Investment Articles and Commentary

VANGUARDS SEVEN COMMON MISTAKES IN FUND SELECTION: 1998 (My comments follow)

1. Overemphasizing performance, especially short term. Amazing how many people focus on a fund's return for the last week or month. Primarily fostered by Money Magazine, etc.

2. Misjudging a fund's investment risks. This amazes me even more. People have little, if any, idea of how to identify and quantify risk.

3. Ignoring the impact or fund costs on risks. Everything else being equal, one fund will beat another similar one due solely to the lower costs. Active managed funds have higher costs so you better be sure they produce.

4. Failing to match investment goals with a fund's objective. If I am using a managed fund, I check a fund thoroughly before investing. (The issue with index is normally moot.) Occasionally, it has been interesting to note how fund objectives change over time. But I won't sell just because the fund has changed since I am looking to the manager to increase returns. But if the returns fall short as well, I'm outta there.

5. Misinterpreting investment results. (Were dividends included, what time frame, etc.)

6. Lacking patience to evaluate a fund investment properly. It's called research, research, research. If you can't do that, you are one bad investor.

7. Following blindly the recommendations of friends and publications. This is a real problem for investors and "referrals". Anyone getting a referral thinks everyone else has done a lot of homework where in fact no one really has. And many of these people writing articles wouldn't know standard deviation and Bill Sharpe if it bit them. And if you don't know either, you have no business investing by yourself. Your fundamentals are totally flawed.

INVESTMENT NEWSLETTERS: 1998 Tons of newsletters spout their inherent capability in providing insight to the best investments. Any good in total? Well a researcher did a study and this is the synopsis of his work

"This paper analyzes the equity-portfolio recommendations made by investment newsletters. The dataset spans 16 years, is free of survivorship and back-fill biases, and includes the recommendations of 145 different newsletters. Overall, there is no significant evidence of superior stock-picking ability for this universe of newsletters. Some individual letters do have superior performance records, but this does not occur more often than would be expected by chance, and these records are never more extreme than would be expected for the sample size. In addition, while there is some short-term performance persistence, a strategy of buying past winners does not earn statistically significant excess returns."

CHANCE OF LOSS: (1998) If we look at the S&P 500 from 1926 up to 1993, there was about a 30% chance that in any one year, you would lose money. If you do the formula for standard deviation over a period of five years, the chance of loss drops to 11%; over ten years the loss drops to 3% and over 15 years the loss goes down to 0. Those are statistics however and do not necessarily refer reflect the real-life scenario that can really hurt. Take 1973 and 1974 for example. During those two years, the stock market lost over 40 %. My point? Statistically the markets risk does drop the longer you happen to be in the market; but if it does drop at the worst time for you, statistics will offer little consolation. If you do a continual review of economics, I think you can stay well within the range of statistics and also limit you loss to anyone year period to perhaps no greater than 10%.

STOCK MARKET VOLATILITY: (Federal Reserve Bank of New York) Their article indicates that although volatility increased in 1996, the rise simply reflected a return to post World War II norms from the unusually low volatility experienced between 1992 to 1995. In fact, the daily volatility of the Dow from 1992 to 1995 was at its lowest level in decades. They note that a doubling of the Dow's level causes a 5 fold increase in the number of days in which the index closes up or down 50 points. The Dow Jones industrial average increased more than 60 % between 1992 in 1995 alone. Therefore they indicate that the daily swings in the Dow by 50 points, until recently an aberration, will continue to occur regularly.

INVESTMENT BEHAVIOR: 1998 (Frank Armstrong). While there are exceptions, "economists are constantly amazed at the ability of individual investors to obtain such poor investment results. In an efficient market, individuals should not be able to do as poorly as they do. An entire branch of economics has devoted itself to trying to explain Investor behavior, and how to explain their results in the markets."

INVESTOR OVERCONFIDENCE: 1998 (Simon Gervais & Terrance Odean) You have read my previous comments about the inability of individual investors to really understand what they are doing. Basically, if they do not know what the fundamentals of investing are- alpha, beta, correlation, diversification, Sharpe ratio etc., then you are primarily kidding themselves about their inherent capabilities. Secondly is my (slightly) irreverent definition about the male ego and is effect on investing:

MALE EGO: A genetic mutation that flourished. Responsible for more bad investments and bad investment decisions than any tax law changes by Congress. Though usually noted in the male species, females are also prone to its insidious faults- lack of reading and adequate research followed by defective decision making based on insufferable narcissism and the rationalization it was someone else's fault when the investment tanks. Used a lot by stupid people or intelligent people acting stupid. Caution advised when using this as the main rationale for investing.

Gervais and Odean did a survey in 1997 of many investors. While their comments are in more fluid terms than mine, you'll see they simply match my comments of many past years.

They referred to the fact that a novice investor does not know why he/she is successful until enough time passes so that they can gauge how they are doing by the increases or decrease of their portfolio. They noted that they take too much credit for their successes and take less responsibility for the losses. Therefore the overconfident man (usually a man so I will dismiss the "she" in further commentary) tends to become more risky in the investment orientation than his ability sustains. "An overconfident trader trades too aggressively, thereby increasing trading volume and market volatility." "Overconfidence does not make traders wealthier, but the process of becoming wealthy can make traders overconfident."

The problem that I see is that such overconfidence in this type of market is invariably due to luck- not skill- or at least limited skill. And should they take such overconfidence into retirement and the market changes, they can then put their families into an untenable financial situation when the risky investments possibly fail- or at least exhibit too much volatility for retirement use.

In terms of losses- Tversky and Kahneman noted in as early as 1979 that "contrary to expected utility theory, people placed different weights on gains and losses and on different ranges of probability. They found that individuals are much more distressed by prospective losses than they are happy by equivalent gains." They noted that some economists think people are twice as likely to feel the pain of a loss than the joy of a gain. context of losses or gains. And from their 1979 article they "found that people are willing to take more risks to avoid losses than to realize gains. Faced with sure gain, most investors are risk-averse, but faced with sure loss, investors become risk-takers."

Additionally- and noted here previously- people have a tremendous aversion to selling a stock or fund that is doing terrible- even when presented with all the fact indicating the lowered ranking by independent services. Professor Statman is an expert in the behavior known as the "fear of regret." "People tend to feel sorrow and grief after having made an error in judgement. Investors deciding whether to sell a security are typically emotionally affected by whether the security was bought for more or less than the current price. One theory is that investors avoid selling stocks that have gone down in order to avoid the pain and regret of having made a bad investment. The embarrassment of having to report the loss to the IRS, accountants, and others may also contribute to the tendency not to sell losing investments." I have often found another issue- emotional or sentimental familiarity. Some "investors" may have been given stock by a family relative, a deceased member of the family, through a divorce, etc. The emotional attachment may preclude them from selling since the benefactor- though possibly deceased- would think less of them.. Same scenario where so many employees are using employer stocks- primarily in 401(k) plans. The attachment to their work precludes selling a stock that may well be fundamentally flawed but where they are actively involved with the company that they "cannot possibly consider" a sale. As proof, consider Digital. Once a solid company with value escalating from the mid 30's to $200 per share, it plummeted to as low as $16 a share before recovering only slightly. But I know of some that did not even remotely diversify when presented with independent Value Line ratings of D.

Statman also acknowledged the "conventional wisdom to avoid the possibility of feeling regret in the event that their decisions prove to be incorrect. Many investors find it easier to buy a popular stock and rationalize it going down since everyone else owned it and thought so highly of it." (That's the standard "herd mentality" that many articles comment about.)

As regards my MALE EGO, the professors noted that "People are overconfident in their own abilities, and investors and analysts are particularly overconfident in areas where they have some knowledge. However, increasing levels of confidence frequently show no correlation with greater success. For instance, studies show that

MEN CONSISTENTLY OVERESTIMATE THEIR OWN ABILITIES IN MANY AREAS INCLUDING ATHLETIC SKILLS, ABILITIES AS A LEADER, AND ABILITY TO GET ALONG WITH OTHERS.

Money managers, advisors, and investors are consistently overconfident in their ability to outperform the market, however, most fail to do so. (That's why the use of index funds is, to some degree- valid investing asset allocation.) "In summary, people trade for both cognitive and emotional reasons. They trade because they think they have information when they have nothing but noise, and they trade because trading can bring the joy of pride. Trading brings pride when decisions turn out well, but it brings regret when decisions do not turn out well. Investors try to avoid the pain of regret by avoiding the realization of losses, employing investment advisors as scapegoats, and avoiding stocks of companies with low reputations."

The different "spin" I put on the commentary is the reference to the use of the term "investors". These people are NOT investors- they are novices with limited background and skills and with a lot of emotional baggage they bring to the "game". For all intents and purposes, there is no emotion to investing. It is simply research of numbers and estimates of company and worldwide economics. If you play it any other way, you still might reach high financial goals. But it was undoubtedly due to luck and extra risk- not skill. Will you be lucky?????

FUND REPORTS: (1998) Literally every magazine and WEB site (But not mine) let's you instantaneously see how your mutual fund is doing. But the ludicrousness of trying to buy the best fund has reached a level of absurdity (actually, it happened many years ago with literally all the financial magazines offering their best list on which fund will do the best for the next year, quarter, 5 seconds.) And in the most recent issue of WORTH (these people are really out to lunch- they are still suggesting the use of illegal planners) they have their 1998 mutual funds report and how they did and what they plan on doing about it. "1998 MUTUAL FUND REPORT: BEAT THE S&P: Ninety-five percent of professional money managers were humbled by the Standard & Poor's 500 Stock Index last year. We think we can help you do better. Included in this special report: the Worth mutual-fund portfolio and performance forecasts for 850 funds."

WORTH says its funds also didn't make the grade. In fact, if you view their chart of their 15 top fund picks during the last three years, only two were repeats from the year before. So why would you use what Worth recommends? I dunno.

Worth also commented that they were focusing on value stock since that has historically done better than pure growth. Well that is the same commentary one could use for small cap stocks- but they have NOT done well for about a decade.

So what about using the "best" recommendations from the likes of Schwab. Any better? Well, Money magazine noted this in their May study of Schwab fund recommendations: Number of stock funds that have made every Schwab list since 1993. ZERO. That's right, 0, nada, zilch, none. And it distributes its recommendations of funds each quarter to about 500,000 investors.

Money reviewed the 35 domestic equity fund list of the first quarter of 1995 but found that 20 had dropped to the bottom half of their peer group over the subsequent 3 years. Only 4 remained in the top quarter of their categories. And not one fund is in their most recent list. One problem is that they supposedly pick the hottest funds going.

Peter Bernstein, recently interviewed in a Business Week article, noted it is tougher for managed portfolio managers to beat the market due to two reasons. The first is that the market has become more efficient due to a manager's greater capability (due to technology, I submit) in market behavior, risk/reward trade offs, quantitative analysis, etc. And the second reason is that managers have also become more conservative. If you want to beat the market, you almost universally have to take on more risk. If you are successful, the market will reward you handsomely. But if you make just one mistake, it's normally bye, bye. Look a Jeff Vinik with Fidelity Magellan.

During the period of 1960- 1981, the average annual return of equity mutual funds relative to the S&P 500 was 17.5% for the top 20% of funds. In the period of 1982- 1987, it dropped to 8.5%- and I bet they weren't the same funds at all. The bottom mangers just stayed lousy. Between 1960 and 1981, the worst 20% were about 10% lower. But most recently, they were about 14% lower. Bernstein states that the "moral of the story is that the manager selection may be the greatest investment risk of all".

Also, Bill Sharpe- the Nobel winner in economics- is a staunch supporter of index funds and a recent Asset Management article with him confirmed many of the corresponding statistics as to why managers do not consistently outperform. I also wanted to show some of Sharpe's recent commentary regarding risk and some poignant commentary he had about individual competency.

"Investment decisions are moving to individuals who are ill prepared to make them. These are complicated issues. To say, here are 8,000 funds, or even here are 10, do what's right, is not very helpful. The software versions and some of the human versions of the advice that people are getting often seem to ignore risk. They're bookkeeping schemes in which you earn 9% every year like clockwork. You die right on schedule. There's no uncertainty at all. Making a decision as to stocks vs. bonds. vs. cash and about how much to save, without even acknowledging uncertainty- let alone trying to estimate it- seems to me the height of folly."

Obviously I buy Worth, Smart Money and many others. They DO have good material in them. The problem is, they also have just plain garbage because the 1. their "journalists" have little or limited understanding of investments or planning overall and 2. they are out to sell magazines and 3. many of their readers don't have a clue what to do and don't want to find out by doing any serious research.

TOTALLY UNREALISTIC RETURNS: (1998) A Paine Weber survey indicated that inexperienced "investors" are expecting outlandish returns much higher than long term investors. Over the next 12 months they expect returns at 15.2%. Those that are the least experienced expect even higher returns of 18.1% and are the least likely to see the market as overvalued.

Actually, let's see how well history repeats itself. Take a look at the S&P's great returns from years past and see how well it did in the subsequent future. Four times since 1926 large-company stocks have generated inflation-adjusted returns of more than 14.5 percent for periods of 10 calendar years. However that unusual level of return never lasted even five more years.

So, will this time be different? No one knows but, in my opinion, anyone that thinks we are going to continue to receive relatively stable and consistent 14.5% returns for the next 5 or 10 years is a quart low.

MUTUAL FUNDS: (1998) Fund commandments (Individual Investor). They suggest 10 issues to review when considering a mutual fund.

1. If a fund has experienced rapid growth, consider looking for another with seminar strategies but fewer assets. History had shown that when many funds get to big, they get to unwieldy and the yields suffer.

2. In conjunction with above, John Bogle noted that giant funds have little freedom to go beyond a limited number of well-known stocks. They therefore suggest that one never by an actively manage bond with more than 10 billion in assets. The article noted that the 30 biggest funds each have more than eight billion in assets, and not one beat the S&P 500 in 1997.

3. Stick with companies that have recorded low management turnover in the past. While you cannot be sure that a new manager might not do better, disruption of management generally mean problems overall.

4. Stay with funds whose focus remains the same. The point being that when some funds became larger, the portfolio shifted focus- say Small to Midcap- and yields suffered.

S&P 500 or LESS: (1999) In 1998, the S&P 500 returned 27%- the fourth consecutive year over 20%. Its 5 year return was 194%, the best since 1926. However, 10 stocks accounted for almost half the performance at 43%. The average stock in the index was up 11%. The median price changes (half did better, half did worse) was 3.5%. The 50 largest companies representing 55% of the index's weighting had an average gain of 47% whereas the remaining 450 stocks had an unweighted gain of just 7%. The Russell 2000 index lost 2% in 1998. On the NYSE, 945 stocks were up while 1,429 were down. In the over the counter market, 1,261 were up and 2,360 were down. In percentage terms, 63% of the stocks were down for the year.

Or from a slightly different analysis- stocks with more than $20 billion capitalization rose by 25.9%; those between $5 billion to $20 billion rose by 6.2%. The average growth in other cap groups actually declined in price and those with under $250 million in capitalization declined the most at a negative 24%. Same thing is happening now

STOCKS: (1999) According to Ibbotson Associates, stocks have returned 11.2% a year, on average, since 1926. In about 1983, the annualized return was 9.4%. A NY Times article analyzed the next 10 years of returns from two different scenarios- that returns would average 18% annually; earnings would grow 6% a year (on the high side of performance during the recent past), and that inflation would stay low, at 2%. For the worst case he plugged a price-to-earnings ratio of 17.6 for the S&P 500 into his equations, the average during periods of low inflation. He also assumed a much lower, but not outlandish, earnings growth rate of 2% a year.

The conclusion? If stocks returned what they have for the past decade, the S&P would be trading at 48 times earnings in 2009, or 50% higher than the 32 times earnings for the index today. But if the p/e ratio reverted to normal levels in a low-inflation economy, stocks would return just 1.9% each year.

"No sensible person can honestly say they expect the S&P to sell at 48 times earnings," said Peter J. Tanous, the president of Lynx Investment Advisory Inc. in Washington. "If they do, there's only one word for them -- and the word is delusional."

If you are attempting to do your retirement planning based on the higher returns, I bet you can plan for a short retirement.

MARKET NEUTRAL TRADING STRATEGIES: (1999) (Individual Investor): This is an attempt to go both long and short and the same time and making a little cash at the same time and has been touted as diversification at its best- or extreme. What the analysts does is buy stocks that he thinks will go up and goes short (sells) stocks he thinks will fall. With the money form the "sale", he invests in Treasury bills and picks up some extra cash. So should you take a plunge in this "can't lose" strategy.? Well, does Long Term Capital strike a cord? Every time I have heard of the new thing on the block that will beat everything else (CMO's for example, Option Income Funds), I decide to wait awhile- maybe a year or two to see what happens. Next, the costs may exceed 2% annually- and the Vanguard S&P is under .25%. They definitely need more money to analyze both longs and shorts but you better make a piece of change to support the extra fees. And they tend to trade a lot due to the different exposures. Well, there goes your tax benefits.

But the bottom line is- do they work? The Barr Rosenberg fund was down 0.7% in mid December. The Euclid Market Neutral fund was down 4.5% in the first six months of operation.

They have been touted by Bill Sharpe, President of the IBCFP and others as the "investment du jour". Use at your own risk. I'll pass.

STOCK GROWTH: (1999) (Mutual Funds) $1.00 invested in a diversified growth fund in 1871 would have grown to $33,770- a 8.6% annual return. $1.00 in Treasury bills would have grown to $9.88- 1.8% annual return. $1.00 invested in gold would have FALLEN to $.57 adjusted for inflation and storage costs. All include dividends and interest and adjustment for the 1,214% increase in consumer prices- but not taxes.

NEW FUNDS: (1999) I offer these as statistics only- I do NOT buy new funds just looking for a fast winner with the intent of selling shortly thereafter. Basic investment parameters should always be addressed. But there are times when you need to be aware of inconsistencies/anomalies in the market that defy the efficient market theory and diversification. Anyway, Kobren Insight Group did a study of new funds a their immediate performance versus the rest of the market. They found that new funds outproduced existing funds by about 66%. In the first year, 66.4% of large cap value stocks beat the older competitors by about 2%; 71.6% of mid cap growth beat old funds by about 2.9% and 71.7% of small cap beat old funds by a significant margin of 9.2%. Almost without question the increase is due to the far smaller base of stocks new funds work with and the fact that the managers may have picked a couple stocks well that show faster and higher returns than old funds that have greater diversification. And almost universally, the difference starts to dissipate within a year thereafter.

STOCK OPTIONS: (NY Times 1999) An interesting study by Wyatt Worldwide showed that companies that offered the greatest number of stock options actually underperformed companies that did not offer as many. They tracked 940 companies and divided them into three categories based on potential dilution to their shares if the options already granted as well as those available for future grants were exercised. The dilution, expressed as a percentage of the shares outstanding was as high as 18.7% for the top third of companies and returned a median of 13.5% for shareholders in 1997.

