This is an article from the April 2011 issue of Financial Advisor Magazine that I was featured in. In this article, Mary Rowland writes about two books that attempt to discuss the topic of how to invest in this ever-evolving market: Buy—DON’T Hold: Investing With ETFs Using Relative Strength To Increase Returns With Less Risk by Leslie Masonsen and Power of Passive Investing: More Wealth With Less Work by Richard Ferri. By using technical investing (like they do at Dorsey Wright and Associates), it is much easier to understand the analysis – and have better investing results because of it.
Here’s the article:
Here’s a question I’d like answered: Is investing a science with strategies and tactics that improve from year to year, eventually becoming nearly foolproof so that the professional investors who take the time to study them become better and better at it? Or are the frequent changes we see in investment strategies part of a random, mostly dysfunctional journey in which some investors seem to be on the leading edge today, only to tumble into disgrace and obscurity when the cycle turns?
I recently read two books on the topic of how to invest in this new-era market. One was written in 2010, one in 2011. Do the past two and a half years, during which we’ve observed one of the most stunning crashes in the history of the market, provide any new answers to these questions? Any new proof of what works and what doesn’t work?
This period—since September 2008—has seen the most active discussion on market strategies that I’ve heard in my 30 years of covering investing and financial planning. Two different schools of thought have emerged from the crisis. They are not new, but an affirmation of strategies that have existed for nearly a century.
The consensus of both is that we don’t have to throw up our hands and play a game of darts to choose investments. Rather, there is something that investors can know, some strategies that they can use. Not surprisingly, both rest on consistency. Consistency always beats knee-jerk reactions. And consistency depends on the financial advisor’s ability to convince the client—and himself—that he is practicing a strategy that will help grow the portfolio and protect it against loss.
So let me tell you about the books in the hope that they will clarify your own positions and help you see how to talk with clients about investing. I first received Leslie N. Masonson’s book, Buy—DON’T Hold: Investing With ETFs Using Relative Strength To Increase Returns With Less Risk, published by the Financial Times Press, in 2010. Masonson is one of the financial planners/investors who sent an e-mail to me last year when I wrote a column about modern portfolio theory versus technical analysis. Masonson has written several books on investing, including one called All About Market Timing (2003). His books have received mostly good reviews on Amazon.com, so I don’t think he’s a flash in the pan. Buy—Don’t Hold was the number two book in the mutual fund category on a recent day. The other book I will talk about was number one in the same category on the same day.
Like many avid investors, Masonson became interested in investing when he was a teenager and his grandmother gave him one share of Pan Am stock. That was in 1957. He also wrote a book on day trading. I know that many financial planners view day trading and market timing as a formula for disaster. I’m not comfortable with them myself because I don’t have the necessary time and discipline to carry them out. However, I’ve wanted to address the topic with guidance from someone who is esteemed in that field. I spent some time (on the phone) with Masonson this winter, trying to get a better grasp on his method.
In his book, Masonson says: “My goal is to provide you with a non-emotional, systematic approach to investing that will make money in bull markets and protect your portfolio in bear markets.” When I spoke to him, he was not confident about the stock market’s future going forward. “After this 100% recovery since March 9, 2009, this market will face reality and come tumbling down,” he said. “This has been the fastest rise in history. So expect the downswing to be nasty.” He says he is 100% in cash.
Masonson takes issue with most passive investing, or buy-and-hold, strategies. For example, he says that rebalancing a portfolio on a particular date makes no sense because certain asset classes might have long periods of outperformance. “Selling them arbitrarily on a fixed date because they went up more in relationship to the total portfolio and buying other asset classes that have not done well is a backward way of investing.” The better approach is to “invest in the right asset classes at the right time and switch to other asset classes as they start outperforming the current classes.”
I don’t see how any investor could disagree with this. The problem for most of us, or perhaps I should say for me, is that we don’t have the foggiest notion of how to identify the “right time.” Those who use technical investing, like Tom Dorsey at Dorsey Wright Associates in Richmond, Va., have studied this field for decades and have the sophisticated tools necessary to make that decision. They also have the confidence of many advisors.
Some say that advisors who teach the DWA method, like Ric Lager in Minneapolis, have helped them to understand the analysis and they have had much better investing results because of it. Some, like Charles Scott of Pelleton Capital Management in Scottsdale, Ariz., say they would not still be in business if it were not for DWA’s tutoring on point-and-figure analysis and the results they have achieved with it. I wonder, though, how many advisors who don’t study with a master can do this sort of investing on their own and how much time it might take them. It sounds as if it requires nerves of steel. I also wonder if all the negative publicity about technical analysis comes because of its use by investors who don’t have a firm hold on it.
