Investment Home Runs and Singles

Consider the following four investment scenarios:

1. You invest $1,000 in a company early in your life (age 25) and hold it until retirement (age 65) and this company gives you 16% annually for the 40-year period; your initial $1,000 will be worth $326,000 at retirement.
2. You invest $2,000 in two companies ($1,000 in each company) and hold it for 40-years and these two companies give you 14% annually for the 40-year period; your initial $2,000 will be worth $331,000 at retirement
3. You invest $4,000 in four companies ($1,000 in each company) and hold it for 40-years and these four companies give you 12% annually for the 40-year period; your $4,000 will be worth $332,324 at retirement.
4. You invest $8,000 in eight companies ($1,000 in each company) and hold it for 4-years and these eight companies give you 10% annually for the 40-year period; your $8,000 will be worth $329,158 at retirement.

We can approximate from the calculations above:

• $1,000 growing at 16% for 40-years = $8,000 growing at 10% for 40-years
• $1,000 growing at 16% for 40-years = $4,000 growing at 12% for 40-years
• $1,000 growing at 16% for 40-years = $2,000 growing at 14% for 40-years

In baseball analogy, the 10% returning investment is a single; the 12% returning investment is a double; the 14% returning investment is triple and 16% returning investment is an old-school non-juiced natural-power home run.

Consider investor X; X is a risk taker. This person always tries to find the next big thing. LetÂ’s suppose this person starts with $8,000 at age 25 and buys into 8 companies with home-run/strikeout type of potential. If 7 of his companies strike-out and go bankrupt, but if only one survives and gets 16% return for 40-years; this investor will have same amount of money as investor Y who invests $8,000 for 10% return. The investor X survives in the investment world even if the investment success rate is only 12.5% for investor X.

Now, the question is:
Since $1,000 invested at 16% gives you the same terminal value as $8,000 invested at 10% in 40-years, should an investor always try to look for the home runs? Should an investor only try to find the next Microsoft, Dell, Cisco, Coca-Cola, Home-Depot, Wal-mart type of stocks and latch on for the 16% ride? Or should an investor invest more money and hit singles with many stocks? Should an investor go for 3-4 yard conservative rushes or go for 50-60 yard bombs and risk interceptions? Should an investor go close to the basket to get a high-percentage two points or pull up at mid court every time for a low-percentage three points?

Your comments are always welcome.

Secular Bear Market?

Are we in a secular bear market? The answer is yes, theoretically speaking. The indexes have not got back to the peaks or gone beyond the peaks achieved in the year 2000.

Is this a wise way to look at your investments returns? Is your portfolio in secular bear market since 2000? Maybe, the answer is no.

How?

I want you to look at the returns of the broad market index from 1990 to 2006. If you had invested $1,000 in the stock market every year from 1990 to 2006, what would your portfolio look like today? I used the MSN Moneycentral’s chart tool to calculate the returns of the Vanguard 500 Index Fund (VFINX) from 1990 to 2006. The Vanguard 500 Index Fund tracks the performance of the S&P 500 index.

• $1,000 invested on 1/1/1990 is valued at $4798 today
• $1,000 invested on 1/1/1991 is valued at $5088 today
• $1,000 invested on 1/1/1992 is valued at $3781 today
• $1,000 invested on 1/1/1993 is valued at $3584 today
• $1,000 invested on 1/1/1994 is valued at $3252 today
• $1,000 invested on 1/1/1995 is valued at $3226 today
• $1,000 invested on 1/1/1996 is valued at $2322 today
• $1,000 invested on 1/1/1997 is valued at $1865 today
• $1,000 invested on 1/1/1998 is valued at $1414 today
• $1,000 invested on 1/1/1999 is valued at $1104 today
• $1,000 invested on 1/1/2000 is valued at $912 today
• $1,000 invested on 1/1/2001 is valued at $1019 today
• $1,000 invested on 1/1/2002 is valued at $1116 today
• $1,000 invested on 1/1/2003 is valued at $1417 today
• $1,000 invested on 1/1/2004 is valued at $1161 today
• $1,000 invested on 1/1/2005 is valued at $1064 today
• $1,000 invested on 1/1/2006 is valued at $1034 today

As you can see from the returns above, almost all of the money invested is not in a bear market. Only the $1,000 invested in the year 2000 is losing money today. We can say that the money invested in year 2000 is in a secular bear market. Every other dollar invested before and after year 2000 has made money in the hypothetical portfolio.

So, whenever you read or hear about “secular bear market”, take it with a grain of salt. It may not mean much to you.

All disclaimers apply.

Balanced/Hybrid Fund Performance

I like balanced/hybrid funds.

The main reason I like balanced funds is that the balanced funds let investors allocate assets more efficiently among underlying asset classes. I believe this efficient asset allocation generates positive excess returns for investors. To understand the effects of this balanced/hybrid strategy I am going to throw some numbers at you below. I know there are a lot of numbers and the Math is tedious, but stay with me.

As always, when looking at the performance numbers, I will use Vanguard Index fund returns for comparison. We are going to look at the returns of 3 funds.

(1) The Vanguard Total Stock Market Index (VTSMX)
(2) The Vanguard Total Bond Market Index (VBMFX)
(3) The Vanguard Balanced Index (VBINX)

The Vanguard balanced index employs a 60/40 strategy. 60% of the balanced index basically mirrors total stock market index and the remaining 40% mirrors total bond market index.

Now lets look at the returns of these 3 funds for the past 10 years.

The Vanguard total stock market index returned 9.06% annually for the 10-year time period ending 3/31/2006. This turned the original $10,000 invested 10 years ago into $23,802.83 on the 3/31/2006.

The Vanguard total bond market index returned 6.02% annually for the 10-year time period ending 3/31/2006. This turned the original $10,000 invested 10 years ago into $17,937.01 on the 3/31/2006.

The Vanguard balanced index fund returned 8.24% annually for the 10-year time period ending 3/31/2006. This turned the original $10,000 invested 10 years ago into $22,073.00 on the 3/31/2006.

Now, here comes the interesting part. Let’s consider a situation where someone chose not to invest $10,000 into the Vanguard balanced index fund, but instead invested $6,000 and $4,000 separately into the Vanguard total stock market index fund and the Vanguard total bond market index fund respectively. How much money these separate investments would be worth after the same 10-year holding period? The $6,000 invested in the stocks would be worth $14,281.70 and the $4,000 invested in the bonds would be worth $7,174.80. The total of these two investment would be worth $14,281.70 + $7,174.80 = $21,456.50.

These calculations show that the balanced fund returned about $616 more. The initial investment was same in both situations: $6,000 in the total stock market index and $4,000 into the total bond market index. But the balanced fund investment came out ahead in the race.

As we can see from the calculations above, the balanced fund generated excess returns for the investor. With the balanced fund investment, the whole is greater than the sum of its parts. Why this happened? I believe that the balanced/hybrid mechanism generated some extra dollars for the investor. When the stock market went down, the balanced fund was forced to buy stocks by either selling the bonds and/or by directing the new money coming into the fund towards the stocks. When the stock market went up, the balanced strategy forced the mutual fund manager to either sell the stocks and/or direct the new money towards bonds to keep the fund in the intended target allocation.

Buy low and sell high. This is very easy said than done. The balanced funds achieve ‘buy low and sell high’ by the way they are formed. The balanced funds with fixed target allocation takes the human emotions out of the investment process, and that is exactly what most of the investors need to succeed in the in the market.