The Poor Investor – Investigatory Value Investing

"Faber est suae quisque fortunae" -Appius Claudius Caecus

Monthly Archives: April 2012

“Sell in May and Go Away!”

After reading this week’s Barron’s I saw an interesting little chart that showed the growth of $100 if the “sell in May” strategy were followed, also known as the Halloween indicator (original research paper).  Surprisingly, if you had followed a strategy of investing $100 in the S&P 500 since 04/30/45 during October – April periods versus May – September periods, your $100 would have turned into $9329 in the former period versus $99 in the latter.

The chart in Barron’s:

One would think, after seeing this chart, that selling in May, or maybe even April to get ahead of the curve, would be a prudent investment strategy.  However, if you extend the timeline out a bit more you get a picture that looks like this (this chart uses May-Oct. and Nov.-April, however, it is more representative due to the fact that the months are split 50/50, as opposed to 58/42 in the above chart):

Now, you may have noticed that November – April still outperformed.  However, clearly, if you had ignored the period from May – September you would have missed out on some nice gains during this time frame, as a buy-and-hold strategy through all periods worked best.  But what is the difference in periods due to?  If you look at the average returns by month since 1925, you’ll see quite readily:

It seems one of the major culprits is September.  So why not sell in September?

As Ken Fisher points out in his book “Debunkery,” from which this chart was first found, the two worst Septembers (which are notably in the May – October period) were down 29.6% in 1931 and 13.8% in 1937, due to the Great Depression.  All other months, on average, offered gains over the long haul.

What else accounts for the big downtrend in the May – October period:

  • Panic of 1901: May 17, 1901
  • Panic of 1907: October 1907
  • Black Monday: October 19, 1987
  • Friday the 13th mini-crash: October 13, 1989
  • Economic crisis in Asian: 1997 mini-crash: October 27, 1997
  • September 11th attacks: September 11, 2001
  • Internet bubble bursts: October 9, 2002
  • Global Financial Crisis starts: September 16, 2008
  • 2010 Flash Crash: May 6, 2010

To name a few…

Who is to say the next big stock market crashes won’t happen to coincide with April or July, the best performing months on average?

Bottom line: Don’t rely too much on statistical anomalies and try to “time the market” or you might be left holding the bag.

—-Written by: The Poor Investor

Is Diversifying Your Portfolio Harder Now?

I was reading an article from Fidelity called “Where to Look for Returns” and came across an interesting table I wanted to share with all of you:

For those of you looking to diversify your portfolios this appears to be a lot more difficult nowadays.  It also appears that these high correlations are not going to change anytime in the near future.  Furthermore, it is my belief that return enhancement via the effects of rebalancing (great article about rebalancing) may be reduced due to these high correlations.

Note: Personally, I use TIPS for portfolio diversification since historically (and currently) they still have the lowest correlation to equities.

—-Written by: The Poor Investor

Are You Wired for Investing?

Dear Readers,

Recently I came across a website that offers a variety of tests for investors and investment advisors: MarketPsych.com.  The test I found most beneficial on the website is for individual investors and is based off the Five Factor Model, also known as the “Big Five.”  In order to not interfere with the test validity I will not discuss too much more about it.

Link to test:

Individual Investor Personality Test

Here is another test, which tests your “Wall Street Risk IQ.”

Feel free to post your results and comments regarding whether you agree or disagree with the personality test.

—The Poor Investor

IQ and Successful Investing

Robert Shiller, professor of economics at Yale, recently wrote an article about a study in the Journal of Finance that showed high-IQ investors tend to outperform low-IQ investors.

The study can be summed up to some extent in this line from the study itself:

“Lack of cognitive skill is so fundamental as a driver of nonparticipation that it deters large amounts of wealth from entering the stock market.”

The bottom line is that those with higher cognitive ability tend to participate more in the stock market, as illustrated below:

(Please forgive my lack of artistic ability and accuracy).

What’s astonishing is that external factors in the study such as wealth, income, age, and occupation were controlled for.  Participation rates are just higher for those with higher IQs, period.

Even more importantly though, the study goes into the decisions made by those with higher IQs and finds that their investment decisions are much better than those with lower IQs as well.  What did they find?

High IQ Investors:

  • Diversify their portfolios more
  • Favor small capitalization and value stocks
  • Favor high book value in relation to market price
  • Are more likely to hold mutual funds
  • Hold larger numbers of stocks
  • Have lower-beta portfolios
(These findings corroborate much of the information you’ll find in the education section of this website).
In the “conclusion” section of the study some other important findings (such as those from other studies) are noted:
“While we have not fully resolved the participation puzzle, our results suggest the intriguing possibility that the odds are stacked against low-IQ investors when they do participate in the financial markets. Calvet et al. (2009) show that investors who make some investment mistakes tend to make many of them. Grinblatt, Keloharju, and Linnainmaa (2011) document that high-IQ investors’ stock purchases earn larger risk-adjusted returns, that their purchases and sales experience lower trading costs, and that their trades are less subject to profit-eroding behavioral biases like the disposition effect. Grinblatt, Ikaheimo, Keloharju, and Knupfer (2011) observe that high-IQ investors pay lower effective mutual fund fees by constructing “home-made balanced funds,” that is, portfolios of equity and bond funds.”
So does this mean you’re doomed to poor performance if you have a low IQ?  Not necessarily.  It just means that investing in the stock market might be more of an uphill battle for you.  However, if you understand the reasons why high IQ investors tend to perform better and emulate those same characteristics there is a high probability that you will also do well in the stock market.  However, it might not hurt to take an intelligence test just to see where you stand.
—-Written by: The Poor Investor
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