The middle third who would be diluted by just 10.6% if all the options were exercised returned 16.9%. The study requires more time but may be worth noting.

STOCK OPTIONS: Are you a heavy hitting executive that gets company stock options? Some employees have gifted the options to children /other beneficiaries and got the asset out of their estate for a very limited gift tax. But the IRS is saying that the options, when tied to continued employment, are not valued till the exercise date potentially several years later. The value may be substantially different than the original value 3 to 5 years later and the executives/taxpayers may be required to cough up some major taxes. Be forewarned

DELISTING: (1999) This is why the returns on small cap stocks are not necessarily valid. The companies may simply not be there to be counted. How's that?? In October 1998, 564 companies had already been delisted from the Nasdaq market that year because their price drooped under $1.00 per share. In an attempt to boost the quality of its issuers, stocks that fall under $1 for 30 days or more are subject to delisting. At the beginning of 1998, about 226 Nasdaq stocks, or 4.1% of the 5,500 on the market, were under $1.Now about 600 Nasdaq stocks, or 10% of the total market, trade under $1. "That's more than the annual totals in many years and is on track to eventually eclipse last year's total of 717 deletions and the record of 719 in 1988."

ANALYSTS: (NY Times 1999) "A 1999 study says there are 2,427 analysts following the market, up 32% from 1997. So what is it that they really do? Since 1997, time spent on fundamental research has fallen from 47.58% to 39.89%. Next year, analysts expect to devote less time yet -- less than 37% -- to research.

Time spent on company visits and contact has also dropped, from 17.21 percent to 15.21 percent. But time spent selling to institutional clients has risen to 23.22 percent from 22.11 percent. What analysts are selling increasingly today is not the ability to plumb a company's business and uncover investment gems or scams but rather the ability to make investors buy the stocks they follow."

ANALYSTS: (NY Times) "A 1999 study says there are 2,427 analysts following the market, up 32% from 1997. So what is it that they really do? Since 1997, time spent on fundamental research has fallen from 47.58% to 39.89%. Next year, analysts expect to devote less time yet -- less than 37% -- to research.

You want to see something truly comical in article? Notice how the percentages are defined to the hundredth decimal place. Absurd. Such "analysis" is flawed.

WANNA BUY A FIVE STAR FUND???: (NY Times 1999) According to a study by by Christopher R. Blake, associate professor of finance at Fordham University's Graduate School of Business, and Matthew Morey, assistant professor of economics at Fordham, Morningstar's five-star funds, as a group, do not beat the market, even if they clearly do better than the average one-star fund. For example, the average fund with a five-star rating on Jan. 1, 1993, underperformed the market by 3.8 percentage points for the five years through Dec. 31, 1997. And while a one star fund is not good, they found that the differences between the performances of the average five- , four- , and three-star funds are so small as to have very little statistical significance.

The Value Line Mutual Fund Survey also bases its ranking on historical risk-adjusted performance, though it looks at performance over different periods than Morningstar does and defines risk differently. Yet, on average, its group of highest-ranked equity funds have performed more than one percentage point a year worse than Morningstar's.

One system that has worked system calls for the purchase each Jan. 1 of the best-performing diversified no-load equity fund of the previous year. According to Sheldon Jacobs, editor of the No-Load Fund Investor in Irvington, N.Y., such an approach would have produced a 20.2 percent return, annualized, since the beginning of 1975, beating the Wilshire 5000 by an average of 3.2 percentage points a year".

I have noted that strategy for years and there are articles that I have written about its capabilities. But a couple things require note. First, it is lacking in almost any tax efficiency unless all the accounts were tax deferred. In that regard, literally no tax sheltered accounts allow every fund that exists- save for perhaps an independent IRA account (and those may be limited in size anyway). Secondly, it is almost only valid for up markets since it is the momentum that keeps it going. Further commentary on how "easy" it is to use comes from a former professor, Mark Carhart, who has studied fund performance year to year back to 1962. "If fund performance were all a matter of luck, one would expect that just 10 percent of all funds in the top performing decile one year would repeat that performance the next year. But Carhart has found that a greater percentage of those top performers manage to do so. Here's the catch: He has also found that the top decile performers in any one year are more likely to end up the next year in the bottom 10 percent." And in usin g the Jacobs strategy, the portfolio was 31% MORE volatile than the broad based market.

The article states what I have said for years, "The problem with the popular rating systems is that they do a poor job of distinguishing between adviser skill and mere luck." andUnless they're willing to just go with the roll of the dice, investors should judge a fund's performance only by comparing it to others that focus on the same kinds of securities and pursue a similar investing style.

If you or your adviser is not reading stuff form the Federal Reserve Boards, your ability to use a rating service for any investing is highly suspect.

MORE VOLATILITY (NY Times 2000) "Only a decade ago, the NASDAQ composite averaged about one big day -- defined as a close at least 1 percent above or below the previous day -- each month. So far this year, it is averaging three such days every week. New ways of trading, brought on by technology and financial engineering, can roil the markets until other traders become used to the effects generated by such trading. That was true of institutional block trading in the 1970s and computerized index arbitrage in the 1980s. And it may be true now of Internet-based day trading, which has made it possible for individual speculators to trade much more rapidly, and with lower trading costs, than ever before." True- but perhaps once the market tumbles somewhat, investors may begin to realize that their trading actually produced loses as compared to a buy and hold scenario and hold back on excessive trading. (Actually, who am I kidding. Such investors don't read research papers anyway. Further, they universally think they are smarter than literally any analyst and can therefore make higher returns than almost anyone.)

The article noted that energy had been bid up to astronomical highs in the 80's- primarily on the precept that oil was a "limited" commodity that would have to increase in price. (Do you realize there is now more oil available for capture than at any time in history? May seem incongruous but it is the ability of new technologies in getting to large amounts of oil that were previously unobtainable.) Anyway, the article went on to say that "technology stocks may be the oil shares of this era. They now make up a quarter of the S&P 500, far more than their share of gross domestic product or corporate profits. The proportion is even more extreme in the NASDAQ, where the five largest computer-technology companies -- Microsoft, Intel, Cisco, Dell and Sun Microsystems -- together account for a third of the value of the more than 4,000 stocks in the index." True again, but look to Greenspan's comment that technology may have fundamentally changed our entire economics, manufacturing, lifestyle and just about everything else. At least that is how I see it. New technology will increase every single day. Admittedly not all of us will be able to follow all the innovations. But corporations will make such effort and continue to provide productivity increases, safety advances and more.

The article noted that "volatility in the NASDAQ market set a record in 1987, with a standard deviation of 1.57 percent, easily exceeding the 1974 peak of 1.12 percent. That was a record that stood until 1998, when the figure hit 1.66 percent. Through October it was 1.79 percent. With the S&P 500, the volatility explosion is not nearly as great. On average, there are about two days a week with a percentage change of at least 1 percent, compared with three for the NASDAQ. But that figure is higher than for any full year since 1974, slightly exceeding the 1987 figure. The standard deviation of daily returns, however, is down to 1.18 percent through October from 1.28 percent in 1998. Those are the two highest figures since 1987, but they are far below that year's figure of 2.02 percent."

What the article did not note was that the early 90's had three years in a row of the least volatility of the stock market's history. Then it was real easy to earn a yield and make it also look like it had no risk. Maybe this is a little payback.

DIVIDENDS- (2000) Used to be that the value of the stock market was, in large part, measured by the dividends being paid by corporations. Historically, if the dividends fell, so did the market. And if you had solely listened to that, you would have missed some huge gains since the early/mid 90's. But a lot of the previous valuation methods were no longer valid. Per the NY Times, "Standard & Poor's Corp. reports that 117 companies announced dividend increases in September, 10 fewer than had raised their payouts a year earlier. It was the 15th consecutive month that the number of dividend increases was down year-over-year. What is unusual is that the economy is doing so well even while companies are growing more reluctant to raise their dividends. This is the seventh such streak of at least 15 months since S&P began counting dividend increases back in 1955. In all but one of the six previous runs, there was a recession in the period. Recessions, of course, usually mean sharp falloffs in corporate profits. So a dearth of dividend increases in such periods should be expected."

Dividends can go so low because investors do not care much about them. It is appreciation/capital gains that have made them rich, and it is the pursuit of capital gains that drives stock investments now.

New Paradigm or Mean Reversion by Jeremy Grantham and Jack Gray (PDF format only 2000) Are we really seeing a change in all the investment fundamentals or will there have to be a reversion to the mean? It either means that the P/E ratio of 30 is now an absolute- or maybe we go back to something more akin to past reality- say 15- 20. We have seen some change most recently with the drop in tech stock but that does not deter many from looking at the rest of the stock market as a long term, almost riskless, piggy bank.

Characteristics, Covariances, and Average Returns: 1929 to 1997, James L. Davis, Eugene F. Fama, and Kenneth R. French. The world's foremost financial economists confirm the existence of premia for both small and value stocks, and make a powerful argument that the excess returns from these factors are due to risk, and not mispricing.

This is not what happened over the last 10 to 15 years since investors paid little attention to P/E ratios with the advent of the Internet and teh associated tech stock. But maybe it is a precursor or coming events and returns. You must understand reversion to the mean if you are a serious investor.

OVERSEAS ACCOUNTS: (2000) The IRS wants to make examples of US Citizens who have escaped paying legitimate taxes by the use of "secret foreign bank accounts." (Rob Lambert, Asset Protection Corporation) "Recently the 29-member Organization for Economic Cooperation and Development (OECD) published a list of 35 Countries which it said were guilty of practicing harmful tax practices. They were given a year to decide whether to "eliminate harmful features of their regimes" or face "defensive measures" to be defined over the coming year. The countries on this "Bad Tax Haven List" are Andorra, Anguilla, Antigua and Barbuda, Aruba, Bahamas, Bahrain, Barbados, Belize, British Virgin Islands, Cook Islands, Dominica, Gibraltar, Grenada, Guernsey, Isle of Man, Jersey, Liberia, Liechtenstein, Maldives, Marshall Islands, Monaco, Montserrat, Nauru, Dutch Antilles, Niue, Panama, Samoa, Seychelles, St. Lucia, St. Kitts and Nevis, St. Vincent and the Grenadines, Tonga, Turks and Caicos, US Virgin Islands and Vanuatu.

The 30 industrial countries in the Financial Action Task Force on money laundering, affiliated with OECD, published a list of 15 territories which it said were failing to cooperate in the international battle against money laundering. These Countries accused of fostering money laundering are The Bahamas, Cayman Islands, Cook Islands, Dominica, Israel, Lebanon, Liechtenstein, Marshall Islands, Nauru, Niue, Panama, the Philippines, Russia, St. Kitts and Nevis, and St. Vincent and the Grenadines.

Last month the Group of Seven industrialized nations released a table of more than 40 tax havens worldwide, classifying them according to the quality of their financial regulation and supervision. A number of the countries receiving poor marks on this list were also on the Bad Tax Haven List and the Money Laundering List. The countries appearing on all three lists are The Bahamas, Cook Islands, Liechtenstein, Marshall Islands, Nauru, Niue, Panama, St. Kitts and Nevis, Saint Vincent and the Grenadines.

Institutional ownership: As of the third quarter 1999, the FED noted that mutual funds owned $2.7 trillion of the $16 trillion of U.S. stocks. That's about 17% up from 7% ten years ago. Pension and insurance companies, et al, own about $5.3 trillion. That's 33% up from 18% ten years ago.

Households and non profit organizations owned $6.6 trillion. That's 41% compared to 51% ten years ago.

Slower future growth??: (2000) Eugen Fama and Kenneth French say that the the historical equity risk premium may be much lower than previously stated. "If we use the average growth rate of real dividends for 1950-1999, 1.61 percent per year, to estimate the expected future growth rate, the expected real stock return is 2.93 percent. The riskfree real interest rate for 1999 is 2.24 percent, so the estimate of the expected equity premium is 0.69 percent. If we replace the 1950-1999 dividend growth rate with the higher average growth rate for 1872-1999, 2.15 percent per year, the expected real stock return rises to 3.56 percent, and the expected equity premium is 1.32 percent."

Slower future growth??: (2000)Eugen Fama and Kenneth French say that the the historical equity risk premium may be much lower than previously stated. "If we use the average growth rate of real dividends for 1950-1999, 1.61 percent per year, to estimate the expected future growth rate, the expected real stock return is 2.93 percent. The riskfree real interest rate for 1999 is 2.24 percent, so the estimate of the expected equity premium is 0.69 percent. If we replace the 1950-1999 dividend growth rate with the higher average growth rate for 1872-1999, 2.15 percent per year, the expected real stock return rises to 3.56 percent, and the expected equity premium is 1.32 percent."

Innovation: (2000) With over 10,000 funds, many fund families just can't get attention- particularly no loads. So what is new- loads. Scudder is adding sales charges as high as 5.5 percent to all 36 of its funds. The number of load funds has inched up to 64.3 percent of all funds from 63.8 percent three years ago. Direct sales of funds to investors fell to 18 percent of total fund sales in 1999, from 23 percent in 1990

But the article addressed this,"A broker can provide much-needed guidance about dividing one's money among bonds, stocks and cash, and can help select the funds themselves."

Why? Brokers may add insight greater than an unsophisticated investor. But a broker CANNOT lend substantial- even needed - knowledge because a broker has never been taught the fundamentals of investing.

V = D0 + D1 +     D2 + ........ Dn
                1+k     (1+k)^2         (1+k)^n

Where: V    is the present value
            D0   is the dividend initially
            Dn   is the dividend in the nth year
            k     is the discount rate, or the desired
                   rate of return

V + D0 (1+g / 1+k) + (1+g / 1+k)^2 + ........ + (1+g / 1+k)^n

P / E = 1-b
            k-g

    Where: b = earnings retention
         k = discount rate
      g = growth rate

Buy and Sell: (2001) Also repeatedly addressed, "buys" from brokers and analysts outnumber "sells" by a large margin. In a sampling of over 27,000 recommendations, a strong buy garnered 35.7%; buy at 36.8%; hold at 26.6% and sell at only 0.9%.

Company	Country	Close	Shares	US $ % Chg	Market Cap	Weight
Microsoft Corp.	USA	111.688	5204852	-0.17	581.32	8.5
General Electric Co.	USA	159.063	3277652	-0.2	521.35	7.62
Intel Corp.	USA	139.063	3340999	-2.5	464.61	6.79
Exxon Mobil Corp.	USA	77.250	3461574	2.32	267.41	3.91
Deutsche Telecom AG	Ger	89.400	3029604	5.88	264.75	3.87
Wal-Mart Stores Inc.	USA	55.188	4453740	2.2	245.79	3.59
International Business Machines Corp.	USA	121.000	1802604	5.27	218.12	3.19
Lucent Technologies Inc.	USA	64.500	3187478	-0.67	205.59	3.01
Citigroup Inc.	USA	60.500	3371665	-2.12	203.99	2.98
France Telecom	Fra	191.000	1024615	5.07	191.3	2.8
AT&T Corp.	USA	58.813	3195043	2.73	187.91	2.75
Toyota Motor	Jap	5110.000	3760650	3.73	179.89	2.63
BP Amoco	UK	5.415	19486680	1.76	168.37	2.46
American International Group Inc.	USA	107.625	1548241	3.18	166.63	2.44
SBC Communications	USA	43.063	3411379	-1.15	146.9	2.15
Merck & Co.	USA	61.750	2337422	-1.79	144.34	2.11
Hewlett-Packard Co.	USA	142.375	1001493	-3.31	142.59	2.08
British Telecommunications	UK	12.640	6506713	2.82	131.23	1.92
Royal Dutch Petroleum	Swi	59.000	2144296	1.7	123.67	1.81
MCI Worldcom Inc.	USA	42.672	2838345	-0.62	121.12	1.77
Coca-Cola Co., The	USA	47.000	2469980	-1.31	116.09	1.7
Morgan Stanley,Dean Witter & Co.	USA	95.813	1136881	1.12	108.93	1.59
Hsbc Holdings	UK	7.725	8458658	4.75	104.27	1.52
Allianz AG	Ger	418.500	245270	3.26	100.34	1.47
Johnson & Johnson	USA	71.250	1391649	-10.94	99.15	1.45
Novartis AG (Namen)	Swi	2188.000	72130	2.7	97.22	1.42
Siemens AG	Ger	165.300	594841	5.15	96.11	1.4
Bank of America Corp.	USA	54.438	1707184	0.46	92.93	1.36
Bell Atlantic Corp.	USA	59.500	1552786	-0.21	92.39	1.35
Disney (Walt) Co.	USA	41.500	2069931	-0.3	85.9	1.26
BellSouth Corp.	USA	44.688	1881844	0.85	84.09	1.23
Roche Hldg AG (Drc)	Swi	19310.000	7026	1.18	83.57	1.22
Chase Manhattan Corp.	USA	96.188	824777	-2.35	79.33	1.16
Nestle SA (Namen)	Swi	2989.000	40352	2.73	74.3	1.09
Procter & Gamble Co.	USA	56.438	1315714	0.56	74.26	1.09
DaimlerChrysler AG	Ger	70.200	1013733	3.45	69.56	1.02
Bank of Tokyo-Mitsubishi Ltd.	Jap	1441.000	4675455	2.12	63.07	0.92
Lloyds TSB Group Plc	UK	6.650	5475337	5.79	58.1	0.85
Du Pont (E.I.) De Nemours & Co.	USA	54.813	1052473	-0.11	57.69	0.84
UBS	Swi	431.500	215289	2.69	57.22	0.84
Chevron Corp.	USA	85.625	656266	1.18	56.19	0.82
Credit Suisse Group (Namen)	Swi	331.000	273838	3.9	55.83	0.82
ING Groep N.V.	Net	56.790	996677	0.32	55.33	0.81
General Motors Corp.	USA	85.375	640208	-1.87	54.66	0.8
Ford Motor Co.	USA	44.688	1137033	0.42	50.81	0.74
AXA	Fra	144.600	356336	-0.97	50.37	0.74
Morris (Philip) Cos.	USA	19.813	2314476	1.28	45.86	0.67
ENI	Ita	5.020	8002128	0.47	39.27	0.57
Boeing Co., The	USA	36.000	934540	2.49	33.64	0.49
Unilever Nv (cva Ntfl4)	Net	48.780	571576	1.78	27.25	0.4
Total Market Cap	6,840,601,637

Momentum Investing (NY Times 2001) This article from Mark Hulbert describes how you could invest in the "best" funds as identified in a newsletter. "Specifically, we will assume that every Jan. 1, you started following the model portfolio of the investment ne¬M�

The strategy might somehow work better, they contend, for advisers like mutual fund managers.

