In a recent post , I described a market timing experiment where a market timer decides each month whether to own the S&P 500 or to hold all cash. The result was that the market timer had to guess right 60% of the time from December 1990 to March 2008 to keep pace with an investor who simply bought and held through the whole time period. That experiment assumed that the investor was using a tax-sheltered account, as the Canadian Capitalist observed in his comment on that post. What happens if you have to pay taxes on the interest, dividends, and capital gains? I ran the experiment again, this time taking into account taxes. To give the market timer as much help as possible, I assumed that the buy-and-hold investor sells everything at the end of the complete time period and pays capital gains taxes. Tax rates vary from one jurisdiction to the next. For this experiment, I assumed a tax rate of 40% on interest income and 20% on dividends and capital gains. I assume that the marke...

Government intervention into the U.S. housing crisis has become an issue in the ongoing presidential race. McCain, Clinton, and Obama have each made statements about how the crisis should be handled. I find that my opinion on this matter shifts depending on who I focus on. Let me go through some hypothetical players so that I can show you what I mean. Case 1: Irresponsible Homeowner Carl saw his friends making money from rising house prices and decided to buy a condo to get in on the action. He chose a condo selling for $280,000, but he couldn’t really afford it on his modest income. In an obviously shady arrangement at the height of mortgage excesses, he managed to get a mortgage for $300,000 with only half-size payments for the first year. Carl knew he couldn’t afford the higher payments after the first year. His plan was to profit from the increased value of his condo in a year by either selling it or renegotiating his mortgage based on the new condo value. Things have...

All available evidence and logic tell us that the vast majority of investors can’t beat the market by market timing. This applies to professional money managers as well. I tried a little experiment to see how accurate a market timer’s predictions would have to be to succeed at beating the market. Market timing refers to the practice of jumping in and out of the stock market in an attempt to avoid market declines. The Experiment Suppose that a market timer decides at the beginning of each month whether to have all of his money in the S&P 500 stocks or all of it in cash. His goal is to avoid being in stocks during the months where stocks perform worse than cash. Each month the market timer has a certain probability of guessing right. If he just tosses a coin, this probability is 50%. The question is how high this probability has to be for the market timer to beat the strategy of just buying and holding through thick and thin. I gathered data on the S&P 500 from December...

People have a lot of tendencies that serve them well in many aspects of their lives, but can be harmful when it comes to investing in stocks. One of these tendencies is to prefer the familiar over the unfamiliar. I saw this during the high-tech bubble when ordinary people with minimal investing experience suddenly had stock options worth more than their houses. For some reason, these people found it difficult to cash out even though the stock options represented 80% or more of their net worth. I used to try a little mental exercise with these people. I would say “imagine that your options have been cashed out and the money is sitting in your bank account. Would you use it all to buy stock in a high-tech company at soaring prices?” The usual answer was something like “No way! That would be a ridiculously risky thing to do.” But, to my knowledge, only one person who tried this mental exercise with me was persuaded to cash out most of his options. Most people continued to hold their...

Bloomberg reports that mutual funds are selling stocks and hoarding cash. Of course, this would have been a better strategy when stocks were at a peak, rather than after they have dropped. This is definitely not a case of better late than never. When it comes to selling stocks in anticipation of dropping prices, I take the approach of better never than late. I just stay invested in stocks through the ups and downs because I don’t believe that I can predict the future direction of the market. It always seems easy to look back and think that what happened was inevitable, but it’s never so easy when you look forward. Mutual funds have a history of selling stocks at market lows and buying in at market highs. We can see this by tracking their cash levels. At market lows mutual funds tend to have high cash levels, and at market highs they tend to have low cash levels according to Larry Swedroe in his book “Rational Investing in Irrational Times.” So, it seems that the professional mone...

When we save for retirement, we tend to focus on that magical day when we will stop working. However, you won’t need to withdraw your entire retirement savings all at once on that day. For the most part, you’ll just need a certain amount per month plus the odd larger amount for things like a car, boat, or skydiving gear. Your retirement could easily last for more than 20 years. So, you’ll have to continue making decisions about how to invest your savings after you’ve retired. Most people (including me) believe that it makes sense to invest more conservatively as you get older. This usually means increasing the amount of money you invest in bonds and cash rather than stocks. In his book “Rational Investing in Irrational Times”, Larry Swedroe offers the following guidelines for percentage of money in stocks vs. how long it will be until you need the money: 0-3 years: 0% 4 years: 10% 5 years: 20% 6 years: 30% 7 years: 40% 8 years: 50% 9 years: 60% 10 years: 70% 11-14 years: ...

Insider trading is buying or selling a company’s stock when you have important inside information about the company that has not been made public. We tend to think of insider trading as being illegal, but that is an oversimplification. The top executives of a company almost always have inside information. If insider trading were illegal, then these executives could never trade their own stock. In the U.S., insiders are allowed to create prearranged trading plans, called 10b5-1 plans, for trading stock. The idea is that the executives can set out a plan to commit to trading stock at particular prices or at particular times. This way, the stock trades will happen automatically when the time comes, and the executive is protected from accusations of insider trading. Insiders beat the average But the insiders still seem to outperform other traders significantly. Business Week reported that “Alan D. Jagolinzer, an assistant professor at Stanford University Graduate School of Business...