers opportunities for investors,” he added. “People like action and they like to gamble.”

The lesson here: the market rewards patience.

https://finance.yahoo.com/news/buffett-stock-markets-casino-like-characteristic-can-agonizing-investors-184338850.html

Overview of the Different Classes of Arbitrage

Classic Arbitrage Category

1.  Friendly Mergers

This is where two companies have agreed to merge with each other.

An example would be Burlington Northern Santa Fe (BNSF) railway's agreeing to be acquired by Berkshire for $100 a share.

This presents an arbitrage opportunity in that BNSF's stock price will trade slightly below Berkshire's offer price, right up until the day the deal closes.

These kinds of deals are plentiful.


2.  Hostile Takeovers

This is where Company A wants to buy Company B, but the management of Company B doesn't want to sell.

So Company A decides to make a hostile bid for Company B.

This means that Company A is gong to try to buy a controlling interest by taking its offer directly to Company B's shareholders.

An example of a hostile takeover would be Kraft Foods Inc.'s hostile takeover bid for Cadbury plc.

This kind of corporate battle can get real ugly, but it can offer lots of opportunity to make a fortune.


3.  Corporate Self-Tender Offers

Sometimes companies will buy back their own shares

• by purchasing them in the stock market, and 
• sometimes they do it by making a public tender offer directly to their shareholders.

An example of this would be Maxgen's tender offer for 6 million of its own shares.

You can arbitrage on these self-tenders.




Special Situations Category

4,  Liquidations

This is where a company decides to sell its assets and pay out the proceeds to its shareholders.

Sometimes an arbitrage opportunity arises when the price of the company's shares are less than what the liquidated payout will be.

An example of this would be when the real estate trust MGI Properties liquidated its portfolio of properties at a higher value than its shares were selling for.


5.Spin-Offs

Conglomerates often own a collection of a lot of mediocre businesses mixed in with one or two great ones.

The mediocre businesses dominate the stock market's valuation of the business as a whole.

To realize the true value of the great businesses, the company will sometimes spin them off to the shareholders.

It is possible to buy a great business at a bargain price by buying the conglomerate's shares before the spin-off, as when Dun & Bradstreet spun off Moody's Investors Service.

Spin-offs come under the category of special situations.



6.  Stubs

Stubs are a special class of financial instrument that represent an interest in some asset of the company.

They can also be a minority interest in a company that has been taken private.

An arbitrage opportunity arises when the current stub price is lower than the asset value that the stub represents and there is some plan in place to realize the stub's full value.

Warren's earliest arbitrage play involved buying shares in a cocoa producer, then trading the shares in for warehouse receipts for actual cocoa, which he then sold.

The warehouse receipts were a kind of stub.

Though they are known under many different names - minority interests, certificates of beneficial interests, certificates of participation, certificates of contingent interests, warehouse receipts, scrip, and liquidation certificates - they still present you with many wonderful opportunities to profit from them.



7.  Reorganizations

This is a huge area of special situations that offer some very interesting arbitrage-like opportunities.

A most notable being ServiceMaster's conversion from a corporation to a master limited partnership and Tenneco Inc.'s conversion from a corporation into a royalty trust.

Tendering Your Shares

The company doing the buying will make an announcement that it is asking shareholders to tender their shares between, say, June 1, 2010 and June 20, 2010.

This time period for tendering is usually twenty and sixty days.

Under certain circumstances, the time period may be extended.

If you don't tender your shares within that window of time, you may be stuck with the shares and have to try selling them directly in the market.

You may end up with another fixed price at which the company will buy them from you.

Either way, it may not be as good a deal as the tender offer.



Withdrawing shares from being tendered

During the time period to tender your shares, you also have the right to untender them.  

After you tender your shares,

• you may decide not to wait until the tender to sell them or 
• you may decide you want to hold the shares for the long term.

Whatever the reason, once tendered, they can be untendered during the window for tendering.

If the tender offer is increased in price after you have tendered your shares, you automatically receive the increased price for your shares.

Arbitrage - where to look for these companies?

Where to discover what companies are -

• planning on merging,
• attempting a hostile takeover 
• spinning off a business, 
• doing a liquidation, 
• planning a share buyback, or
• reorganising into a trust or partnership?

Keep a vigilant eye on the financial press and any and all services that track such corporate events.