They are right, but only to a point — and not by enough to make it worth following. Consider one hot-hands strategy that has modestly beaten the market — investing in the previous year's top performer among the Fidelity Select sector funds. Over the last decade, that approach would have gained 24 percent a year, on average, versus 17.4 percent for the S.& P. 500. But it would have been very risky — nearly three times riskier than the overall market, as measured by relative volatility."

S&P??: (2001) In 1999, only 33% of mutual funds were able to beat Standard & Poor's (S&P) 500. In the year 2000, over 72% of all mutual funds managed that task. Nearly half of all funds managed to outgain the S&P 600 Small Cap index in 1999. In 2000, a mere 16% managed the task. Includes in-depth charts and comparisons of mutual funds to their respective asset class indexes. Issues article by Jim Wiandt.

Real Estate ETF (2001) The first exchange-traded fund that tracks a Real Estate Investment Trust (REIT) index began trading on the American Stock Exchange on Friday, 2/2/2001. The new ETF was launched by Barclays Global Investors (BGI) and is called the iShares Cohen & Steers Realty Major Fund (trading symbol: ICF). The fund will track a modified cap-weighted index of 30 REITs, and has an expense ratio of 0.35%. News article by Index Funds staff.

Are Stock Option Rescissions an Unfair Benefit? (2001) When the tech-stock bubble burst last year, a number of companies allowed key employees to cancel previous options-based stock purchases that had left them with deep losses. The implications of such favoritism are troubling enough that the SEC - not to mention shareholder activists - are taking a closer look.

Experience (Morningstar 2001) The typical manager of a stock mutual fund today has an average of 5.7 years of experience at the helm, according to data from Morningstar Inc. Bond-fund managers have slightly more, 6.6 years

HIGH: The Nasdaq's 57% drop from its March 2000 high ranks as its second-worst bear market, and at 1 year old, it is tied as fourth longest. On average, it took the Nasdaq 2 years to recover to its old high in past bears. In the most extreme case — the record 1973-74 bear — the recovery took 5 years and 8 months.

Momentum Investing: In an article in the October 2000 issue of the Journal of Finance, Charles M.C. Lee and Bhaskaran Swaminathan presented their findings on a study examining whether past returns and past trading volumes had predictive value in terms of future returns. Past trading volume predicts both the magnitude and persistence of future price momentum. In the intermediate-term, a strategy of buying past high-volume winners and selling past high-volume losers outperforms a similar strategy based on price momentum alone by 2% to 7% per year. In the long-term, a strategy of buying low-volume winners and selling high-volume losers exhibits return continuation up to three years, while a strategy of buying high-volume winners and selling low-volume losers exhibits return reversals in years two and three. These findings are consistent with behavioral models in which stock prices initially underreact, but ultimately overreact, to fundamental news. In this context, past trading volume provides information about the level of investor interest, and indirectly, about the imminence of price reversals.

Here’s a revealing snapshot of S&P 500 performance following "Negative Return Years" 2001

Given recent increases in the use of stock options by both “new economy” and “old economy” companies, one might reasonably expect that employees – the beneficiaries of this perk - understand how options work. But according to recent research by Wharton professors David Larcker and Richard Lambert, employees tend to be relatively uninformed as to the basic economics of stock options, a finding that has important implications for employers, boards of directors and management consultants.

Stock prices will fall?: 2001 Stock prices could thus fall substantially after the boomers retire since the demand that kept prices high will no longer exist. Full article from Wharton

Do stocks always win? (2001) If you take a really long period, the variability of returns smooths out any distortions in stock returns. But if you look at shorter periods (say 1973/74), things are not so rosy. Read this article from Evanson.

UP or DOWN and for How Long? (2001) "If an investor entered the market during the last century when the Dow was one standard deviation above its long-term trend line - an exuberant bull market top - how long did they have to wait? For an investor who got in at the top in 1929, it took until roughly 1960, in inflation adjusted returns, to merely break even on his investment. At the next big bull top in 1968, it took until the early 1990s to break even - or about 25 years. Also, these are simply break-evens after inflation, a 0% return. These figures do not include dividends (data from Siegel, p. 59). Leuthold (InvestmentNews, 5/21/2001) notes that an investor at the peak in 1929 took until August 1998 - almost 69 years - to reach a nominal return of 10% on his money, including dividends. After inflation, this is a yearly return of about 7%. It took investors 69 years to reach the long-term expected return from stocks.

In addition, from its peak in 1929, our long-term investor had to endure an 86% decline in the value of his portfolio to its low in July 1932. The Dow Industrials holds some of America's largest and financially soundest companies, and cannot be considered an aggressive or speculative part of the stock market. Yet, investors choosing this relatively conservative sector would have required extraordinary nerves, and several decades to achieve average long-term stock returns on their investment, far more than can be realistically expected."

Efficient market theory: (2001) Supposedly every element about a company is known instantaneously by all entities at all times. So nobody gets any better benefit in analyzing a stock or getting a better price. But a study shows that, city by city stock markets rise more often on days when the sun shines in the morning than when skies are overcast. The study, "Good Day Sunshine: Stock Returns and the Weather," is by two finance professors, David Hirshleifer of Ohio State University and Tyler Shumway of the University of Michigan.

Returns: And more idiocy: Among investors offering a prediction for the market's return over the next 10 years, 39% said stocks would deliver 15% a year or more, according to a survey from Gallup Organization and UBS PaineWebber.

Investors are overconfident," says Meir Statman, a finance professor at Santa Clara University in California. "They think that they'll earn more than the market. They all think they're above average."

Admittedly, the 15 years though year-end 2000, stocks gained an average 16% a year, while bonds earned 8.6%.

You can divide the past 75 years into 61 rolling 15-calendar-year stretches, starting with the 15 years through year-end 1940, continuing with the 15 years through 1941, etc.

Out of these 61 rolling periods, there were just 13 occasions when stocks generated 16% a year or more, (Ibbotson Associates). Most of these 5-year stretches ended in the late 1950s, the early 1960s and the late 1990s.

You can divide the past 75 years into 61 rolling 15-calendar-year stretches, starting with the 15 years through year-end 1940, continuing with the 15 years through 1941 and so on.

Out of these 61 rolling periods, there were just 13 occasions when stocks generated 16% a year or more, according to Chicago's Ibbotson Associates. Most of these dazzling 15-year stretches ended in the late 1950s, the early 1960s and the late 1990s.

The people alleging 15% returns are not above average. They are universally stupid. You cannot say you know anything about securities as an element of sophistication unless you already knew the answer to this, "How many stock do you have to have in a portfolio in order to insulate it due to unsystematic risk?"

For the record, I have never used more than a 10% return for stocks for any analysis I have EVER done. Measuring 20 stock market peaks since 1900, one finds that it took a median of 14.8 years for the investment made at the peak to reach an ACR of 11%. If you invested money at the 1956 market peak, it took 41 YEARS before your annual compound rate of return (ACR) reached 11%.

Year	Liquidations
1990	33
1991	40
1992	9
1993	12
1994	52
1995	156
1996	170
1997	141
1998	222
1999	166
2000	225
2001 through 3/31	40

Load Funds do better? 60 percent of all mutual fund assets remain invested in load funds. (NY Times) Past academic studies have shown that the average load fund manager performs no differently than the average no-load manager. That is already bad news for load funds, because it removes the performance-based justification for investing in them.

But recent studies note that even before the impact of loads, the average load fund underperforms the average no-load. After loads are taken into account, needless to say, the average load fund lags far behind.

A 1996 study by Mark Carhart examined all domestic diversified equity mutual funds from January 1962 to December 1993. Little noticed at the time was Mr. Carhart's discovery that the average load fund lags behind the average no-load by approximately 60 basis points a year, even before loads are taken into account — equivalent to more than 6 percent over a decade. (See, "On Persistence in Mutual Fund Performance," appeared in the March 1997 issue of the Journal of Finance.)

The first is a statistical flaw known as survivorship bias. This creeps into any mutual fund research that focuses only on funds that exist today (the "survivors") and ignores those that have gone out of business over the years (the "nonsurvivors").

Serious as survivorship bias is, it still would not have affected comparisons between loads and no-loads if not for the fact that more load funds go out of business than no-loads. In fact, according to Mr. Carhart's study, more than 90 percent of funds that went out of business from 1962 to 1993 were charging either a front-end or a back-end load at the time they disappeared.

If these two studies had not corrected for survivorship bias, we might not have known that the typical load fund underperforms the no-load. But now that we know, we face another mystery: Why hasn't the intense competition among mutual funds for investors' assets removed this performance difference?

At least two factors are involved, both revealing much about the psychology of investing.

The first is that the payment of a load discourages investors from switching to another fund. That, in turn, helps to immunize inferior load funds from the redemptions that equally inferior no-load funds would experience. As a result, load funds are relatively invulnerable to the competitive pressures that otherwise might eliminate the performance difference.

How much more reluctant are load-fund investors to switching? One gauge is the average time that investors hold on to load and no-load funds. According to Dalbar, a financial research firm based in Boston, the average load fund investor in 1996 held on to his equity fund for 3.2 years, in contrast to 2.9 years for the typical no-load fund investor.

Undoubtedly, many psychological motivations influence load-fund investors to hang on to their funds. Maybe some investors see load funds as well worth the extra cost, because of the help they receive from the sales representative. If so, it would take poor performance over a sustained period to persuade investors to switch.

But investors are often reluctant to switch even if they place no value on the hand-holding they receive and even when their fund is a poor performer. This is because of cognitive dissonance, a universal psychological trait that makes us loath to acknowledge our mistakes — even to ourselves. Load- fund investors thus hold on longer than they would otherwise in order to avoid the painful realization that the money paid to the fund's sales representative was a total waste.

A second factor is related to the first. Load-fund investors' reluctance to switch has helped them at the same time that it has hurt them: They tend to have a higher average exposure to equities than do no-load investors, whose frequent switching leads to a higher exposure to cash.

The resulting benefit to load-fund investors is significant. According to Dalbar, the average equity investor in load funds from 1984 to 1996 made 118.8 percent, in contrast to 113.9 percent for the average no-load fund investor.

In other words, despite the lesser performance of the average load fund, average load fund investors are making more money. As a result, they are probably not aware that they could have made even more by investing in no-loads — if, of course, the absence of loads didn't tempt them into moving their money around.

But as is the case with most psychological hang-ups, consciousness is a big step toward change. When no one knew that the average load fund lagged behind the average no- load, investors had no motivation to find an alternative source of discipline. Now that we know, and given the magnitude of some funds' loads, investors have a powerful incentive to find a way to behave more like a load-fund investor while investing in a no- load fund."

Stock options are a boon to shareholders because they motivate management and align the interests of investors with those of executives. Oh really? (NY Times 2001) "The greatest damage to this theory has been done by companies that reduce the strike prices of their stock options after their shares have plummeted. Option repricings, as they are called, are quite simply a gift to management and workers that outside shareholders do not receive.

Companies that reprice their options have typically argued that doing so is necessary to keep treasured executives from leaving for sweeter packages elsewhere. Implicit in this argument is the belief that an exodus of executives would hurt the company."

But research by Catherine M. Daily, S. Trevis Certo and Dan R. Dalton at the Indiana University's Kelley School of Business indicates that companies that reprice options actually show higher levels of executive turnover later. More important, the study found no evidence that the repricing of options was associated with improvement in the financial performance of the company.

They found that in the first year after a repricing, chief executive turnover at the companies was 16.3 percent, versus 4.7 percent at companies that had not repriced. By the end of 1998, companies that had repriced options clocked chief executive turnover at 25.5 percent. Those with no repriced options had turnover of 10.5 percent.

Yet the Investor Responsibility Research Center reports that 59 companies repriced options this year, as of June 15. That was far higher than the 31 that repriced in all of 2000, but down from the 312 that did so in 1999."

Jeremy Graham: (2001) People ask what is going to happen next year, and I say I haven't the faintest idea. In general, the short term is unknowable and in an uncertain world, it should be unknowable. Think of yourself standing on the corner of a high building in a hurricane with a bag of feathers. Throw the feathers in the air. You don't know much about those feathers. You don't know how high they will go. You don't know how far they will go. Above all, you don't know how long they will stay up. You know canaries in Jamaica end up in Maine once in a blue moon. They just get swept along for a week in a hurricane. Yet you know one thing with absolute certainty: Eventually on some unknown flight path, at an unknown time, at an unknown location, the feathers will hit the ground, absolutely, guaranteed. There are situations where you absolutely know the outcome of a long-term interval though you absolutely cannot know the short-term time periods in between. That is almost perfectly analogous to the stock market.

Fear and Greed and a whole mess more (WSJ 2001) In context with the quote above, Clark Winter noted that "During the transition from one emotional point to the next, various investments become attractive. For example, after a market meltdown -- like the one of the past year -- investors become afraid of incurring further losses, so they seek out value stocks and other securities seen as ''safe havens.'' When the investment outlook brightens and a feeling of safety emerges, people start wanting higher-than-average returns, so they turn to growth stocks for this opportunity. Finally, as investors clamor for even fatter returns -- just before greed kicks in -- momentum stocks are in favor.

And this is a very good comment from Brad Elman called "'investing 'evangelism.'' In the rush to go public, launch a startup or create a new product, ''companies were buying employees T-shirts, leather jackets and nice pens with the companies' names on them. People were inundated with the message that their company was it

And Bob Dreizler says the most irrational cases he encounters involve someone who refuses to sell a stock simply because a parent or grandparent owned the investment. I have seen that happen a lot- and I have seen almost all of them underproduce the market.

There is no such thing as emotion in investing. It's just a lot of reading and research- with specific attention to economics. Otherwise, you are just kidding yourself.

Reversion to the Mean: (2001) to revert to its 50-year average return of 8%, the Dow would have needed to drop 46% in 2000 from its 1999 close (it fell 6%) or post zero gains for 8.5 years.

The stocks analysts rated "buy" or "strong buy" in the last three years had far more risk than the average stock. (WSJ 2001) The average return on the stocks that the analysts rated as holds was greater than the buys and strong buys. The holds also turned out to be less risky.

The highest rated stocks, the strong buys, returned 12.5%, the buys returned 12.1% and the holds returned 12.8%.

The stocks that got the highest ratings in March 1999 soared 66.8% over the next year. But once the bubble popped, the risk surfaced. The stocks with the highest recommendations in September 2000 lost 16.7% through June, the last month for which data are available. The holds gained 8.6% in that period.

Convertible Securities: (WSJ 2001) Convertibles are securities, including bonds and preferred stock, that can be swapped into common stock under certain conditions. In essence, they give investors the opportunity to get a bond-like return and still reap benefits if a company's share price soars.

How have convertible securities performed for investors? So far this year, convertible-securities funds have lost an average of 7.93%. Over the past five years, these funds have returned an average of 10.1% annually

Emerging markets: (2001)They may end up doing well, but the problems now overwhelm the upside (NY Times) Even with huge rallies from time to time, the leading index of emerging market stocks is off 43.3 percent since 1993, in dollar terms, and 29 percent in the last year. The last decade is replete with crises that have reduced or erased gains from previous years, like Asia's financial collapse in 1997, Russia's devaluation of the ruble in 1998, Brazil's devaluation in 1999, Turkey's this year, and Argentina's struggle to avoid default on its debt and devaluation of its currency.

Fund fees: (Fitzrovia International 2001) Annual mutual-fund fees have increased by about 10%, compared with a rise of 1% in 1999. More than 25,000 funds it monitors world-wide, 530 increased their management fees last year compared with 450 in 1999.

Mutual Funds (NY Times 2001) In 1999, there were 10 mutual funds that performed the best in a great year for stocks. All the funds more than tripled in value during the year, and the best of them leapt nearly 500 percent. Most of the funds were small and had little in the way of a track record; for four of them, 1999 was their first full year. Nine of the 10 funds have lost at least two-thirds of their value since 1999, and the 10th is down almost 50 percent. Over the same period, the Standard & Poor's 500-stock index fell 29 percent, while the Nasdaq composite lost 63 percent of its value.

Most of the big winners in 1999 were funds that were willing to enthusiastically embrace the new economy and to ignore traditional valuation parameters. These funds bought new issues, particularly of Internet companies.

Your experiences can lead to specific behaviors that harm your wealth. For example, you are prone to attribute past investment success to your skill at investing. This leads to the psychological bias of overconfidence. Overconfidence causes you to trade too much and take too much risk. As a consequence, you pay too much in commissions, pay too much in taxes, and are susceptible to big losses.

The attachment bias causes you to become emotionally attached to a security. You are emotionally attached to your parents, siblings, children, and close friends. This attachment causes you to focus on their good traits and deeds. You also tend to discount or ignore their bad traits and deeds. When you become emotionally attached to a stock, you also fail to recognize bad news about the company.

When taking an action is in your best interest, the endowment bias and status quo bias cause you to do nothing. When securities are given to you, you tend to keep them instead of changing them to an investment that better suits your needs. You also procrastinate on making important decisions, like contributing to your 401(k) plan.

Emotions get in the way of making good investment decisions. For example, your desire to feel good about yourself—seeking pride—causes you to sell your winners too soon. Trying to avoid regret causes you to hold your losers too long. These emotions have the consequence that you sell stocks that are performing well and keep those that are performing poorly. This hurts your return and causes you to pay higher taxes.

When you are on a winning streak, you may feel like you are playing with the house’s money. The feeling of betting with someone else’s money causes you to take too much risk. On the other hand, losing causes emotional pain. The feeling of being snake bit causes you to want to avoid this emotional pain in the future. To do this, you avoid taking any risks by not owning stocks at all. However, a diversified portfolio of stocks should be a part of everyone’s total investment portfolio. Experiencing a loss also causes you to want to get even. Unfortunately, this desire to get even clouds your judgment and induces you to take risks you would not ordinarily take.

So that you can avoid feeling bad about previous decisions that didn’t turn out well, your brain filters the information you receive. This process, called cognitive dissonance, adjusts your memory about the information and changes your recollection about your previous decision. Obviously, remembering inaccurately will reduce your ability to evaluate and monitor your investment choices properly.

Finally, the brain uses shortcuts to reduce the complexity of analyzing information. These shortcuts allow the brain to generate an estimate of the answer before fully digesting all the available information. For example, the brain makes the assumption that things sharing similar qualities are quite alike. Representativeness is judgment based on stereotypes. Additionally, people prefer things that have some familiarity to them. However, these shortcuts also make it hard for you to correctly analyze new information and can lead to inaccurate conclusions. Consequently, you put too much faith in stocks that are familiar to you or represent qualities you desire.

