How Much Are You Willing To Lose?

If you’ve been obsessing over the issue of whether stocks are overvalued or not, Jason Zweig says you’re asking the wrong question.

In a recent piece for The Wall Street Journal, Zweig says the real question is “how much can I stand to lose before I bail out”? Why? “Because even if your assessment of market valuations is perfectly accurate, that won’t do you any good if you lack the financial or psychological fortitude to follow through.” Zweig says to use past losses for stocks or any other asset as a gauge for what future losses could be. For example, he says U.S. stocks fell 51% from late 2007 through the end of the bear market so investors should consider that such a decline could hit again before investing.

“None of this means you shouldn’t own stocks — or any other asset,” Zweig says. “It just means your have to think more honestly about what you are getting yourself in for.” By doing so, you can help avoid the fate of so many investors who bail after declines hit, locking in what should have been only temporary losses.

Paying To Have Your Adviser Shoot You In The Foot

In a recent Intelligent Investor column for The Wall Street Journal, Jason Zweig provides some interesting data on how investors — and their advisors — often underperform the funds in which they invest.

In the 12 months ending Sept. 30, Zweig says that investors in 47 funds with at least $1 billion in assets underperformed the funds by at least 3 percentage points, according to Morningstar. Over the past five years, the average gap between fund returns and the actual returns of investors in those funds has averaged 1.17%. Similar performance gaps have been found by researchers looking at stock fund and hedge fund investors, and even exchange-traded fund investors will lag their funds, Zweig says.

One big reason for these gaps is that investors chase hot funds and dump cold ones at the wrong times. What’s particularly interesting is that some research shows that professional advisers are guiltier of such behavior than individuals. One study found that from 1991-2004, investors underperformed their U.S. stock funds by an average of 1.6 percentage points. For load funds sold by brokers, the gap was 1.9%, Zweig says; for no-load funds bought directly by investors, it was 1.0%. That led one of the study’s authors, Geoff Friesen, to  tell Zweig that instead of shooting themselves in the foot, many investors “are paying someone else to do it for them.”

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Zweig: Tie Yourself to the Mast — Or Don’t Buy Stocks

With stocks at all-time highs, is it time to bail? Not if you want to make money over the long haul, says Jason Zweig.

On the Wall Street Journal’s Total Return blog, Zweig responds to a reader who contended that continuing with a buy-and-hold strategy “when you see a train [that is, a market downturn] coming at you” is foolish. “If only it were that simple,” writes Zweig. “Does history show that there are indisputable and unambiguous signs that consistently forewarn that the stock market is about to crash? There’s no such thing. Which market forecasters have reliably, repeatedly seen — and publicly warned about — the train coming down the track? None. Who discloses the complete track record of all market predictions, right and wrong, so we can evaluate the overall accuracy of prediction? No one.”

Zweig notes how few investors saw big downturns coming over the past decade or so — and that those big downturns were often preludes to huge gains. He says that his point isn’t that “all investors should tie themselves to the mast” — that is, put in place measures designed to force themselves to stay disciplined during tough times (a reference to Ulysses, who asked to be tied to a mast so he wouldn’t succumb to the song of the sirens). “It was that if you can’t tie yourself to the mast, you probably shouldn’t buy stocks at all — because your willpower alone will not be enough to enable you to stay the course. And the ultimate benefits of owning stocks accrue only to those who can buy and hold. Investors who either can’t afford to take the risks of short-term losses or can’t stand the psychological trauma don’t belong in stocks — and should feel no shame about staying on the sidelines.”

Zweig also offers some interesting data on just how much stocks returned over the past two turbulent decades — it’s more than you might think. “Along the way,” he says, “investors lost roughly half their money twice, in 2000-02 and in 2008-09. That’s what stocks do.”

What’s Your Advantage?

If you don’t want to put all your faith in luck, you need to have an advantage to beat the market over the long haul. But The Motley Fool’s Morgan Housel says that many investors don’t really think about what their advantage is — or whether they even have one.

Housel notes that, late in his life, value guru Benjamin Graham actually talked about how he thought stock-picking wasn’t for most investors. So many investors had adopted the in-depth, analytical techniques Graham pioneered that it had become tougher to make money with them. Housel thus asked The Wall Street Journal’s Jason Zweig, who wrote the commentary and footnotes in the latest updated version of Graham’s classic The Intelligent Investor, if he thought that meant Graham would have simply had all his money in index funds today. “No, I don’t think so,” Zweig said. “He would advise knowing your advantages and your disadvantages, and not playing a game you have no advantages in.”

That led Housel to think about what his own advantages might be when it comes to stock picking. He offers a couple that pertain to individual investors, including “time”. “I’m patient to the point of obsessive when it comes to delayed gratification,” he says. “I bought stocks all the way down in 2008 and 2009, dreaming about what they’d be worth in 2038 and 2039. That’s a big advantage over Wall Street, whose definition of ‘long term’ is the time between Lightning Round segments on CNBC. If Wall Street is thinking about the next ten months, and you’re thinking about the next ten years, case closed — that’s your advantage.”

Two other advantages individual investors can have, Housel says: the ability to think about stocks as businesses, not stocks, and a steadfast belief in reversion to the mean. “It’s simple stuff, but it’s one of the most powerful forces in finance because, by definition, only a small portion of investors can be contrarians,” he says of mean reversion. “It’s much easier to say ‘I’ll be greedy when others are fearful’ than to actually do it. But those who can truly train themselves to be skeptical of outperformance and attracted to underperformance will likely do better than most. They have an advantage.”