• Wall Street Journal
• Major regional newspapers for investment opportunities
• Google:  search the words "tender offer" and "mergers"
• Internet paid services e.g., mergerstat.com
• Internet free services e.g., search engines at: 

Yahoo!  http://finance.yahoo.com/news/category-m-a and http://us.biz.yahoo.com/topic/m-a/. , MSN http://news.moneycentral.msn.com/category/topics.aspx.topic=TOPIC_MERGERS_ACQUISITIONS.

Leverage and Arbitrage

When is it safe to use leverage in your arbitrage?

The certainty of the deal presents an opportunity to safely use leverage - borrowed money - to increase the rate of return.

With arbitrage situations that is certain to reach fruition, be willing to leverage.

This is the exception to the usual advice against the evils of borrowing money to buy stocks.



What is the risk of using leverage?

The danger with any stock investment is that it will not perform, that the share price won't increase, that it will drop like a rock, taking our capital with it.

Borrowing money to invest in a risky investment is a sure way to eventually go broke.


How can you benefit from using leverage?

A high probability of the arbitrage deal being completed equates to a large amount of the risk being removed.

If you are certain that you are going to make your projected profit, it is safe to use borrowed money to increase your rate of return.

The use of leverage gives you the advantage of being able to pull additional earning power out of capital tied up in other investments.



When should you not use leverage?

There are two reasons:

(1)  If the deal or event that drives the profit is not certain, then borrowing capital to invest in it can be an invitation to folly, and,
(2)  If the time element is not certain, then determining the difference between the cost of borrowed capital and the rate of return becomes an impossible calculation.


The Time Danger of Using Leverage

In the game of using leverage, time is never on your side - quicker is always better

You can comfortably borrow $1 million at 5% to invest if we are 'certain" that the deal will be completed in the time period we projected.

If the investment, instead of its taking one year for our stock to move up, it takes four years; then the borrowed money is costing us $50,000 a year and if we hold it for four years, our interest costs will balloon to $200,000.

It is the certainty of both the time and the return that allows you to leverage up and use borrowed money to safely invest in arbitrage and other special situations.

Leverage, if used carefully, and only with deals where there is a high probability of performance, this strategy makes it possible to greatly enhance the performance of your arbitrage investments.

The Arbitrage Risk Equation Warren Learned from Benjamin Graham

An example of arbitrage.

Announcement of the $55 a share tender offer
Stock was trading at $44 a share before the announcement.
After the announcement, you are buying the stock at $50 a share.
Likelihood of Deal Happening 90%.


1,  Determine what is your potential return?

Tender offer $55 a share
You can buy the stock at $50 a share
Your arbitrage investment has a projected profit (PP) of $5 a share
This gives a 10% projected rate of return on your $50 investment.


2.  What is the likelihood that the event will occur as a percentage?

Does it have a 30% chance of being completed?  Or a 90% chance?

Likehood of Deal Happening = 90%



3.  Adjusted projected profit (APP)

APP
= Projected Profit x Likelihood of Deal Happening
= PP x LDH
= $5 x 90%
= $4.50


4. Adjusted Projected Rate of Return (APRR)

APRR
= Projected Profit / Your Investment
= PP / I
= $4.50 / $50
= 9%.


5.  What is the risk of the deal falling apart?

What is your risk of loss?

If the deal fails to be completed, the per share price of the stock will return to the trading price it had before the tender offer was announced.

If the stock was trading at $44 a share before the announcement of the $55 a share tender offer and after the announcement, we are buying the stock at $50 a share, we have a downside risk of $6 a share if the deal falls apart and the price of the company's stock returns to $44 a share ($50 - $44 = $6).

Thus, if the deal falls apart, you have a projected loss of $6 a share.

Projected Loss $6 a share
Likelihood of the deal falling apart (LDFA) 10%


6.  Adjusted Projected Loss

Adjusted projected loss (APL) of $0.60 a share ($6 x 0.1 = $0.60)


7.  Risk-adjusted projected profit (RAPP) 

RAPP
= Adjusted potential profit - Adjusted projected loss
= APP - APL
= $4.50 - $0.60
= $3.90


8.  Risk-adjusted Projected Rate of Return (RAPRR)

RAPRR
=Risk Adjusted Projected Profit / Investment
=RAPP/I
= $3.90 / $50
= 7.8%


Is a risk-adjusted projected rate of return of 7.8% an enticing enough return for us?