The self-control problem can be thought of as the interaction between your two selves—the planner and the doer. The doer wishes to consume now instead of later and to procrastinate on unpleasant tasks. The planner wishes to save for later consumption and to complete unpleasant tasks now. This conflict between desire and willpower occurs because you are influenced both by long-term rational concerns and by emotional factors that are more oriented toward the short term.

Most people want to maintain self-control and implement decisions that provide benefits over the long term. However, you often recognize that your desire is stronger than your willpower. Therefore, you may employ many techniques to help your willpower. I categorize these techniques into two groups: rules of thumb and environment control. These techniques help you to reduce desire and increase willpower.

For example, if you like to trade actively, you may realize this behavior is not optimal in the long term. As a compromise between the two selves (the planner and the doer), you open two brokerage accounts. One is for the majority of your wealth to implement a long-term buy-and-hold strategy while the other is used to have fun. Of course you could leave it all in just one account and actively trade only a small portion of your overall wealth, but it might require too much self-control to do that. Having two accounts give you a better chance of learning self-control.

Perhaps instead of handling your self-control problems by controlling your environment, you may have gone to the other extreme. Online traders are using information obtained in chat rooms to make investment decisions. These decisions are usually irrational because they are spur-of-the-moment decisions based on rumor, not information.

Tech stocks (WATTS 2001) They studied 1,900 tech companies back to 1995 and found that only 3.4% of the companies whose stock price plunged to single digits rebounded to $15 or higher within a year. .

Of the 437 com-companies that plunged to single digits in 2000, only 5- 1.1%- have rebounded in 2001 (and that was as of July 2001)

PCI Deflator: (2001) the PCE deflator is derived from the CPI data but is calculated differently, using a complicated system known as the chain-weighting method. The deflator is a better cost-of-living measure because it more accurately reflects consumers' changing purchases of goods and services.

The CPI seeks broadly to measure how much more it costs to buy the same basket of goods now compared with a year earlier. In the PCE deflator, on the other hand, the weights of items in the basket change each year, to reflect how people shift their spending towards cheaper goods.

If the price of apples rises, people buy more pears. The CPI thus tends to overstate inflation. But the PCE may understate it, because it assumes that shifts in spending in response to the higher prices of some goods do not lower consumers’ standard of living.

The CPI also gives twice as much weight (20 per cent) to changes in the price of owner-occupied housing. But in both measures this price is based on the cost of renting a similar property, using a method that many economists reckon is distinctly dodgy.

Not everybody within America’s Federal Reserve System loves the PCE as much as Greenspan.

Above all, the Fed’s critics emphasise one big difference between America’s CPI and that in most other countries: the increasing use of `hedonic’ pricing methods to strip out the effects of improvements in the quality of home computers, cars, clothes, televisions and so on. Hedonic pricing breaks down a product into its key features —say, the memory and speed of a computer —and then assigns prices to those features rather than to the product as a whole. This allows price rises due only to higher quality to be knocked out of the index.

Years	PCE Deflator	Gold

1986-91	4.3%	$402
1991-95	2.5%	$367
1996-99	1.5%	$323
'96	1.6%	$388
'97	1.4%	$331
'98	1.5%	$294
'99	1.5%	$279

As the table indicates, the consumer price deflator has been rock steady over the past four years, averaging only 1.5%. Virtual price stability (cyberspace e-commerce price declines are not yet recorded).

Explaining the Tax Advantages of ETFs: (Jim Wiandt and Will McClatchy 2001) For all the talk that ETFs are more tax-efficient, there's rarely a detailed explanation of exactly why this is so. As a result, many investors do not truly understand the tax benefits and liabilities of ETFs.

* Consumers want to believe that the professionals can perform the services they are hired to do. Too often in the domain of financial advisors, even those with CFP’s or CPA’s, this is not the case.

The consulting communities’ simple asset allocation policy solution for institutional investors can be challenged on several scores. Why should investors expect that the past relationships between return and short-term volatility are good estimates for the future? Why should institutional investors be overly concerned about market volatility in returns when setting their long-term asset allocation policy? Why shouldn’t the asset allocation policy be adjusted if asset class return expectations change?

In addition to the proposed regs, the IRS has also issued Notices 2001-72 and 2001-73, which provide "rules of administrative convenience" that will help employers comply with the new regs. Specifically, Notice 2001-73 concerns the payment of FICA and FUTA taxes, while Notice 2001-72 addresses income tax withholding on "disqualifying disposition[s]" of stock received from the exercise of qualified options. (Note: Both Notices will be published in Internal Revenue Bulletin 2001-49 on December 3, 2001.)

The regs, when made final, will apply to statutory stock options exercised on or after January 1, 2003. However, employers would be permitted to apply the final regs to options exercised before that date if they so choose.

Class-action suits charging IPO abuses could cost Wall Street firms up to $5 billion to settle. (WSJ 2001) This year, more than 1,000 suits have been filed on behalf of shareholders in 263 companies that went public during the heyday of high-technology IPOs. Losses alleged in the suits amounted to between $10 billion and $50 billion. The allegations generally track regulatory probes into whether brokerage houses broke securities laws by manipulating stock prices by requiring customers who received shares in an IPO to place so-called aftermarket orders for additional shares at higher prices, a practice known as "laddering."

A series of variables is entered into a plan, including assets, asset allocation, and cash flows, ending value.

A simulation generates many different returns, randomly selected for each simulation, or lifespan.

At the end of each simulation, the returns are calculated and an ending value is determined.

The process starts again with a new "life" and generates another set of unique returns for each time period.

A "probability of success" is calculated at the end of all simulations according to the number of times a client accomplished the goals set out in the plan .

Just another reason why humans cannot buy stock- (NYTimes 2001) The Securities and Exchange Commission on Tuesday warned companies to stop misusing pro-forma earnings, saying the practice can mislead investors. They can

• Contain alternative calculations of financial results. For instance, the use of "earnings before interest, taxes, depreciation and amortization," commonly called EBITDA, is problematic because it leaves out key costs.

• Leave out "unusual or non-recurring transactions." Such reports are suspect unless specifics are given on the omitted transactions.

• Vary wildly from the official results. If a firm that lost money based on official accounting rules reports a pro-forma profit, the company's unprofitability is covered up.

Overconfidence (Belsky, Gilovich 2001) "We're not talking specifically about conscious arrogance, although overconfidence might certainly manifest itself in such out and out hubris. It's not so much that some folks think that they are especially gifted and some folks do not, although that is certainly true. Rather, what research psychologists have discovered about overconfidence is that most people- those with healthy egos and those in the basement of self esteem- consistently overrate their abilities, knowledge and skill, at whatever level they might place them."

Risk Free Rate: (William Bernstein 2002) Financial economists like to talk about the risk-free rate: basically, the time value of money sitting in a perfectly safe vehicle. From an historical perspective per se, the very use of the term is fascinating. After all, it implies a society that is strong and stable enough to support a risk-free investment. Living in what is likely the most secure political, social, and economic environment ever seen on the planet, we take the existence of a "risk-free investment" for granted. But this is not always the case.

Was high- now low?: (Larry Swedroe 2002) The last half of the twentieth century was a golden era for US equity investors. From 1950 through 1999 the S&P 500 Index produced annualized returns of 13.6% per annum, or a real rate of 9.2% per annum. Even more impressive are the returns of the last quarter of that century. From 1975 through 1999 the S&P 500 Index produced an annualized return of 17.2%, and a real rate of return of 11.8%. That is the good news. The bad news is that for today’s investors the result of those great returns is that today future expected returns are now much lower.

Common Determinants of Bond and Stock Market Liquidity: (2002) The Impact of Financial Crises, Monetary Policy, and Mutual Fund Flows l (Tarun Chordia, Asani Sarkar, and Avanidhar Subrahmanyam) The authors study common determinants of daily bid-ask spreads and trading volume for the bond and stock markets over the 1991-98 period. They find that spread changes in one market are affected by lagged spread and volume changes in both markets. Further, spread and volume changes are predictable to a considerable degree using lagged market returns, lagged interest rates, lagged spreads, and lagged volume. During financial crises, stock and bond spreads and volume are more volatile and become more highly correlated; moreover, money supply positively affects financial market liquidity, albeit with a two-week lag. During normal times, increases in mutual fund flows enhance stock market liquidity and trading volume, but during financial crises, U.S. government bond funds see higher inflows, resulting in increased bond market liquidity.

412 (i) Benefit Pension Plan The plan must be funded solely by individual or group life insurance and annuity contracts that are part of the same series, that include the same mortality tables and rate assumptions for all participants.

VALUE STOCK: (2002) From 1964 to 2000 large value stocks outperformed large growth stocks 14.5 percent to 11.1 percent, and small value stocks outperformed small growth stocks 16.6 percent to 12 percent. Not only has the value premium been very large, but it has also been very persistent - about equally or more persistent than even the equity premium. In addition to providing greater returns, the standard deviation of value stocks has been lower than the standard deviation of growth stocks. From 1964 to 2000, the standard deviation of large value and large growth was 16.7 and 17.5, respectively. The standard deviation for small value and small growth was 23.8 and 27.2, respectively.

Derivatives: (NY Times 2002) Unlike markets for stocks, bonds and commodities, where the assets traded and the details of those trades are easy to understand, the derivatives market is hardly transparent. The terms specified in a derivative contract can take up scores of pages of text, and trading is not always public.

In their simplest definition, derivatives are contracts that promise payments from one investor, or "counterparty," to another, depending on future events. Those events can be as ephemeral as changes in the prices of securities or commodities from which the contracts are derived — hence the name — or as concrete as weather changes (which Enron turned into a booming business).

The contracts' payments are usually calculated in relation to the value of some underlying asset, like a bond or a shipment of oil.

Now even before we go further with the Times article, I know some are having problems in understanding some of the above. Here's the point. Remember Long Term Capital from a few years ago? It was doing the same thing with 2 Nobel Laureates and 27 PhD's in defining "ever" element that could go on with their system thereby providing an essentially no lose scenario. It melted primarily because human beings do not have to act rationally at all times. Maybe it's 60% or 80% or whatever given XZY conditions. But you cannot pattern them to 100%. Hence the default of LTC required an effective bailout of the U.S. banking system to the tune of $3.5 billion.

In June, according to the Bank for International Settlements, the over- the-counter market for derivatives consisted of contracts based on $100 trillion in underlying assets — about twice the value of all the goods and services produced by the entire world in a year, and a 38 percent increase in size since 1998.

Michael R. Darby, a finance professor at the University of California at Los Angeles, puts it this way: "Do the products have the ability to offset risk through a true hedge? Yes. Do they have a potential for accounting abuses or trading abuses? Yes."

Those bells and whistles also hurt the financial system by reducing the transparency of a company's activities for outsiders. Yet even a company's own directors might not understand its derivatives portfolio. "Boards shouldn't allow transactions they don't understand. "That doesn't mean people don't do it."

True. But even if you have an MBA, I doubt that many director's really have a true understanding of what is going on the inherent underlying risk. Yes, they can work properly. But there are unregulated and subject to abuse.

"Outside the financial sector companies' use of derivatives is mostly unregulated and is believed to have increased sharply in the last few years. "

Ethical conduct therefore occupies the central role in stemming systemic risk in derivatives markets. "In most cases, the accidents and negative fallout that have surrounded some derivatives episodes have been due to a lack of risk controls in the firms that have precipitated the events."

Stock splits: (NY Times 2002) Stock splits were a major force behind the big increase in share counts at major companies. According to Mr. Galbraith, there were almost 400 stock splits at S.& P. 500 companies from 1997 to 1999. For years, splits had been a powerful signal of future gains in a stock. From 1995 to 1999, shares that had split gained more than 40 percent in the subsequent 12 months. But in 2000, that trend was reversed, and companies averaged a decline of 26 percent the year after their split.

Investments advice: (Employee Benefit Research Institute and the American Savings Education Council 2002) Benefit statements top sources of financial guidance

Financial planners fare well, but retirement benefit brochures and statements remain the top information sources utilized by employees. The new results show that 82% of respondents access those resources for guidance. Sixty-eight percent of employees turn to newsletters or magazines. Seminars (66%), financial planners (61%) and workbooks or worksheets (58%) round out the top five.

By age, 40-59 year olds are more likely to read newsletters and magazines for financial advice than those aged 20-39 (72% vs. 58%). And those in the 20-39 age group are more likely to obtain financial information through online services than persons aged 40-59 (57% vs. 38%).

Managed funds do better in a downturn? (2002) Putnam's stock funds had a rough year in 2001, declining an average 17.2%, compared with a 9.9% average decline for No. 1 fund firm Fidelity Investments' stock portfolios and a 7% average loss for the Vanguard Group.

EPS (WSJ 2002) Basic EPS consists of the common stock shares outstanding. It's computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. So it's easy to see that when more common stock shares are issued (the denominator), EPS will decrease.

Many will argue, though, that diluted EPS is a truer number. Not only is common stock included in the diluted EPS calculation, but so are things that could be converted to common shares and cause further dilution of the stock, a k a "common stock equivalents. So things like preferred stock, unexercised stock options and some convertible bonds are factored in as well.

Diluted EPS is everything that could cause dilution. Think of that number as your worse case scenario. If everyone exercises or converts everything, that's what the company's EPS would look like.

Managing Investment Risk : Bodie, Seigel, Ramaswamy. These are real heavy hitters. Read Bodie's comments about the lack of time diversification. I have repeated these comments for over 10 years- to almost all deaf ears.

Small Cap Inefficiency (Larry Swedroe 2002) One of the more persistent claims from Wall Street is that the inefficiency of information in small-cap stocks allows active managers to exploit market mispricings and outperform passive benchmarks. It is important to note that part of this claim is true - generally, the smaller the market capitalization, the fewer the number of analysts there are performing research on the company. Smaller companies also have less institutional ownership. The lower level of research being conducted might lead to an inefficiency of information. However, inefficiency of information is only a necessary condition for active managers to be successful. It is not, however, a sufficient condition. The sufficient condition is that the information inefficiency has to be large enough that after all expenses of the effort (including the costs of research, trading costs, and fund operating expenses) there is a positive return (alpha) above a passive investment alternative such as an index fund. Unfortunately, as you will see, there not only is no evidence to support the belief that active managers are likely to add value, there is also no logic to the belief either.

In his famous study, "On Persistence in Mutual Fund Performance," Mark Carhart found that for the period 1962-1993, after adjusting for style (comparing small-cap funds to small-cap benchmarks, value funds to value benchmarks, etc.), the average actively managed fund underperformed its proper benchmark by 1.8 percent per annum. If he had looked at after tax basis the performance would have been even worse. He also found:

There was no persistence in performance beyond that which would be randomly expected - the past performance of active managers is a very poor predictor of their future performance.

Turnover reduced pretax returns by almost one percent of the value of the trade. (1)

A study by Russ Wermers, covering the period 1975-1994, found that on a risk-adjusted basis the average actively managed fund underperformed a proper benchmark by 2.2 percent per annum. Once again, this figure is before the negative impact of taxes. (2)

A study by Jim Davis, covering the period 1968-1998, examined the returns of 4,686 funds. Davis sorted the funds into deciles by market capitalization. He found that there was no evidence of any superior performance of active managers.

Incubator Funds (Swedroe 2002) There is another bias in performance data that comes from the use of what are known as "incubator funds." Incubator funds are newly created funds, seeded by mutual fund families with their own capital. The funds are not available to the public. Here is one way the game may be played. A fund family creates several small-cap funds, possibly even under the same manager. Each fund might own a different group of small-cap stocks. The fund family incubates the funds, safe from public scrutiny. After a few years they bring public only the fund with the best performance. Magically, the performance of the other funds disappears. Unfortunately, a recent SEC ruling allows fund families to report the pre-public performance of incubator funds. Thus we have the potential for huge distortion of reality.

Total amount of closely held shares limits U.S. Ownership (2002)

Country	% of market cap closely held	% of U.S. investor portfolio	% of world market
Brazil	67.13	0.24	1.12
Canada	48.82	0.54	2.49
China	68.74	0.02	0.91
France	37.98	0.65	2.56
Germany	44.74	0.49	3.62
Hong Kong	42.73	0.21	1.81
Italy	37.54	0.32	1.51
Japan	38.38	1.04	9.72
Netherlands	33.74	0.81	2.05
Switzerland	25.73	0.47	2.53
UK	9.93	1.66	8.76
U.S.	7.94	91.29	49.6

Acquiring funds (WSJ 2002) In stock-fund mergers, for instance, the typical target fund trailed its average peer in each of the two years prior to the merger and then edged its average competitor in the year after the merger. The typical acquiring fund, however, went from topping its category average by more than two percentage points the year before the merger to being just about even with the pack the year after the merger.

In 1999 there were 490 fund mergers, compared to 924 last year. So far this year we've had 499. Ten years ago there were about 880 US stock funds and since then their ranks have nearly quadrupled. Industry vets say most stock funds need between $50 million and $80 million to cover their costs. Today more than 1,000 US stock funds have less than $50 million

Not worth the risk: (Weiss 2002) Only 20 percent of 7,055 U.S. common stocks adequately compensate investors for the amount of risk they are taking. At the same time, 51 percent of the lowest-rated stocks (those rated D+ or lower) are expected to deliver insufficient returns to cover the investors' risk, while 29 percent are only rated C (fair).

"Most Wall Street analysts often tell investors to hold on for the long-term, ignoring fundamental weaknesses in the companies they are recommending." "Instead, investors should continually review the risk of each of their holdings and sell those stocks that harbor excessive risks compared to their upside potential."

Overall, 63 percent of the 7,827 stocks Weiss reviewed posted negative average returns in the second quarter of 2002. Market sectors suffering dramatic declines over the quarter include biotechnology (down 31.02 percent), telecommunications equipment (down 28.93 percent), and broadcasting and cable television (down 23.11 percent). As investors moved into defensive stock holdings, some of the sectors that reported a positive average return for the quarter were gold (up 24.51 percent), homebuilding (up 13.06 percent), and aerospace and defense (up 11.82 percent).

A 2002 paper suggests that options do NOT have a positive effect on company performance. (NY Times) A number of explanations are possible. Other incentives, like cash pay and an executive's reputation, may be as strong as stock in motivating executives. Even if stock is a powerful incentive, the strength of the economy and the long-term health of a company may determine its results more than a group of executives can.

Bonds and dying. Something new for me- a death put. If you buy a bond and DIE, the company will buy back the bond at par. But you have to die- you cannot put the bond back to the company while you are alive.

Bond commissions: They were about 0.7% for newly issued muni bonds; 1% to 2% for bonds on the secondary market; under 1% for Treasuries and 2%+ for corporate bonds.

