Investment management has its share of rules. Some make sense and others sound like they should make sense. Here is one rule that I used to follow and today have some misgivings about.
I taught at the local Adult Ed night school a class on basic money management and one of my topics was that students should not use the ‘Rearview Mirror Method’ of investing. The rearview mirror method is buying those domestic stocks or sectors that have already performed well and making the assumption that they will continue to do well. The reason that I gave was that rarely does the #1 performing sector and /or stock repeat its stellar performance for two or three years in a row. I now admit I was wrong.
We all should know that one of the worst myths is that lightening rarely strikes twice in the same place. Lightening in fact has a propensity to strike the same place just as hurricanes are formed in the same part of the world and Tornado Alley earned it’s moniker because of the constant severe weather. The information I got by reading and listening to investors who I thought were smarter than me about ignoring past great performing investments was truly bogus but I didn’t think too much about it at the time.
I urged my Adult Ed students to create an asset allocation that would provide a shotgun approach to their investing. In this way the amateur investor would be assured of having at least some money exposed to whatever would be the future leading sector instead of the past best performer.
Today we know that the theory of asset allocation is pretty much a recipe for investment mediocrity and, as we learned, does absolutely nothing to protect a portion of, or any, assets in a global economic meltdown. And, as I will explain, rearview mirror investing may be just what you should do and indeed produce gains that other methods will not.
Financial and investment planners are back to the basics, after having their egos and credos bruised, and are dusting off the old asset allocation doctrine and trying to explain away 2008 as an anomaly to anyone who will listen. They are saying it’s quite alright to return to the church of Modern Portfolio Theory, even though secretly most of them should, or do, know the concept is seriously flawed.
Conservative investors smart enough to ignore asset allocation from 2000 to 2009 and invested wholly in the bond sector were well rewarded as the sector outperformed the S&P 500 index for the entire decade. Opportunity was not only knocking but trying to kick in the door to whomever had a bit of common sense. Past performance was an important issue for those ten years. If not ‘the’ issue.
The same was true in the 1990s when technology was the best performing sector. Ignoring the rear-view mirror method of investing cost investors significant profits.
As we enter 2011 equities are a sector many investors do not want to approach for fear of a 2008 repeat. But, the sector has had two years of solid performance, even though most of 2010 was underwater. The final quarter in 2010 significantly outperformed fixed income. Going forward it’s easy to understand that fixed income is close to the end of its run and equities are where investors should be.
For many investors reallocating their portfolios to take advantage of the equity markets is a daunting, if not impossible task. Left to their own devices they’d leave things be. What they need is a simple and easy method to guide them.
The confusion stems into what specific equity sector to invest. There are large cap, mid-cap, small cap plus growth and value along with blended fund choices. The experts contend that large company stocks have been seriously neglected for years. But if history is a guide, moderately- aggressive investors may well want to overload their portfolios with small to mid-cap growth/value (or blended) investments as they are what have lead the equity performance in 11 out of the past 13 years.
In the last 13 years large cap stocks have lead equities as best performers only twice.
There is no science to this system of buying funds, stocks or ETFs using the rearview mirror. At the close of the year simply check what was the best performer and either add or modify your holdings to include it.
Most small to midcap funds and stocks pay no dividends and may be inappropriate for some investors. Still it bears some serious consideration to have some money invested by tailgating on the previous year’s leading investment sector. Check with your financial advisor or planner before adopting any plan that seriously deviates from your current set strategy; especially if your plan is to maximize current income.
And before a talking head pooh-poos this concept please remember that almost every financial planner, analyst and broker reviews past history of a fund, stock and manager before accepting or rejecting it, or them, as acceptable for their clients.
Finally, if you’re an active investor you’re bound to come across news about a hot stock or fund that some money manager or uber- investor bought a lot of. Before you follow that manager or investor you better check to see where the price of the investment he or she bought is before you commit your money. Many times the news filters down to the amateur investor long after the stock has had its run and is about to head to the land of profit taking. A case in point was Bill Gross at Pimco who invested over $21 million of his money into two Pimco closed-end funds. By the time news reached the average investor share price on both closed-end funds had climbed dramatically making the buy at a significant premium while Gross had bought at a significant discount.
It’s okay to play follow-the-leader only don’t be silly about it.
Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.
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