If it is, we make our investment.



[If the RAPP is a negative number, walk away from the deal.]



Additional notes:

It is probably not necessary to do these calculations, though they serve as a means to help you think about the potential of the opportunity presented.

A successful arbitrage operation has more to do with the art of weighing the different variables than attempting to quantify them down to a hard scientific equation that tells you when to buy and when to sell.

These variables themselves can change and often they are simply unique to that situation.

They are tools that can be helpful if used properly.



-------------------------------------


Summary

Announcement of the $55 a share tender offer
Stock was trading at $44 a share before the announcement.
After the announcement, you are buying the stock at $50 a share.
Likelihood of Deal Happening 90%.


1,  Determine what your potential return is?

Your arbitrage investment has a projected profit (PP) of $5 a share
This gives a 10% projected rate of return on your $50 investment.


2.  What is the likelihood that the event will occur as a percentage?

Likehood of Deal Happening = 90%


3.  Adjusted projected profit (APP)

APP
= Projected Profit x Likelihood of Deal Happening
= PP x LDH
= $5 x 90%
= $4.50


4. Adjusted Projected Rate of Return (APRR)

APRR
= Projected Profit / Your Investment
= PP / I
= $4.50 / $50
= 9%.


5.  What is the risk of the deal falling apart?

Thus, if the deal falls apart, you have a projected loss of $6 a share.

Projected Loss $6 a share
Likelihood of the deal falling apart (LDFA) 10%


6.  Adjusted Projected Loss

Adjusted projected loss (APL) of $0.60 a share ($6 x 0.1 = $0.60)


7.  Risk-adjusted projected profit (RAPP) 

RAPP
= Adjusted potential profit - Adjusted projected loss
= APP - APL
= $4.50 - $0.60
= $3.90


8.  Risk-adjusted Projected Rate of Return (RAPRR)

RAPRR
=Risk Adjusted Projected Profit / Investment
=RAPP/I
= $3.90 / $50
= 7.8%


Is a risk-adjusted projected rate of return of 7.8% an enticing enough return for us?

If it is, we make our investment.



[If the RAPP is a negative number, walk away from the deal.]

Using Annual Rate of Return to Determine the Investment's Attractiveness

The time it takes to achieve the projected profit ultimately determines a great deal of the investment's attractiveness.

Therefore, the time it takes to get to fruition ultimately determines our annual rate of return.

Time ultimately determines the attractiveness of the deal.

By viewing investment returns from a yearly perspective, it is possible to put these returns into perspective compared to what other investments are paying.

Two reasons why investors lose money in the stock market

1.  They buy poor quality stocks.

2.  They pay too high  prices.  

Buying Cheaply Works

When we talk about value investing there is a lot of evidence that value investors have been on the right side of the trade. The statistical studies that run against or contradict market efficiency almost all of them show that cheap portfolios—low market-to-book, low price-to-book—outperform the markets by significant amounts in all periods in all countries—that is a statistical, historical basis for believing that this is one of the approaches where people are predominantly on the right side of the trade. And, of course, someone else has to be on the wrong side of the trade.

Those studies were first done in the early 1930s; they were done again in the early 1950s. And the ones done in the 1990s got all the attention because the academics caught on. There is statistical evidence that the value approaches—buy cheap securities—have historically outperformed the market. Buying Cheap works.


http://csinvesting.org/wp-content/uploads/2012/06/greenwald_2005_inv_process_pres_gabelli-in-london.pdf

The 7 classes of arbitrage and special situations that Warren Buffett has invested into.

Warren Buffett has focused on seven classes of arbitrage and special situations.

Classic Arbitrage 

1. Friendly Mergers
2. Hostile Takeovers
3. Corporate tender offers for a company's own stock

Special Situations

1. Liquidations
2. Spin-offs
3. Stubs
4. Reorganisation

Time Arbitrage

Example to illustrate "time arbitrage":

Company ABC's stock is trading at $8 a share.

Company XYZ offers to buy company ABC for $14 a share in four months.

In response to the offer, Company ABC's stock goes to $12 a share.


How can you arbitrage on this situation?

The simple arbitrage play here would be to buy Company ABC's stock today at $12 a share and then sell to Company XYZ in four months for $14 a share, which would give a $2 a share profit.

Unlike the normal everyday stock investment, this is a solid offer of $14 a share in four months.