Bye bye (USA Today 2002) Since the bear market began in March 2000, 414 stock mutual funds have been liquidated, says Morningstar, the mutual fund tracker. That's half the liquidations in its database, which stretches back dozens of years and covers 4,074 stock funds. An additional 566 stock funds merged into other funds.

Bond funds have been a big victim of fund mergers. Morningstar says 584 bond funds have merged or liquidated since March 2000.

Standard Deviation (2002)- The range of standard deviations for ultra-short term bond funds is a mere 0.14 to 1.32, with an average 0.67. The standard deviations for precious metals funds range from 17.58 to 37.23, with an average of 25.74.

Ethics and competency: (Weiss 2002) Among the 62 brokerage firms covering companies filing for bankruptcy between May 1 and August 31, 2002, 46 firms, or 74 percent, continued to recommend that investors buy or hold shares in the failing companies (1) even as they were filing for Chapter 11, according to a study by Weiss Ratings, Inc., the nation's leading independent provider of ratings and analyses of financial services companies, mutual funds, and stocks.

A total of 54 publicly traded companies filed for bankruptcy during the four-month period studied. Of this group, 19 bankrupt companies were rated by the brokerage firms covered in this analysis, receiving a total of 126 ratings. Those ratings break down as follows:

Weiss Ratings determined that 90.9 percent of the ratings issued on companies filing for bankruptcy were either "buy" or "hold" ratings, compared to the 66.6 percent issued in this most recent four-month period. Conversely, the previous Weiss study found that only 9.1 percent of the ratings issued to the bankrupt companies were "sell" ratings, whereas "sell" ratings comprised 27 percent of the total ratings reviewed in the current Weiss study.

47% of Failing Companies Continued to Receive Unanimously Positive Ratings - Of the 19 failing companies rated by brokerage firms, nine, or 47 percent, continued to receive strictly positive ratings on the date of their bankruptcy filing. For example, on the day it filed for Chapter 11, APW Ltd. received two "buys" and five "holds." Another nine companies received a mix of positive and negative ratings, including Adelphia Communications, which received five "buys," three "holds" and two "sells," and WorldCom, Inc., which received seven "buys," six "holds," and fourteen "sells." Only one company, Panaco, Inc., received a "sell" rating exclusively. The table below summarizes the ratings received by the 19 rated companies that filed Chapter 11 between May 1 and August 31, 2002 as of the date of failure and six months prior to failure.

34 Brokerage Firms Fail to Issue Any Warnings to Investors - Among the 62 brokerage firms studied, 34 failed to issue a single "sell" rating on any of the companies filing for bankruptcy during the four-month period ending August 31. For example, CIBC World Markets maintained three "buy" ratings and two "hold" ratings on failing companies, while Thomas Weisel Partners maintained three "buy" ratings and one "hold" rating up through the date the rated companies filed for bankruptcy. In addition, Goldman Sachs and Credit Suisse First Boston each maintained five "hold" ratings on failed companies at the date of bankruptcy. Also sticking with "buy" ratings until the very end were ABN Amro, Argentina Research, Banc of America, Buckingham Research, Commerzbank Securities, Dresdner Kleinwort Wasserstein, Jesup & Lamont Securities, JP Morgan, Kaufman Brothers, Pacific Crest Securities, Performaxx AG, Raymond James, RBC Dain Rauscher, Robertson Stephens, Sanford C. Bernstein, SG Cowen, SoundView Technology, and USB Piper Jaffray.

Fourteen firms avoided issuing positive ratings on failing companies, issuing only "sell" ratings at time of bankruptcy, including Argus Research, BB&T Capital Markets, Davenport & Co., Fortis Bank and HSBC. Another 14 firms issued "sell" ratings by the date of the bankruptcy filing but also maintained at least one positive rating on other bankrupt companies.

Emotions and risk. (2002) Some readers will recognize these two individuals Kahneman and Tversky which are identified herein as the leaders in the psychology of investing. Kahneman just won the Nobel award for his work. Here is some commentary on how people think regarding risk and reward that suggest seemingly irrational wrinkles in behavior.

In a 1981 article, they reported results of a study in which 152 students were given hypothetical choices for trying to save 600 people from a disease. Using one strategy, exactly 200 people could be saved for certain. Using another, there would be a one-third chance everyone would live, and a two-thirds chance no one would be saved. Seventy-two percent of the subjects, preferring the less risky strategy, chose the first option. But when the researchers presented 155 other students with the same choice worded differently — either 400 people would die for sure or there would be a one-third chance that no one would die — only 22 percent chose the first option.

The difference, Professor Kahneman and Mr. Tversky explained, stemmed from the presentation of the options as sure gains or sure losses. People in their experiments generally shunned risk when gains, like lives saved, were in question — they wanted to lock in the gains with certainty. Yet people preferred risk when the alternative was a certain loss, even if taking the risk implied the chance of an even greater loss.

Efficient Market?: (2002) Burton Malkiel admitted that psychological factors affect the stock market and that markets overshoot, creating bubbles such as the Internet technology craze of the late 1990s that lifted stock prices to untenable levels. However, he said, “none of the patterns that have been discovered have been dependable, many have self-destructed as soon as they have been discovered, and many aren’t economically meaningful.” “The stock market is far less predictable than many of my academic colleagues have asserted. While the market is not statistically a perfect random walk, in my judgment investors would be very well-advised to act as if it was essentially unpredictable.”

Malkiel gave a few examples of alleged predictabilities that, he said, on closer reflection don’t hold up. One is the popular suggestion that growth stocks perform better over the long haul than value stocks. Even if it were true for a period, he said, there could be two explanations. One is the behavioralist explanation, which is that investors are overconfident in their ability to predict growth stocks and therefore overprice growth stocks. The other is the belief that efficient-market proponents hold – that if there’s a pattern for some time, it could be because the value stocks are actually riskier. In other examples, Malkiel noted that patterns in stock prices that get chalked up to investors being exuberant or pessimistic could simply be the adjustment of stock prices to economic conditions. For those in the efficient-market camp, however, the most convincing proof of the efficiency of the market is the fact that professional portfolio managers cannot consistently outperform the market.

And of course investors know which funds will beat another- "investors do not know in advance which managers will rise to the top. The 20 best performing funds in the 1970s, which doubled the returns of the S&P 500 index, underperformed the index in the 1980s, noted Malkiel. The 10 best in the 1980s underperformed in the 1990s. Those who managed the best funds in 1998 and 1999, which did three times as well as the S&P 500 index over the same period, were “written up in Money magazine as the genius portfolio managers,” said Malkiel, “and in 2000 and 2001 it was fly now, pay later, because they did three times worse than the index.”

On the other hand, Richard Thaler mentioned Bob Schiller, whose book Irrational Exuberance argued forcefully that prices were not rational during the Internet bubble, called the confusion about this “one of the most remarkable errors in the history of economic thought.”

Both professors agreed that stock market bubbles eventually deflate but that it’s difficult to predict when that will occur. Similarly, they noted that it’s hard to take advantage.

What troubles Malkiel most as a proponent of efficient markets, he conceded, “is that when the market got it wrong, the market was not giving the right signals to businesses about what the true cost of capital was – and we had an enormous overinvestment in not only Internet companies but the telecommunications structure to make the Internet run.” About 95% of the long-distance fiber is currently unused. “We had a tremendous misallocation of resources.

For Thaler this misallocation of capital is a big iceberg. “The fact that it’s hard to predict prices and that most money managers don’t earn their fees do not tell us anything about whether the capital markets are doing a good or bad job of allocating capital,” he said. “We know there was a $7 trillion mistake in the late 1990s.” He doesn’t think the government or any other entity could do a better job of allocating resources, but that doesn’t mean the market is efficient.

My comment- overall, the market is very efficient. It may be immediately but it may also take a day, week, year or more. I certainly believe that, at some point, perhaps, if necessary over a long period of time there is absolute efficiency. Take for example the 1990's. Everybody had the same info- but the value of the market was undeniably scewed. That's because the makret, at times, is almost totally emotinally driven (IPO's and tech stock) and may not make any current sense. Finally it makes a move towards rationality- hence the downturn to something more logical. There is currently another overreation but, at some point, it will correct to proper efficiency. Sometimes, however, you only know after the fact.

Buy and Sell: (2002) in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since.

Stock Options A lengthy pdf article on the nature and use of stock options from Clark and Bardes

Turnover: (Morningstar, USA Today 2003) the average stock fund has a 111% turnover rate. As for large-company value funds- Those with the highest turnover fell an average 5.9% the past five years.

Funds with the very lowest turnover, however, were the second-worst performers. The best returns went to those funds in the second quartile — above-average turnover.

Utility Stocks: (2003) these stocks never deserved their reputation for safety. "As a stand-alone asset, utilities have never been a good deal for widows and orphans, or anybody else, for that matter," argues William Bernstein. over the past 50 years, investors could have matched the return on utilities, but with far less risk, by buying a mix of 30% bonds and 70% in the Standard & Poor's 500-stock index.

"Demography and the Long-Run Predictability of the Stock Market" (NY Times 2003) Three professors, John Geanakoplos of Yale, Michael J. P. Magill of the University of Southern California and Martine Quinzii of the University of California at Davis suggest that while the market may rally periodically, its overall direction will be downward until around 2018.

The professors' approach depends on a simple indicator: the ratio of the number of middle-aged people to the number of young adults in the population. When this ratio rises, the overall market's price-to-earnings ratio will rise, too, the professors predict. When the age ratio declines, as it is likely to do until about 2018, the market's P/E will also decline.

The big difference in the sizes of these generations has already led to wide swings in the stock market, the study found. As the first baby boomers approached middle age in 1985 and began investing heavily, their buying more than offset the selling of the older generation then entering retirement. Stocks entered a multiyear bull market.

That trend is reversing, according to the model, which predicts that the market has entered a long decline caused by baby boomers selling stocks as they approach retirement. The sales will be only partially offset by the purchases of the smaller group entering middle age.

The model predicts that this long-term trend will not turn positive again until after 2018, when retirees' stock sales will be more than offset by the purchases of younger investors. This trend will strengthen as the larger baby boom "echo" generation, born between 1985 and 2005, enters middle age.

Mutual Funds: (WSJ 2003) Even though many straggling funds are routinely merged away, taking their records with them, more than 70% of actively managed U.S. stock funds still trailed the S&P 500 in the 10 years ending Nov. 30 according to Morningstar data. The sundry fees and sales charges levied by funds are major contributors to that woeful record along with investors' belief that they can pick stocks or managers that will beat the market over time.

Two professors, [John Freeman of University of South Carolina and Stewart Brown of Florida State,] found that the largest 10% of pension funds [with average assets of $1.6 billion] had average advisory fees of 0.2%, while the largest 10% of mutual funds [with average assets of $9.7 billion] had advisory fees that were 2.5 times those of pension funds. This is just an advisory fee [for managing the portfolio], not the fee for sending out statements and so forth.

Lipper Inc. (2003) said 96 percent of equity funds finished the year in negative territory. Morningstar noted that precious-metals funds were up more than 65 percent, and real estate funds, up a bit more than 4 percent.

New fund rating system? (NY Times 2003) Three professors, Randolph B. Cohen and Joshua D. Coval of the Harvard Business School and Lubos Pastor of the University of Chicago Graduate School of Business, new technique assumes that a manager's ability can be detected by comparing his portfolio with those of other fund managers — and not by looking at his own past performance. If the stocks he currently owns are also owned by managers with stellar records, for example, then the odds are high that he is a good manager. In contrast, he probably is not worth betting on if he holds only stocks that are primarily owned by managers with awful records.

Under the new system, a fund with a dismal record may receive a high rating, provided that its current holdings overlap with those of portfolios with good records.

The new system is superior in two ways to approaches that focus only on results. First, there is a higher degree of statistical confidence in its conclusions — from four to eight times higher, according to the professors, depending on how those traditional approaches adjust performance for risk.

Consider funds that have been around for less than five years — a group that, according to Lipper Inc., now contains 55 percent of all United States diversified and sector equity funds. According to Professor Cohen, a focus on track records alone for such funds "can be quite misleading" because there is not enough data to have much confidence that winning managers have genuine ability or that losers were not just unlucky.

Hedge this (NY Times 2003) Mr. Ackman and Mr. Berkowitz were both hard-driving Harvard Business School graduates who set up Gotham Partners Hedge Fund in 1993 with just $3 million in assets that, at their peak in 2000, ballooned to $568 million.

They had a glittering client list, dazzling reputations and smarts galore. But it blew up. They received a mountain of requests from investors asking for their money back and had suffered a devastating setback in one of their biggest investments.

Why did they have problems? "An examination of Gotham's activities in recent years shows a series of ill-timed bets, a surprising lack of diversification and a dangerous concentration in illiquid investments that could not easily be sold when investors wanted their money back. Looking back, it appears that Mr. Ackman and Mr. Berkowitz made a classic investment mistake, throwing good money after bad. "

The men described themselves to investors as value-oriented and risk-averse. They are 36 and 40 years old. Gee, lots of business and real life experience, eh?

Buy and Sell (WEISS 2003) Among the 30 brokerage firms covering companies filing for bankruptcy between September 1 and December 31, 2002, 20 firms, or 66 percent, continued to recommend that investors buy or hold shares in the failing companies right up to the day they filed for Chapter 11, according to a study by Weiss Ratings, Inc., an independent provider of ratings and analyses of financial services companies, mutual funds, and stocks. This represents a modest improvement compared to earlier Weiss studies that showed 74 percent of brokerage firms recommended companies failing between May 1 and August 31, 2002, and 94 percent recommended those failing between January 1 and April 30, 2002.

During the four-month period ending December 31, 2002, 51 public companies filed for bankruptcy. Of this group, 18 bankrupt companies were rated by the brokerage firms covered in this analysis, receiving a total of 55 ratings.(2) These ratings break down as follows:

Breakdown of Ratings Issued by 30 Brokerage Firms on Companies Filing Chapter 11

In analyzing the breakdown of ratings issued on failing companies, Weiss found that the number of "sells" rose to 50.8 percent by year-end as the industry responded to calls for reform. Conversely, the number of "buy" and "hold" ratings declined to 6.8 percent and 35.6 percent, respectively.

Among the 30 brokerage firms studied, nine, or 30 percent, issued only "sell" ratings on companies filing for bankruptcy during the last four months of 2002. Lehman Brothers and Salomon Smith Barney accurately warned investors about troubled companies, each issuing four "sells" exclusively. The other firms that warned investors of failing companies, issuing only "sells," were Blaylock & Partners; Buckingham Research; Deutsche Bank; Goldman Sachs & Co.; Kaufman Bros.; Loop Capital Markets; and Merrill Lynch. In contrast, the four brokerage firms maintaining a "buy" rating on a company filing for bankruptcy between September 1 and December 31 were Bear Stearns; Credit Lyonnais; Punk, Ziegel & Company; and SCO Financial Group.

Hedge: (2003) Van Hedge Fund Advisors estimates there are 4,600 hedge funds controlling $340 billion in assets, or less than 1% of the $36.6 trillion at work in the nation's capital markets.

But the industry has grown at a 20% clip in recent years as more investors have sought out sophisticated fund managers to hedge the risk of tumbling stocks.

Buying stocks in a 401(k): (NY Times) Until recently, brokerage accounts in retirement plans have been limited to small companies. By last year, 11 percent of large companies — those with 5,000 or more employees — included brokerage accounts in their 401(k)'s, according to a survey by the council. That compares with 5 percent in 1997. Self-directed accounts are expected to be offered in nearly one-third of all retirement plans by 2006.

One impediment to the rapid rollout of 401(k) brokerage accounts is fear of corporate liability. Federal regulations protect 401(k) sponsors from liability for losses incurred by participants who make their own investment decisions, but the sponsor is responsible for selecting and monitoring investment managers and investment options.

Just 6 percent of eligible 401(k) participants nationwide have actually opened individual accounts at companies that offer them."

Anybody buying stocks in a 401(k) is almost universally a moron. O.K., that's harsh. Stupid is fine.

Brokers: There are about 600,000 Series 7 licensed brokers in the U.S. And millions of stupid people that use them. The fundamentals of investing have never been taught as part of any licensing training to brokers. And these fundamentals are not found on the back of a cheerios box.

Dividend Stocks (Weiss 2003) Dividend-paying stocks outperformed their peers in 2002, delivering an average total return of 5.1 percent to investors, compared to a 22.1 percent loss in the S&P 500 Index and a 17.3 percent average loss among all non-dividend-paying stocks, according to Weiss Ratings, an independent provider of ratings and analyses of financial services companies, mutual funds, and stocks. Weiss noted that the 5.1 percent total return generated by dividend-paying stocks was composed of a 3.2 percent average dividend yield plus a 1.9 percent average stock price appreciation during the year. Among the 2,009 dividend-paying stocks studied by Weiss, only 725, or 36 percent, currently receive a favorable (B+ and higher) Weiss Investment Rating.

Hedge: (USAToday 2003) Once available only to investors with net worths north of $1 million who could invest $250,000, a new breed of hedge funds aimed at the masses allows investors to get in for as little as $25,000. Hedge fund assets have doubled to $600 billion in just four years. There now are an estimated 6,000 hedge funds, double just five years ago.

The ability to short the market, or make money when stocks fall, has helped hedge funds shine during the bear market. The average hedge fund gained 15% from 2000 through the end of 2002, vs. a 33% drop for the Standard & Poor's 500 index, says Van Hedge Fund Advisors. Last year, funds specializing in short selling gained 32%, tops among hedge fund styles and far better than the S&P's 23% decline.

But 800 hedge funds shut down last year, mostly because of insufficient capital. Funds typically charge an upfront management fee of 2% — and then get a 20% cut of the profits."

I think it is almost comical why some use hedge funds. they note that they lost a lot of money in the past recession and therefore hope to make some of it up by buying risky hedge funds. Joke. Why did they not simply reduce their risk exposure during the downturn and buy some bonds. They would make essentially the same return as a hedge fund with about 75% less risk. Ah, but that might be obvious- heaven forbid.

Motley foolish: (2003) according to the Hulbert Financial Digest's calculations, their model portfolios produced an average loss of 26.4 percent, in contrast to a 20.4 percent loss for the Wilshire.

How have the Motley Fool portfolios stacked up over the 6-plus years the HFD has tracked the service? Taking into account several portfolios that it used to maintain but which were discontinued along the way, the HFD calculates that the Motley Fool produced a 1.3 percent annualized return between Jan. 1, 1997 and Jan. 31, 2003, underperforming the 3.4 percent annualized return of the Wilshire 5000 over the same period.

Furthermore, among the 98 newsletters for which the HFD has data over this 6-plus year period, the Motley Fool stands in 62nd place.