Masonson has never used buy-and-hold and never buys individual stocks. Instead, he uses ETFs exclusively. He completed a master’s thesis in college on the relative strength methodology and uses the Web site ETFscreen.com as well as his own site, buydonthold.com. His book contains myriad sources for those who want to incorporate technical analysis into their practices.
Masonson also uses various stop-loss orders to protect principal. For those advisors and investors who wish to learn about technical analysis, he developed what he calls the “Stock Market Dashboard,” composed of eight free, publicly available indicators. Here are the indicators he uses to decide when to move money in and out of the market:
1. The percentage of New York Stock Exchange stocks above their 50-day moving average.
2. The times when a broad market index such as the S&P 500 crosses the 100-day moving average.
3. The point at which the NYSE daily new highs minus the daily new lows reach an extreme number, which he defines.
4. The number of stocks that are on buy signals on a point-and-figure chart.
5. The bullish percentage in weekly investor sentiment.
6. The movement of the Moving Average Convergence-Divergence (MACD) Indicator on the Nasdaq composite index.
7. The “Best Six Months” strategy, which dictates that investors be fully invested from November 1 to April 30 of each year and stay in cash for the remainder of the year.
8. The crossover of the Nasdaq Summation Index Moving Average (NASI) with the MACD indicator confirmation.
These indicators seem to be difficult ones. That causes me to wonder if many who experiment with technical analysis fail to understand them and thus to carry out a disciplined investment plan. Masonson provides an easy-to-use, computerized format for using these triggers. He claims that once an investor understands them and gets set up to monitor them with the help of a computer, the required time to carry out the strategy is minimal. He also provides a detailed analysis of ETFs, including several resources that can be used to monitor them on your computer.
If you use technical analysis in your investing practice (or are considering it or want to learn about it), this is a good book for your library. If you don’t use technical analysis and don’t want to spend the time necessary to learn how to do it diligently, you’re better off not to try it. When I spoke with Masonson, he made it clear that anything other than total commitment to this form of trading will not be worthwhile. Worse yet, it could be disastrous.
The second book, The Power of Passive Investing: More Wealth With Less Work, by Richard A. Ferri, with a foreword by John C. Bogle, recommends the exact opposite strategy. Ferri, a Forbes columnist and founder of Portfolio Solutions, traces the history of active versus passive investing back to 1924 when the first open-end mutual fund, Massachusetts Investors’ Trust, an actively managed fund, was introduced. Of course, we know that the first retail passive fund, the Vanguard 500 Index Fund, was introduced by Bogle in 1976.
Ferri provides a chapter on performance studies on active investing from the 1920s and 1930s up through the 1960s, showing that it falls behind the market by a larger portion as time goes on. Interestingly, Ferri notes that after the introduction of index funds, active funds began trading more because the goal became “to beat the market.”
Turnover in the active fund industry is about 15 times higher today than what it was in the 1960s, he says. We know the drill on the advantages of passive investing, too: Active funds carry higher costs, result in higher taxes, often include sales loads, are more risky and, over time, lose to index funds by a 2 to 1 ratio. Like Masonson, Ferri likes ETFs, which offer buy/sell opportunities throughout the day while mutual funds only offer them at the close of business.
A study by Dalbar Inc. covering the 20-year period ending in 2009 found that equity mutual fund investors had average annual returns of 3.2% while the S&P 500 averaged 8.2%. Fixed income fund investors had average annual returns of 1.0% compared with the Barclays Aggregate Bond Index, which averaged 7.0%.
“Are individual investors and advisors really that bad at timing the markets?” Ferri asks. The data suggests they are. He includes a useful chapter, “Changing Investor Behavior,” which talks about behavioral finance and answers arguments against passive investing. He also discusses how to set up a passive portfolio and explain it to clients.
“Why do more advisors recommend active strategies over passive, even though they are supposed to be acting in a fiduciary capacity?” Ferri asks. His answer: because they don’t believe clients would hire them otherwise. “Many advisors falsely believe that competing on returns is the only way they’ll attract new clients,” he says.
Some of them reason that clients won’t need them if all they do is buy index funds and that their fees are not justified if they follow such a simple strategy. They fear clients will expect them to “do something” in a bear market and that they will lose business to others who invest actively and outperform them. All untrue, Ferri says. I say that for the best advisors, managing an investment portfolio is the least valuable thing they bring to the table. But advisors need to have their own response to these questions.
I enjoyed these books because both were professional and each made a good case for its strategy. Both of them might be rewarding to advisors who wish to learn more about this subject and better educate clients.
You can find the original article here.