Unless something screws it up, you will be able to sell the stock you paid $12 a share for today for $14 a share in four months.

It is this CERTAINTY of its going up $2 a share in four months that separates it from other investments.

Once Company XYZ's offer is accepted by Company ABC, it becomes a binding contract between Company ABC and Company XYZ with certain contingencies.


What is the risk of this arbitrage?

The reason that the stock does not immediately jump from $8 a share to $14 a share is that there is a risk that the deal might fall apart  

In this case, we won't be able to sell the stock for $14 a share and Company ABC's share price will probably drop back into the neighbourhood of $8 a share.



Understanding Time Arbitrage

We are arbitraging two different prices for the company's shares that occur between two points in time, on two very specific dates.  This kind of arbitrage is thought of as "time arbitrage".

This kind of arbitrage is very difficult to model for computer trading. 

It favours the investors who are capable of weighing and processing a dozen or more variables, some repetitive, some unique, that can pop up over the period of time the position is held.


In Summary

1.  The arbitrage opportunity arises because of a positive price spread that develops between the current market price of the stock and the offering price to buy it in the future.

2.  The positive price spread between the two develops because

• of the risk of the deal falling apart and 
• the time value of money.

The work of the arbitrageurs (Market arbitrage)

A particular commodity, e.g., gold,  trades virtually at virtually the same price in different markets in the world.

This is the work of the arbitrageurs.

The arbitrageurs will keep buying and selling until the spread in the prices in the two markets is eliminated.

The arbitrageurs will be pocketing the profits on the price spread between the two markets until the price spread finally disappears.

These transactions today are done with high-speed computers and very sophisticated software programs, which are owned and operated by many of the giant financial institutions of the world.

Arbitraging a price difference between two different markets, usually within minutes of the price discrepancy showing up is known as "market arbitrage".

Arbitrage is Warren's secret for producing great results

Professors Gerald Martin and John Puthenpurackal's studied the stock portfolio's performance from 1980 to 2003 of Berkshire Hathaway.

Their findings:

• Portfolio's 261 investments had an average annualised rate of return of 39.3%.
• 59 of those 261 investments were identified as arbitrage deals.
• Those 59 arbitrage deals produced an average annualised rate of return of 81.28%!

Their study brought to light the powerful influence that Warren's arbitrage operations had on Berkshire's stock portfolio's entire performance.

If those Warren's 59 arbitrage investments for that period were cut out from the portfolio, the average annualised return for Berkshire's stock portfolio drops from 39.38% to 26.96%.

In 1987, the S&P 500 delivered a 5% return, while Warren's arbitrage activities earned an amazing 90% that year.

Arbitrage is Warren's secret for producing great results when the rest of the stock market is having a down year.

Certainty of the deal being completed is everything.  The high probability of the event happening creates the rare situation in which Warren is willing to use leverage to help boost his performance in these investments to unheard-of numbers.

Terms: Arbitrage,  Leverage, Compounding

Arbitrage and Special Situations

In the past, these have been the domain of professional investors, who have access to lower brokerage rates.

In the world of arbitrage and special situations, the high retail brokerage rates formed an almost impassable barrier of entry for lay investors.

Simply their brokerage costs often exceeded any potential profit in the trade.

With the advance of the Internet and with the lower rates now available, the world of stock arbitrage and other special situations are opened up to the masses.

Aggressive investors can learn how to identify the bet with the least risk, which can enable the investor to take very large positions and produce results that can be spectacular.

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.

Applying these principles to investing is destined to leave you poorer!

• Don't settle for average.  Strive to be the best.
• Listen to your gut.  What you feel in your heart is usually right.
• If you don;t know how to do something, ask.  Talk to an expert or hire one and let the expert handle it.  that will save you a lot of time and frustration.
• You get what you pay for.  Good help isn't cheap and cheap help isn't good.
• If there's a crisis, take action!Do something to fix it.
• History repeats itself.  The best predictor of future performance is past performance.

Explanations:

As an investor, you can be well above average by settling for slightly less than the index returns.

Listening to your gut is the worst thing you can do.

Although it sometimes pays to hire an expert, you may get less than you pay for.

Trying to fix a perceived investment crisis by taking action is usually a recipe for poor returns.

Using yesterday's results to pick tomorrow's high-performing investments or investment pros is another losing strategy.