Managed Accounts: (NY Times 2003) separately managed accounts, which generally require a minimum investment of at least $100,000, have become increasingly popular. Investors in these accounts actually own the individual stocks and bonds in their portfolios, allowing a higher degree of control and more efficient tax planning than in mutual funds. Annual fees average close to 2 percent of assets a year, according to the Money Management Institute. By comparison, the average stock mutual fund charges 1.47 percent of assets a year for management and other administrative fees.

Despite the sharp market decline last year, total assets in separately managed accounts fell only 1 percent, to about $399 billion, largely because 500,000 investors opened accounts, according to the Money Management Institute, for a total of about two million. The far larger mutual fund industry lost 8 percent in assets last year, closing at $6.39 trillion, according to the Investment Company Institute, a fund trade group.

The largest of these independent stock-and-bond pickers, with $20 billion in assets for separately managed accounts, is Brandes Investment Partners of San Diego. Its United States value equity portfolio lost 21.7 percent last year, before fees, according to Morningstar, compared with an 18 percent loss for the Russell Top 200 Value index, a benchmark for large-cap value stocks.

TCW, which manages about $6 billion in separately managed accounts, also had a poor year. TCW Value Opportunities, a $1.7 billion portfolio, lost 26 percent last year, compared with a 16.2 percent loss for the Russell Mid-Cap index. TCW's mid-cap growth and small-cap growth portfolios also had disappointing years. The mid-cap growth portfolio was down 34.7 percent and the small-cap one by 45.4 percent.

O'Dean: (2003) The professor at UC Berkeley has published lots of data on behavioral finance. His research noted that people sell their winning investments more than their losing ones by about factor of 1.5 to 1. So why do they do that? Overconfidence. And they have limited spans of attention.

He also notes that investor confidence increases in a market that is doing well. There are a lot of investors who think they are geniuses rather than realize that they are taking part in a bull market. "Don't confuse brains with a bull market".

Men trade 45% more actively than women. Single men traded 67% more actively than single women.

He pointed to investors unrealistic perception that knowing more about stocks can lead to better results and the illusion that people can take control of their investing future.

The industry was "pushing people's psychological buttons to get people to trade on their own."

The glut of easily available information about publicly traded stocks is similar to a roulette wheel. You could obtain every possible piece of information about a roulette wheel- the material from which it was made, its technical specifications, its results every time it has ever been spun. But you wouldn't be able to pick where the ball would land the next time it was spun. Similarly, investors can be fooled into thinking that because they have a lot of information about a particular stock, they can predict its future.

"What people have to be careful about is not to trade more actively because it is easier (the internet). There is a form of overconfidence that comes from having too much information.

What about the best mutual funds?. He found that 39% of new mutual fund purchases came from the 10% of funds with the best performance last year. The danger is that investors are likely to buy a mutual fund when its price is too high.

Fund Numbers (WSJ 2003) There were nearly 8,300 funds at the end of last year. The Nasdaq Composite and S&P 500 are off more than 70% and 40%, respectively, from their 2000 peaks.

Beat the market: Joshua D. Coval of the Harvard Business School, David A. Hirshleifer of Ohio State University and Tyler G. Shumway of the University of Michigan- the professors found that about one-fifth of these frequent traders had genuine stock-picking ability. In that group, the average stock gained 44 percent a year, annualized, over this period, versus 14.5 percent for the Wilshire 5000. The findings were also adjusted for risk, to ensure that investors had not beaten the market simply by taking on greater risk in a period when stocks generally were rising.

The professors saw little evidence of stock-picking ability among most of the other investors. Though their average stock slightly beat the market, the professors found that the margin of outperformance was not enough to pay commissions and bid-asked spreads. In other words, a large majority of investors would still be better off investing in an index fund.

About 10 percent of the active traders stood out because their stock picks consistently underperformed the market — reflecting what the professors called "negative ability." The average stock picked by this group lost 23 percent, annualized. These traders clearly would improve their returns by investing in an index fund.

compare each of your 25 most recent stock picks to its appropriate index, being careful to find a benchmark that matches its market capitalization and value or growth characteristics. If you find that at least 18 of those 25 stocks have outperformed their benchmarks over the time you have held them — and that the 25 stocks' average return beats that of their benchmarks — you probably have what it takes to beat the market.

Buffet and Hedging: derivatives are "financial weapons of mass destruction" and pose a "mega-catastrophic risk." Derivatives contracts involve a wide range of securities that typically involve a future payout that is pegged to variables like stock prices, interest rates, or currency values. The market has exploded as investment banks devise new types of instruments to both hedge against market risk and profit from swings in securities markets and interest rates.

For institutions that invest in them, derivatives can be difficult to exit, said Buffett. Derivatives contracts also invite erroneous accounting because they are often valued on assumptions that can be wildly inaccurate, he said. The marking errors almost invariably "favor either the trader who was eyeing a multimillion-dollar bonus, or the CEO who wanted to report impressive 'earnings,"' he said. Furthermore, the problem could become systemic because large amounts of market risk have become concentrated in the hands of relatively few derivatives dealers. The dangers have already been exposed in the electricity and gas businesses, he said, where derivatives activities have diminished substantially. However, other derivatives businesses continue to go unchecked, he said. Regarding the stock market, Buffett said that despite three years of falling prices, relatively few stocks are attractive. "Unfortunately, the hangover may prove to be proportional to the binge," he said. Berkshire Hathaway was able "to make sensible investments" in junk bonds and loans, he said. Its investments in those sectors have sextupled, reaching $8.3 billion by year-end

Book Value (WSC 2003) One of the key indicators that contrarian investors like to look at is the price-to-book (P/B) multiple. Book value is an accounting calculation that shows the difference between assets and liabilities. In theory, book value represents the cash that could be raised by selling off all of a company's assets and repaying all of its debts. Since the costs of starting a business from scratch are higher than that of purchasing an existing business for the net value of its assets, book value is often considered to represent the minimal value of any existing business. For this reason, many investors consider a company trading below its book value to be undervalued

Momentum Investing: (NY Times 2003) academic studies show that stocks that had risen the most over a six-month period, on average, outperformed the market for an additional 6 to 12 months — and that stocks whose prices had declined the most tended to continue lagging behind.

Psychologists have long known that because people hate to acknowledge mistakes, they tend to hold on to losing stocks longer than they keep winners, a tendency known as the disposition effect. In their study, Professor Grinblatt and Professor Han linked the idea to momentum. They concluded that the disposition effect slows the pace of investor reaction to new information.

Consider a company whose stock price rises in response to good news. This increases the number of investors who hold the stock at a profit, which leads to an increase in the proportion of owners who have an above-average predisposition to sell. The increased selling pressure puts a damper on the stock's reaction to the good news.

A similar process occurs when a company reports bad news. As its stock declines, the number of investors who hold it at a loss starts to climb. Because these investors are relatively reluctant to sell a stock when it is down, the pressure on the stock will decline, mitigating the fall in its share price.

This period of underreaction, however, doesn't last forever. The underreaction, for example, prompts new investors to buy stocks whose prices have not fully incorporated the good news or to sell short issues that have not fully reflected the bad news. This buying and selling tends to cause these stocks to continue in the direction in which they first moved on the news — creating price momentum.

Hedge funds (2003): Out of 1,757 hedge funds in the TASS Database, 223 have closed this year. When returns are not that great and you have fees at 20%, it's tough to stay positive.

Mutual Funds Ranked by Kalman Alpha (NY Times 2003) all major rating systems have simply placed funds into whatever peer group seems most similar, based on the most recent report of the fund's investment holdings. The systems then make statistical comparisons that assume that the funds have never deviated from that category. A fund in the small-cap category, for example, is assumed to have invested only in small-cap stocks even if, in the past, it has often held a big portion of large-cap shares.

At least since the mid 1980's, researchers have known that these classification difficulties lead to skewed judgments about the performance of funds that change their investment styles.

The Kalman Filter uses a fund's raw returns to continuously update a forecast of the fund's future performance.

The filter does that by constructing a unique benchmark for each fund, based on the returns of the fund and those of a series of conventional stock market style indexes. The filter adjusts the fund's individual benchmark based on a probability analysis of the shifts that the fund is making among various investing styles. The researchers rate a fund highly only if it has significantly outperformed its own benchmark.

To test their application of the filter, the researchers calculated the return of a portfolio that invested each month in the five funds that outperformed their respective benchmarks by the greatest amount over the previous five years. (That means the portfolio does not necessarily own the five funds with the largest absolute returns.) From January 1993 through 2002, the portfolio beat the Wilshire 5000 by 5.9 percentage points a year, on average. The portfolio also outperformed all other rating systems studied by the researchers.

How does some of the best computer programs compared in doing a retirement analysis.

Think about it. The best software that have next to no correlation each to another. That's not retirement planning- that's guessing.

Consistency: (2003) And two more recommended retirement portfolios from mPower and Financial Engines for 35 year old with 30 years until retirement, $50,000 in current retirement savings and a desired risk profile of 1.5, where average market risk is 1.

The reasons you would use them? They are cheaper than an adviser. And maybe not any better.

Wanna hurt yourself? (2003) Then read this: "The Impact of CEO Turnover on Equity Volatility," by Joshua Rosenberg, Matthew Clayton, and Jay Hartzell . A change in executive leadership is a significant event in the life of a firm. This study investigates an important consequence of a CEO turnover: a change in equity volatility. The authors develop three hypotheses about how changes in CEO might affect stock price volatility, and test these hypotheses using a sample of 872 CEO turnovers over the 1979-95 period. They find that volatility increases following a CEO turnover, even when the CEO leaves voluntarily and is replaced by someone from inside the firm. Forced turnovers increase volatility more than voluntary turnovers—a finding consistent with the view that forced departures imply a higher probability of large strategy changes. For voluntary departures, outside successions increase volatility more than inside successions. The authors attribute this volatility change to increased uncertainty over the successor CEO's skill in managing the firm's operations. They also document a greater stock price response to earnings announcements following CEO turnover, consistent with more informative signals of value driving the increased volatility. The findings are robust to controls for firm-specific characteristics such as firm size, changes in firm operations, and changes in volatility and performance prior to the turnover.

Going backwards: The odd connection between investment losses and rising fund expenses might be most painful in the tech-fund category. At the end of 1999, the average tech fund had more than a billion in assets and carried a 1.77% expense ratio. Today, average assets are down to $331 million and expenses are a smidge above 2%, compared with about 1.5% for the average stock fund. That's a 14% rise for a category that averaged a 30% annual loss over the past three years.

Kahneman and Tversky published a paper that included results from subjects who answered two comparative money problems. And their responses appeared to reveal systematic deviations from rationality: In problem No. 1, subjects were given an imaginary $1,000 and asked to choose between (a) a 50 percent chance to gain $1,000 and a 50 percent chance to gain nothing and (b) a sure gain of $500. In problem No. 2, subjects got $2,000 and were asked to choose between (a) a 50 percent chance to lose $1,000 and a 50 percent chance to lose nothing and (b) a sure loss of $500. The results? In the first problem 84 percent chose (b). In the second, 69 percent chose (a). What's odd here is that if the majority opt for the $1,500 of (b) in problem No. 1, the majority therefore ought to take the same $1,500 payout in answer (b) in the second problem. But instead the majority is willing to take the risk to try to ''break even'' when the problem is framed in terms of losses. Irrationally, people feel differently about losing than they do about gaining, even if either choice produces the same outcome.

It's only money: (2003) Per Wharton insurance and risk management professor Kent Smetters and Cleveland Federal Reserve Bank economist Jagadeesh Gokhale, the U.S. government’s future obligations outweigh its projected revenues so heavily that it would need a permanent income tax increase of 66% or the immediate elimination of all federal discretionary spending to put it on track for balancing its finances. The two argue that the government’s accounting system is backward looking and so has failed to properly account for future outlays such as Social Security and Medicare.

Why small amounts of bonds can hurt your yield: (NY Time 2003) "Investors who buy in bulk can get better yields. For example, at 1:30 p.m. on Friday an investor on Schwab.com seeking to buy just one AAA-rated bond from GE Capital, due on Jan. 19, 2010, with a coupon of 7.375 percent, would receive a yield to maturity of 2.689 percent; someone buying 20 bonds would get a yield to maturity of 3.427 percent. Bond prices move inversely to their yield; a bond generally has a face value of $1,000."

Next time someone wants to buy stock, ask them to tell you what these individual analyses mean. P/E, P/B, EPS, EVA, WACC, CAPM, ROE, RAROC, ROIC, NPV, DCF.

And the answer is: P/E: Price-to-Earnings; P/B: Price-to-Book; EPS: Earnings Per Share; EVA: Economic Value Added; WACC: Weighted Average Cost of Capital; CAPM: Capital Asset Pricing Model; ROE: Return on Equity; RAROC: Risk-Adjusted Return on Capital; ROIC: Return on Invested Capital; NPV: Net Present Value; DCF: Discounted Cash Flow

Investing: (Simon) Among circumstances that a trustee shall consider in investing and managing trust assets are such of the following as are relevant to the trust or its beneficiaries:

4. the role that each investment or course of action plays within the overall trust portfolio;

6. other resources of the beneficiaries known to the fiduciary as determined from information provided by the beneficiaries;

7. needs for liquidity, regularity of income and preservation or appreciation of capital; and

8. an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.

Factors that the trustee may want to consider when examining investments proposed for trust portfolios:

(1) Expectations concerning the investment’s total return, and also the amount and regularity of the income element of that return whenever the beneficial interests or purposes supported by the trust are affected by distinctions between trust accounting income and principal;

(2) The degree and nature of risks associated with the investment, and the relation-ship of its volatility characteristics to the diversification needs of the portfolio as a whole;

(3) The marketability of the investment, and the relation between its liquidity and volatility characteristics and the amount, timing, and certainty of the trust’s cash flow or distribution requirements;

(4) Transaction costs (including tax costs) and special skills associated with the acquisition, holding, management, and later disposition of the particular investment; and

(5) Any special characteristics of the investment that affect its risk-reward tradeoffs and effective return, such as exposure to unlimited tort liability, the presence and utility of tax advantages, and the maturity dates and possible redemption provisions of debt instruments.

Remember the IPO mania? (2003) As part of the proposed $1 billion settlement against more than 300 companies that sold IPOs during the dot-com boom, the lawsuit reveals CacheFlow's insane one-day pop wasn't an accident.

Top customers were given impossible-to-get shares of the hot IPO only if they agreed to keep buying the stock after it began trading, at prearranged, escalating prices. The investment banks not only collected lucrative trading fees, but also made a splash. But common investors, unaware the stock was soaring because of these secret deals — not the strengths of the business — assumed the company's prospects were better than they really were, the lawsuit claims

“The Limits to Dividend Arbitrage: Implications for Cross-Border Investment.” (2003) Wharton finance professors David Musto and Christopher GeczyIndividual investors are often advised to keep 10-20% of their portfolios in foreign stocks, and these days that’s easy to do with a slew of mutual funds. But there’s a problem most investors don’t notice: Many countries require stock issuers to withhold taxes on dividends paid to Americans and other foreign shareholders. This can have important consequences for non-taxable accounts, particularly retirement savings. ,

IRS stops stock option tax shelter: (2003) Under the shelter that is being disallowed, an executive transfers the options to a family member or partnership in return for an unsecured loan. The family member or partnership would be able to exercise the options, and the executive could then delay paying taxes on them until the loan was repaid.

One key to the deal is the artificially reduced price at which an executive would sell his stock options to his family's partnership in return for a promise to be paid 15 years later. The I.R.S., in issuing a revenue ruling disallowing the shelter, said the price paid by family partnerships for the stock options would "rarely, if ever, reflect terms that would be agreed to between unrelated parties."

The crucial element in making the deal attractive was the sale of the executive's stock options at a fraction of their real value to a family limited partnership, which would then exercise the options and use the cash proceeds to buy a diversified investment portfolio.

The executive received a note from the family partnership that paid only interest for 10 years or more, which was taxable to the executive.

The executive also received an i.o.u from the partnership for the artificially low value placed on the options when they were transferred. The note was due in a balloon payment a decade or more into the future, at which point the executive would owe taxes on that money.

Repurchase agreements (NY FED 2003) "The Repurchase Agreement Refined: GCF Repo," by Michael J. Fleming and Kenneth D. Garbade (Current Issues in Economics and Finance, June 2003) One of the largest and most important of the money markets is the market for repurchase agreements. In a repurchase agreement, a borrower of money effectively agrees to provide securities as collateral to the lender to mitigate credit risk. GCF Repo is a recent innovation in this market that reduces transaction costs, enhances liquidity, and facilitates the efficient use of collateral. (professional article)

Perception (Dick LePre 2003): "When it comes to markets, perception is reality. Or, if it is not, it is a lot more important than reality.

In non-economic areas this is true. People are judged, to a significant extent, by their appearance. Clothes, plastic surgery, make-up, high-heel shoes, hair-dos, fancy cars are all about perception.

The "perception is reality" thing may be more true in business and investing than in other areas of society. The entire Internet stock bubble was based on perception not reality. This was not a couple of grifters ripping off some little old lady's life savings; this was a relatively small number of people fooling the majority of the investment community. People make investment decisions based on flimsy information. In addition there is a herding mentality. If enough people thought that Red Hat was worth more than $100/share then, for a brief time, it was. Perception made that market. In the longer run, reality has a way of catching up.

The issue with equities is that many folks in the market do not do enough research because they are not really interested in the stock as a long-term investment opportunity but are only interested in it as a speculative medium."

My comment at this point is that people don't do enough research even on long term investments. For those that do, they simply do not have the requisite skills to understand the nuances of the issues anyway- hence they are doomed to begin with. As stated repeatedly, if you do not know what diversification is by the numbers, you do not hage a clue to the fundamentals of investing and any- certainly most- effort towards analyzing individual companies.

Commentator Donald Moine noted, "Brief spectacular run-ups in the market are usually:

Based more on human psychology than on market fundamentals. For example, many of the companies whose stocks have doubled in price recently have not doubled their sales or earnings. A number of these stocks are still losing money and are still burdened by huge debt.

Accompanied by increased buying. One well-known market commentator characterized the recent pattern of purchases as "panic buying."

Fees: (2003) Morningstar found 57 index funds that charged more than the 0.18 percent — or 18 basis points — charged by Vanguard. The average fee at these funds last year was an astonishing 0.77 percent. The study reckoned that shareholders overpaid by $140 million to own these funds, which an orangutan could run.

The study found 65 money market funds that charged more than the 0.33 percent fee for Vanguard's Prime Money Market fund. The average expense ratio among the funds was 0.97 percent; their shareholders overpaid by $160 million to own them. (Morningstar's data includes only a fraction of money market funds, so the overpayment is vastly understated.)

Number of mutual funds (Investment Company Institute 2003) If you count up all the nation's open-end mutual funds and then net out multiple share classes, to avoid counting the same fund several times, you get 8,253 funds.

Some counters choose not to net out multiple share classes, which would give you the figure 19,238. If you then added in closed-end funds and exchange-traded funds that trade on exchanges like stocks, the figure grows to 19,899

Going down- (WSJ) Companies have long debated whether it is better to offer employees lots of mutual funds -- or a more limited number of choices -- in their 401(k) plans. During the boom years, investors clamoring for the latest hot tech funds pushed for ever-more options. But now there is an emerging sense that employees may actually be more inclined to put money in their retirement plans if they have fewer choices.

large retirement-plan administrators such as Vanguard Group, Merrill Lynch's Retirement Group and Manulife Financial all say they're seeing companies streamline their investment choices. Some clients have trimmed their offerings from several dozen funds to about 15 or fewer.

And this is very interesting- but reflective of the human being. A recent study by economists at Columbia University found that 401(k) participation is higher when employees are offered fewer fund choices. In plans that give workers only two investment options, 75% of workers sign up for their 401(k) plans. When faced with 60 investment choices, enrollment is only 60%. Every additional 10 investment choices, on average, reduces expected participation rates by 2%.

While diversification is a mantra in the investment world, individual investors can also hurt themselves by spreading their money over too many funds. The result can be subpar returns, redundant holdings, and unnecessary taxes and fund expenses.

In all, more than 42 million people have a total of about $1.5 trillion invested in 401(k) plans. During 2002, more than $100 billion evaporated from 401(k) accounts.

Bogle on Funds: (2003) The average mutual fund investor owns approximately 4 equity funds. The average mutual fund manager lasts for 5 years. That means in 10 years, you have 8 managers. In 20 years, you have got 16 managers. In 30 years, 24 managers have taken roughly 3% a year out of your return. You are going to probably pick those managers based on their past performance, another big mistake. So the probability that the average fund investor is going to beat an unmanaged index over 30 years is zero.

Performance- Since 1984, there’s been a 2.9% difference between total stock market return and the return of the average equity fund. The average fund investor, because of timing and selection penalties, has actually done much worse. Costing himself another 5% by some calculations.

If you look back 30 years, you’ll see that half of the funds that existed back then are gone now. And that was in a stable mutual fund industry.

Costs: In 1951, the average expense ratio for the 25 largest funds, with aggregate assets of but $2.2 billion, was only 0.64%. What a difference five decades makes! In 2001, the average expense ratio for the equity funds managed by the 25 largest fund complexes has risen 134% to 1.5%, despite the fact that their assets have soared 845-fold, to $1.86 trillion. The dollar amount of direct fund expenses borne by shareholders of all equity funds has risen from an estimated $15 million in 1950 to something like $35 billion in 2002.

S&P: (2003) the 18 largest S&P 500 stocks account for one-third of the value of the entire index; the 100 largest account for 70 percent.

Hedging and Risks: (NY Times 2003) At the end of last year, models showed that Fannie Mae's portfolio would have lost $7.5 billion in value if interest rates rose immediately by 1.5 percentage points. At that time, the market value of all the assets on Fannie Mae's books, minus all the company's debts, was about $15 billion. So it would have lost roughly half its market value from such a sharp increase in interest rates, according to the models."

Some say this never could happen. Really? Neither could the mess with Long Term Capital(?). Or 9/11.

"Because it is so large, and because many investors think that the federal government will repay its bonds if the company cannot, the government could become engaged in a very expensive bailout of Fannie Mae if it mismanaged its risk, the company's critics warn. And if investors balked at buying Fannie Mae's bonds because they were concerned about the company's financial strength, mortgage rates could rise rapidly."

Hedging can make big bucks if the market acts normally. But the market acts irrationally and therefore the inherent risks can surface.

Stock picking: (2003) Vanguard analysed the performance of 420 US balanced mutual funds that operated in the period between 1962 and 2001. Balanced funds were defined as those with average long-run allocations to both bonds and equities of more than 20 per cent. Only funds with five years of return history were included. The actual performance of the funds was compared with a model portfolio - what the fund manager would have achieved if he or she had simply recreated the chosen asset allocation with index funds.

Vanguard found that, on average, more than 100 per cent of the long-term return of funds was attributable to asset allocation. In other words, the costs incurred in operating the fund were greater than the skills the managers displayed in either market timing or security selection.

Furthermore, the volatility of the model portfolio was only 86.6 per cent of the average fund. In other words, not only does a model portfolio achieve a higher return than most fund managers, it does so with lower risk.

Vanguard found that 7 per cent of the funds in its sample consistently outperformed the model portfolios, while 41 per cent consistently underperformed. On average, the funds that regularly outperformed had lower expenses and lower portfolio turnover than the underperforming funds.

Indeed, the funds with the highest costs produced a performance that fell short of the model portfolio by around a third (eg the model earned 15 per cent a year and the high-cost funds 10 per cent).

"Forecasting Recessions Using the Yield Curve," Marcelle Chauvet (Staff Report no. 134, August 2001) The authors compare forecasts of recessions using four different specifications of the probit model: a time-invariant conditionally independent version, a business cycle specific conditionally independent model, a time-invariant probit with autocorrelated errors, and a business cycle specific probit with autocorrelated errors. The more sophisticated versions of the model take into account some of the potential underlying causes of the documented predictive instability of the yield curve. They find strong evidence in favor of the more sophisticated specification, which allows for multiple breakpoints across business cycles and autocorrelation. They also develop a new approach to the construction of real time forecasting of recession probabilities

Say, just what is a balanced fund?: (WSJ 2003) For instance, credit-rating agency Standard & Poor's Corp. in London divides "asset allocation" -- that is, balanced -- funds into four categories with specific definitions: "defensive" funds can invest no more than 30% in stocks; "neutral" funds always have 30% to 70% of their portfolio in stocks; "dynamic" funds are "usually" invested 70% or more in stocks; and "flexible" funds can invest in any proportion in any asset class -- including 100% in stocks.

Investing: Per a John Hancock survey, after three years of a difficult economy, rising unemployment and declining stock prices, consumer investment preferences have changed in a fundamental way that will continue even after the economy recovers. Specifically, "decision-makers today are increasingly conservative, focusing more on protecting their financial assets and families than building wealth." Also, consumers believe it is more important than ever to choose companies that are known for: safer investment products (74%), expertise in products with guaranteed rates of return (71%), and conservative investment strategies (60%).

INVESTING (NY Times 2003) Some people end up doing nothing when confronted with the need to pick savings goals, select appropriate asset allocations, screen investment choices and rebalance their portfolios regularly.

Research shows that when employees have to fill out paperwork, their participation in savings plans is low. When they must open their own 401(k) plans, the participation rate for workers with less than 12 months of tenure is 50 percent, compared with 90 percent when employees are enrolled automatically but may opt out

401(k) participation peaks at 75 percent when a retirement plan offers two investment options. Her results, based on data from 647 company retirement plans run by the Vanguard Group, also show that participation drops to 60 percent when investors have 60 choices. With each additional 10 choices, participation falls by 2 percent.

As regards when employees had access to a planner- In the division that did not have access to the planner, 17 percent of employees chose to raise their savings each year. But in the division that had access to the planner, 38 percent chose to increase their savings. Nearly 42 percent of employees in that division met with the planner, and four-fifths of those who did increased their savings.

Hot and Cold (NY Times 2003) In a recent experiment, Loewenstein tried to find out how likely people might be to dance alone to Rick James's ''Super Freak'' in front of a large audience. Many agreed to do so for a certain amount of money a week in advance, only to renege when the day came to take the stage. This sounds like a goof, but it gets at the fundamental difference between how we behave in ''hot'' states (those of anxiety, courage, fear, drug craving, sexual excitation and the like) and ''cold'' states of rational calm. This empathy gap in thought and behavior -- we cannot seem to predict how we will behave in a hot state when we are in a cold state -- affects happiness in an important but somewhat less consistent way than the impact bias. ''So much of our lives involves making decisions that have consequences for the future,'' Loewenstein says. ''And if our decision making is influenced by these transient emotional and psychological states, then we know we're not making decisions with an eye toward future consequences.'' This may be as simple as an unfortunate proclamation of love in a moment of lust, Loewenstein explains, or something darker, like an act of road rage or of suicide.

Efficient Frontier: In a comment about the efficient frontier et al, David Loeper of Financeware.com noted that , "the only thing "proved" by the Brinson Hood and Beebower study is that pension funds are diversified. The only way r-squared could have been low was if pension funds ignored the prudence of diversification and concentrated their assets in non diversified portfolios or radically timed the markets.

The results of the study have been misinterpreted to mean that the asset classes you hold, regardless of whether they are diversified or not, are the driving forces of your investment results. It has been held out mistakenly as the "proof" that Modern Portfolio works.

To create an efficient frontier, a mean variance optimizer is applied to risk, return and correlations of asset classes. Lately, schotastic optimizers running Monte Carlo simulations have been used for "better" asset allocation optimizations for the optimization to be valid and prudent. One needs to have a high confidence level in all of the inputs to the optimizer.....that is..... risk, return and correlations between asset classes. One slip up on the estimates and the resulting efficient frontier can put us squarely in inefficient territory. Having studied this for the past years, I am almost of the opinion that the way most optimizers are run in practice is nearly a contrary indicator of future portfolio efficiency. That has to do with the inputs, not the formulas and the reality of our inability to accurately forecast risk, return and correlation. "

My comment- the reason that so many people have lost money is the wholesale reliance on people who place wholesale reliance on MPT as a static format. As stated here and in my book, worldwide, national and local economics keep changing- hence the reason why I provide so much commentary to this specific area. As this changes, certainly so does risk. You might be able to determine that if you are astute. Part and parcel is the change in the rate of return. That can only be guessed at but sometimes it falls into place when you simply view interest rates and how the FED will probably act. Next- and an almost impossibility- is how the correlation of various asset will interrelate with each other. That is more than a guess and the reason why adjustments are so precarious.

So some say just stay the course and be done with it. I disagree and the best real life example is 2000 forward. To just stay put and lose 40% or more is ludicrous. To keep putting money into the market- via the (wrong) dollar cost averaging- is also absurd. That you may not be totally correct in the movement of each and every asset when the economic world goes topsy turvy is better than being totally wrong.

I do not advocate market timing- trying to hit the highs and lows. But a blind focus on staying the course is almost as bad. A review and understanding of investing fundamentals is mandatory. But so is a consistent analysis of economics and adjusting as necessary. You adjust for risk first and foremost. You will get most of the returns of the best of the market- but not always. For example, in the 90's I used the S&P 500 which, at times, held as much as 29% in tech. But I refused to do any more tech.

In the alternative, you will miss most of the lows- but not always. For example, in 2000, I was still in the market when the tech market melted. But in short order, I had most of my clients totally OUT of equities and stayed there until this year.

Perfect? Of course not. Reflective of risk. Yes- and that, I believe, is the duty of a professional.

How we think we will feel: (2003) This represents a fascinating study that will have a major impact on investments. But considering the business per se, it will take at least a decade. AFter all, diversification is still not taught. (NY Times Gilbert, Wilson, Kahneman and Loewenstein) The problem is that we falter when it comes to imagining how we will feel about something in the future. It isn't that we get the big things wrong. We know we will experience visits to Le Cirque and to the periodontist differently; we can accurately predict that we'd rather be stuck in Montauk than in a Midtown elevator. However we overestimate the intensity and the duration of our emotional reactions -- our ''affect'' -- to future events. In other words, we might believe that a new BMW will make life perfect. But it will almost certainly be less exciting than we anticipated; nor will it excite us for as long as predicted. On average, bad events proved less intense and more transient than test participants predicted. Good events proved less intense and briefer as well.

One experiment of Gilbert's had students in a photography class at Harvard choose two favorite pictures from among those they had just taken and then relinquish one to the teacher. Some students were told their choices were permanent; others were told they could exchange their prints after several days. As it turned out, those who had time to change their minds were less pleased with their decisions than those whose choices were irrevocable.

Another recent study asked whether transit riders in Boston who narrowly missed their trains experienced the self-blame that people tend to predict they'll feel in this situation. (They did not.) And a paper waiting to be published, ''The Peculiar Longevity of Things Not So Bad,'' examines why we expect that bigger problems will always dwarf minor annoyances. ''When really bad things happen to us, we defend against them. ''People, of course, predict the exact opposite. If you ask, 'What would you rather have, a broken leg or a trick knee?' they'd probably say, 'Trick knee.' And yet, if your goal is to accumulate maximum happiness over your lifetime, you just made the wrong choice. A trick knee is a bad thing to have.''

Our emotional defenses snap into action when it comes to a divorce or a disease but not for lesser problems. We fix the leaky roof on our house, but over the long haul, the broken screen door we never mend adds up to more frustration.

Gilbert does not believe all forecasting mistakes lead to similar results; a death in the family, a new gym membership and a new husband are not the same, but in how they affect our well-being they are similar. ''Our research simply says that whether it's the thing that matters or the thing that doesn't, both of them matter less than you think they will,'' he says. ''Things that happen to you or that you buy or own -- as much as you think they make a difference to your happiness, you're wrong by a certain amount. You're overestimating how much of a difference they make. None of them make the difference you think. And that's true of positive and negative events.''

* ''Happiness is a signal that our brains use to motivate us to do certain things. And in the same way that our eye adapts to different levels of illumination, we're designed to kind of go back to the happiness set point. Our brains are not trying to be happy. Our brains are trying to regulate us.''

From Investment Advisor- "Investment issues are so complex and the inputs change so rapidly that the portfolio management task cries out for a reliable, simple framework for managing the decision process. Over the last quarter century, personal advisors have embraced just such a framework, loosely formalized under the rubric “modern portfolio theory.” The average advisor is now quite familiar with beta, duration, efficient frontier modeling, indexing, benchmarking, style boxes, Monte Carlo theory, and Ibbotson data on the history of interest rates, inflation and stock and bond returns. These have become our fundamentals, our tools, our “tradition,” if you will." And
"In open markets with significant participation by non-professionals, securities prices tend to reflect cyclical waves of emotional buying and selling as well as traditional economic influences. Long-term success in this semi-rational competitive environment requires alertness to change, an eagerness to realistically appraise both rational and emotional variables, and a willingness to re-examine the adequacy of our traditional tools."

It is true that the "average" advisor is aware of these issues- but that generally may be the extent. None of this is practically taught to such advisors. They use the sophomoric rhetoric and just buy software that does all their allocation. For those that think this harsh, simply pick up the most recent manual for CFP training and note that there is no practical training at all.

Bad practices (Bill Jahnke 2003) Longtime readers know that I have never accepted the stay the course mantra of the planning and "money manager" industries. The reason that so many advisers went in that direction is that they simply do not have the background to do independent thinking. remember, the CFP is effectively nothing more than one semester of college and does not contain enough information and knowledge to do much more than buy a software package based on some set of historical numbers.

Per Jahnke in part, "Many investment practices are based on the beliefs that markets are macro-efficient and that historical returns provide a reasonable basis for estimating future returns. According to the doctrine, investors should allocate as much to stocks as their tolerance for short-term volatility permits, and to stay the course regardless of investment performance unless the client’s circumstances change. Unfortunately, all of the assumptions underpinning the asset allocation policy doctrine are false and the acceptance of the doctrine supports a number of bad practices.

The pricing of asset classes does not operate in accordance with efficient market theory and equity returns are not governed by a stable return-generating process: the time series of stock market returns exhibits fat tails, short-term serial correlation and intermediate-term mean reversion. The “rational man” assumption, central to market efficiency, is false. The vast majority of investors do not base their investment decisions on a dispassionate valuation of well-informed, long-term cash flow projections.

The assumption that historical returns provide an acceptable basis for projecting asset class returns is false for the simple reason that the economic forces that generate returns are ever changing. It is hard to place much credence in the idea that the returns earned in the past adequately describe current investment opportunities and risks, when asset class valuations in terms of price/earnings ratios, yield curves, and economic conditions often deviate from historical norms, which themselves are evolving. The idea that historical returns or historical risk premiums can be extrapolated was promoted by database vendors and consultants, and it carries the tenuous assumption that the practice is consistent with a belief in the macro-efficiency of markets. There is no necessary link between the two.

Acceptance of the asset allocation policy doctrine has resulted in a number of bad practices. The doctrine promotes the belief that stocks are less risky than bonds in the long run, portfolio returns are largely determined by asset allocation policy and a random draw from a known distribution of asset class returns, and the distribution of expected returns converges on the geometric mean return over time. In this idealized world, the risk of investing is reduced to the probability of loss in the short run. In the real world, the uncertainty that investors face is the prospect of not meeting their financial objectives. In the real world, there is no guarantee that stock and bond returns will converge on long-term return expectations. Defining the risk of investing as the probability of loss in the short run is bad practice.

The asset allocation policy doctrine supports the practice of making projections of the probability of loss. The accuracy of return distribution projections, whether short or long term, is dependent on how much information regarding future returns is contained in historical data. Given that there is much about the future that is not discernable from analyzing historical returns, one should expect large errors in projection of returns and the distribution of returns.

* “When past performance of securities are used as inputs, the outputs of the analysis are portfolios which performed particularly well in the past. When beliefs of security analysts are used as inputs, the outputs of the analysis are the implications of these beliefs for better or worse portfolios.”

A growing list of researchers have challenged the practice of extrapolating the historical equity risk premium on a number of grounds, including that it is too large relative to the variability of stock returns for investment horizons longer than a year; that the premium reflects a secular expansion of the market’s price/earnings ratio, which should not be expected to continue; that the stock market is overvalued by traditional valuation yardsticks; that the premium should be lower because society is wealthier; and that future returns for stocks will be disappointing because of diminished earnings growth prospects due to excess capacity, global competition, the issuance of options, and the under-funding of pension and medical benefits. Extrapolating the historical equity risk premium is bad practice whether or not it is adjusted for the secular expansion of the price/earnings ratio.

Blind adherence to the asset allocation policy doctrine resulted in an over-estimation of the equity risk premium, which supported the emergence of the equity cult and contributed to formation of a stock market bubble in the 1990s. Overstating the equity risk premium has resulted in an over-commitment to stocks for many investors and the under-funding of financial plans.

Financial planners add value by continuously evaluating the financial planning implications of alternative economic scenarios, investment solutions and lifestyle choices, managing costs, and counseling a margin of safety in saving and investing. Anything less is bad practice."

And bad practice is exactly the mainstay of the industry. It won't get better till the industry is retrained.

Psychological Defenses: (NY Times 2003) ''The thing I'm most interested in, that I've spent the most time studying, is our failure to recognize how powerful psychological defenses are once they're activated,'' Gilbert says. ''We've used the metaphor of the 'psychological immune system' -- it's just a metaphor, but not a bad one for that system of defenses that helps you feel better when bad things happen. Observers of the human condition since Aristotle have known that people have these defenses. Freud spent his life, and his daughter Anna spent her life, worrying about these defenses. What's surprising is that people don't seem to recognize that they have these defenses, and that these defenses will be triggered by negative events.''

* ''If people do not know what is going to make them better off or give them pleasure, ''then the idea that you can trust people to do what will give them pleasure becomes questionable.''

1996 Yr End 1997 Yr End 1998 Yr End 1999 Yr End 2000 Yr End 2001 Yr End 2002 Yr End 2003 1st Qtr 2003 2nd

Black Monday- (NY Times 2003) SIXTEEN years ago today, the Dow Jones industrial average fell 22.6 percent. new research has found that one-day price swings as big as the one in 1987 are not extraordinary.

The frequency of huge daily gains and losses in the stock market has presented a perennial challenge to historians because these big moves are more frequent than would be expected if the market adhered to what is known as a normal, or Gaussian, distribution. In such a statistical pattern, sometimes also referred to as a bell curve, outliers - percentage changes that deviate significantly from the average - are extremely rare. For several years some researchers have suspected that the markets follow another pattern - a power law distribution, which predicts more outliers than a normal distribution. Power law distributions are widely recognized outside the investment arena. Earthquakes follow them, for example.

the researchers not only confirm that the stock market adheres to a power law distribution but also derive a formula that predicts how often a particular percentage change is likely to occur. They contend that they have captured a universal trait of investment markets. They have tested the formula in global stock and currency markets of varying sizes. Their findings imply that crashes are an inherent feature of markets and that investors are fooling themselves if they believe that another crash of 1987's magnitude will never occur.

Holding periods: Over the last 50 years, the average holding period for an investor in a mutual fund has fallen to less than 3 years from 16.

Fees: (2003) NASD today reminded securities firms they should have reasonable grounds for believing that a fee-based account is appropriate for a particular customer, in light of various factors such as the customer’s financial status, investment objectives and fee structure preferences.

Fee-based accounts, including some wrap accounts, typically charge a customer a fixed fee or percentage of assets under management in lieu of transaction-based commissions. NASD-regulated firms increasingly are offering customers fee-based accounts that charge a fixed fee and/or percentage of assets under management as an alternative to traditional commission-based charges for brokerage services. Many of these firms have expanded their fee-based programs to cover traditional brokerage accounts that do not include investment advisory services.

NASD reminds firms that before opening a fee-based account for a customer, they need to have reasonable grounds to believe that type of account is appropriate for that particular customer. Customers may have reasons, unrelated to the cost structure fee-based accounts, for deciding to handle their investment services on that basis, but all material components of the fee-based accounts, including the fee schedule, services provided and the fact that the program may cost more or less than paying for the services separately must be disclosed to the customer. Firms that administer fee accounts should make reasonable efforts to obtain information about the customer’s financial status, investment objectives, trading history, size of portfolio, nature of securities held, and account diversification. With that and any other relevant information in hand, firms should then consider whether the type of account is appropriate in light of the services provided, the projected cost to the customer, alternative fees structures that are available, and the customer’s fee structure preferences. In addition, there must be a supervisory system in place to monitor on an ongoing basis whether a fee-based account remains appropriate for a particular customer, and should review their sales literature, marketing material and other correspondence related to fee-based accounts to ensure the information is balanced and not misleading.

Hedge funds (NY Times 2003) I do not use these. The returns are too unpredictable and the risk too high. a new study suggests that, on average, hedge funds may perform worse than mutual funds.

Previous studies have overstated average hedge fund returns because of several deficiencies in hedge fund performance databases.

A Reality Check on Hedge Fund Returns," by Pieter Jelle van der Sluis, an assistant professor of finance at the Free University of Amsterdam, and Nolke Posthuma, vice president for research at ABP Investments.

databases for hedge fund performance are misleading because participation in them is voluntary. Each hedge fund decides whether to provide its performance data. Because young hedge funds have too little data to interest those databases' customers, the managers of these new funds often wait several years before starting to report their track records. If their records over those initial years turn out to be poor, they may choose not to report at all.

That wouldn't necessarily create a bias, however, if the databases recorded a hedge fund's returns only after it began reporting performance. But at major databases, that has not been the case. When adding a hedge fund, they also include its historical returns. Because that process, known as backfilling, excludes the poor returns of funds that choose not to report, it paints an overly optimistic portrait of the average hedge fund's performance

Once backfilled returns were eliminated, they found, the average annual return of hedge funds from 1996 through 2002 dropped to 6.4 percent from 10.7 percent.

But even the 6.4 percent figure is upwardly biased, the researchers said, because hedge funds typically do not report their returns over the last few months before they go out of business, during which their returns may be dismal. For example, the record of Long Term Capital Management in the TASS database ends in October 1997, nearly a year before its collapse.

The researchers were unable to measure the magnitude of this second type of bias. Professor van der Sluis and Mr. Posthuma came up with an estimate, however, by assuming that the net asset value of a fund that is closing shop declines 50 percent in the month it stops reporting to the databases. On that assumption, average hedge fund returns from 1996 through 2002 dropped to almost nothing - just 0.1 percent a year, annualized.

That is far worse than the performance of the average mutual fund. According to Lipper Inc., the average annual return of a domestic equity fund over that period was 4.9 percent; for domestic bond funds, it was 6.1 percent.

How Employee Stock Options Can Undermine the Value of Ordinary Shares (2003) Tallying corporate profits has never been easy, but in the past few years it’s become even harder as the debate continues over how to count employee stock options. Most of the discussion is over whether options should be counted as an expense. But also important, says Wharton accounting professor Wayne R. Guay, is what effect options have on the number of stock shares in circulation. The answer can make a big difference when a company computes its earnings per share, and when investors calculate the price-to-earnings ratio. Guay and colleagues John E. Core and S.P. Kothari examine the issue

the economy is far less volatile during the last 20 years. Economists have put forth three explanations why output growth may have become more stable in the past 20 years. One focuses on the conduct of monetary policy and the accompanying decline in inflation. Prior to the early 1980s, the Federal Reserve relied at times on recessions to rein in inflation. Since then, the Federal Reserve has been proactive in keeping inflation contained. Another explanation is that the U.S. economy simply has enjoyed good fortune in that there have been, for example, fewer tumultuous oil price shocks, which can cause volatility in economic activity. The third explanation suggests that improvements in inventory management are important for understanding the reduction in volatility. That is, while the durable goods sector has experienced a dramatic decline in output volatility in the past two decades, final sales of durable goods have seen only a moderate decline in volatility. Therefore, durable goods inventories—the difference between production and final sales—account for a substantial reduction in output variability in the durable goods sector and in the aggregate

Value investing in emerging markets:risks and benefits, Vladislav Kargin This paper identifies a subset of emerging markets that have higher than average expected returns and studies risk properties of this subset by investment simulations. It is found that:(1) the portfolio of ‘value’ emerging markets generates superior returns; and (2) statistical measures of its risk are close to the corresponding measures for the portfolio of all emerging markets. The statistical significance of these results has been checked by a bootstrap procedure. The results imply that the optimal share of emerging markets increases from 0% for an equally weighted portfolio to approximately 25% for the portfolio of undervalued emerging markets.

Mutual funds: (ICI 2003) The number of U.S. households that own mutual funds fell to 53.3 million in July, (47.9 percent of total households) from 54.2 million (49.6 percent) in July 2002. The survey also found that the number of individuals owning mutual funds slipped to 91.2 million from 94.9 million in 2002. About 33 percent of all households -- or 36.4 million -- owned mutual funds inside employer-sponsored retirement plans,

Better analysis? The Upside Potential Strategy: A Paradigm Shift in Performance Measurement (Frank A. Sortino and Bernardo Kuan) "Why should I engage the counsel of a financial advisor to tell me what to invest in? I'll just pick the one that performs the best." But the "hot dot" approach to manager selection is problematic. The problem is that popular performance measures like the Sharpe ratio and the Information ratio are one-dimensional, one-size-fits-all measurement tools which do not recognize a clients' personal variances (e.g., age, goals, level of wealth). Frank Sortino has developed a two-step procedure for performance measurement called the Upside Potential (U-P) Strategy, designed to help individual investors achieve their goals. The results are interesting. In the sell-off of 2000, the top three funds identified in the U-P Strategy were up 13% in a market that declined 32%, while the top three performing funds of the previous year were down more than the market. Takes a long time to load.

This new study is after the fact- as are many new methods of finding the best funds that supposedly beat the market. Personally, I think the research of economics is a much better gauge of what to do. That said, I did not get out of the market before March 2000. Sure, "everyone" knew something should hit the fan given the absurd valuations- particularly of the dotcoms. But the same could have been said in 1997, 98, etc. People out of the market then made little money.

In any case, once the fall of the market was obvious (more than a correction), I opted out of equities almost in full. Clients went to short and medium term bonds till this year. While most people were sustaining losses, we made gains through bonds. Did I hit the highs and lows? That's not the intent. The intent is to manage risk first and foremost. If you do that, you can capture most of the upside and miss most of the downside. Frankly, I think that's a pretty good strategy.

Fund redemption: the redemption rate has soared—from 5% to 15% in the 1950s through the mid-1970s, to the 30%-35% range into the late 1990s (excepting a 60% rate in the turbulence of 1987), and to the 40%-50% range thereafter. The average fund investor, who not all that long ago held fund shares for an average of more than ten years (the reciprocal of, and proxy for, a 10% redemption rate), now holds shares for less than two and one-half years (proxy for a 41% redemption rate).

funds with the highest costs also assumed the highest risks (a standard deviation 30% higher than the lowest-cost funds); generated the highest turnover (160% vs. 22%); and produced the poorest tax-efficiency. As a result, the low-cost group had an even greater advantage (3.8% per year) in risk-adjusted return, and an amazing advantage of 4.0% per year in after-tax return. It’s hard to imagine presenting a more persuasive case about the relationship between fund costs and fund returns.

More correlation: In addition, based on correlations in the 1960s through 1990s, many academics and portfolio managers had concluded that long-term bonds had little use in portfolios. However, brief periods of negative correlation occurred several times over the past seventy-five years, particularly during difficult periods in the stock market.

More correlation: The rolling correlation of various asset classes and sub-asset classes show that correlations are constantly moving, and that newer asset classes have not fully revealed their tendencies. During the 1980s, the Wilshire All REIT index had a high correlation with the S&P 500, but in the 1990s had become less correlated, and even become slightly negatively correlated in 2001.

According to a survey of more than 2,700 individuals with household incomes of $75,000 or more, the key "blind spots" that regularly handicap financial decision-makers from all walks of life are:

-- Mental accounting -- though all money "spends" the same, people treat money differently depending on how they got it.

In the survey questions related to loss aversion, respondents were divided into two groups. The first group was asked to choose between a 100 percent chance of gaining $240 versus a 25 percent chance to gain $1,000 coupled with a 75 percent chance to gain nothing. More than three-fourths of the group went for the sure gain. (Of those opting for a sure gain: All respondents, 77 percent; Doctors, 80 percent; Attorneys, 73 percent; CPAs, 77 percent.)

The second group's choices were: a sure loss of $240 versus a 25 percent chance to lose $1,000 coupled with a 75 percent chance to lose nothing. More than two-thirds of this group opted for the latter, the chance to lose nothing. (Of those opting to lose nothing: All respondents, 68 percent; Doctors, 69 percent; Attorneys, 61 percent; CPAs, 67 percent.)

"These results are not surprising," said Gilovich. "People of all ages and income levels tend to have different tolerances for risk, depending upon whether they're contemplating losses or gains."

In the survey questions related to framing, two different groups of people were asked the same question in two ways.

Roughly 50 percent said they could not when asked, "Could you comfortably save 20 percent of your household's income at this point in your life?" (All respondents, 49 percent; Doctors, 45 percent; Attorneys, 48 percent; CPAs, 44 percent.)

But, more than 7 in 10 said they could when asked "Could you comfortably live on 80 percent of your household income today?" (All, 71 percent; Doctors, 72 percent; Attorneys, 67 percent; CPAs, 77 percent.)

"We make decisions based on how choices are presented. Framing is often influenced by our reference point. In fact, we also see the influence of framing in other key theories of behavioral economics, such as loss aversion," explained Gilovich.

In the survey questions related to mental accounting, respondents were asked to judge how they would spend their money in two apparently different retail situations.

Would they buy a much-needed alarm clock from a local store for $18, or from a store 20 minutes away selling the same clock for $10? And would they buy a new television from a local store for $250, or from a store 20 minutes away for $242?

Two thirds of the respondents would drive 20 minutes to save money on the clock, but almost 75 percent would not drive the same 20 minutes to save the same amount on a new TV set. (Of those opting not to drive the same 20 minutes to save the same amount on a TV set: All, 73 percent; Doctors, 73 percent; Attorneys, 80 percent; CPAs, 79 percent.)

"We approach decisions differently depending on the context in which they're embedded," Gilovich said. "In this example, the relative size and importance of the purchase is what influences the respondents' decisions."

The Northwestern Mutual survey also found that though most people value the need for life, disability income and long-term care insurance, protecting against potential risk does not override the drive to accumulate wealth. While 50 percent of the professionals actually own permanent life insurance, one third of those polled wish they had bought more permanent life insurance and four in ten wish they had bought more permanent life insurance when they were younger.

Flawed Planning (Investment Advisor, Bob Curtis 2004) Where does financial advice often go wrong? Financial planning has had this great boom and with all the positive developments, I am convinced we have seen some real negatives as computer processors have become faster and software has become more sophisticated. As an industry, and this goes back to the Certified Financial Planner approach to planning, we have become completely enamored with the generation of numbers, with pretending we can generate accurate numbers out into the future. So much of the effort in planning is centered on the idea that, if we just get more data and smarter, faster computers, we’ll have better plans. That’s not true. We’re trying to predict the unpredictable. More data, more assumptions, more moving parts in a financial forecast don’t add to the usefulness of results. Think about a 30-year plan. I can assure you, almost every assumption we make, by the end of the plan, will be inaccurate. It does not mean that they are bad assumptions or that you should not make assumptions. It means that we should make as few assumptions as needed and focus on the stuff that really matters.

Give me an example of where advisors are so in love with their data that it obscures the bigger picture. Take returns. When you are planning for long-term retirement, one of the things with the most impact on your plan will be returns. Over 30 or 40 years, small changes in returns have huge impact. The best you can do is pick a portfolio and make some estimates about how it will perform. If we predict a return of 8% annually and the client gets close to eight, we’re doing great. But what planners often do is input every stock, every mutual fund, and every bond and predict what each of those securities will do over 30 years, with growth rates, dividend yields, tax treatment, sequences of spending the stocks versus the bonds and other complex calculations. That’s a different level of detail. It actually makes the end result of the plan less meaningful because you create this set of assumptions for things you cannot possibly predict with accuracy.

Stock options: (2004) A study by Presidio Pay Advisors found that, on average, companies granted stock options equaling 2.6% of their total common shares outstanding, down from the previous three year average of 3.3%. A possible explanation – firms choosing to replace stock option grants with alternative forms of equity incentives due to the pending requirement to expense stock options (the study found that 27% of executives reviewed received a portion of their equity incentives in the form of restricted stock). .

TIPS: (2004) TIPS pay a fixed rate of interest just as other notes and bonds offered by the US Treasury. The difference is that the interest rate, though fixed, is not applied to the face amount of the security but is applied to the inflation adjusted principal amount of the security. If inflation occurs each year, as it normally does, then each year's interest payment will be in a greater amount than the previous payment. In a deflationary economy, the total interest payment will decrease in each period of deflation.

Since payments are made twice yearly, the actual interest payment is determined simply by multiplying the inflation indexed principal amount of the security (whether greater or smaller than the auction price) by one-half the applicable fixed interest rate. This fixed interest rate is determined at the initial auction of the security.

Out of Sight, Out of Mind: The Effects of Expenses on Mutual Fund Flows: Brad M. Barber, Terrance Odean, Lu Zheng- (September 2002), We argue that the purchase decisions of mutual fund investors are influenced by salient, attention-grabbing information. Investors are more sensitive to salient in-your-face fees, like loads and commissions, than operating expenses; they are likely to buy funds that attract their attention through exceptional performance, marketing, or advertising. Our empirical analysis of mutual fund flows over the last 30 years yields strong support for our contention. We find consistently negative relations between fund flows and load fees. We also document a negative relation between fund flows and commissions charged by brokerage firms. In contrast, we find no relation (or a perverse positive relation) between operating expenses and fund flows. Additional analyses indicate that mutual fund marketing and advertising, the costs of which are often embedded in a fund’s operating expenses, account for this surprising result.

Top ten scams: (2004) The following ranking of NASAA's Top 10 scams, schemes and scandals for 2004 is based on the order of prevalence and seriousness as identified by state securities regulators: 1) Ponzi Schemes, 2) Senior Investment Fraud, 3) Promissory Notes, 4) Unscrupulous Broker/Dealer Representatives, 5) Affinity Fraud, 6) Insurance Agent Securities Fraud, 7) Prime Bank/High-Yield Investment Schemes, 8) Internet Fraud, 9) Mutual Fund Business Practices, 10) Variable Annuities. Lambiase also announced that NASAA has created an interactive Fraud Center on its website (www.nasaa.org). The center features details of NASAA's Top 10 scams, schemes and scandals; tips on how to detect con artists and avoid becoming a victim; an Investor "Bill of Rights;" instructions on how to file an investment-related complaint; and contact information for each state securities regulator. "Education and awareness are an investor's best defense against fraud."

Size matters?: (2004) With the exception of small-cap mutual funds , the size of the investment portfolio has little, if any, effect on the performance of the fund, according to a new report. Examining 12 different mutual fund investment styles, Lipper's "Does Fund Size Affect Performance?" research report could not find any "statistical proof at either the 5% or 10% significance level" that the size of the mutual fund had an impact on the overall performance of the fund's shares for the vast majority of funds studied, based on returns from 1997 to 2001.

An Email to Bill Jahnke, (2004) "I, quite obviously, do not have an economics background. But as a student and teacher of investments et al, I had a difficulty many years ago with ". “We assume in our simulation model that successive returns are independent and identically distributed. Our random walk assumption for the three risk premia implies a world where both the unit price of risk (the distribution mean divided by the dispersion) and the level of risk (the dispersion of the distribution) are constant through time.”

I wanted to believe the dogma that was preached. The problem was that the real world did not comply. . “We assume in our simulation model that successive returns are independent and identically distributed. Our random walk assumption for the three risk premia implies a world where both the unit price of risk (the distribution mean divided by the dispersion) and the level of risk (the dispersion of the distribution) are constant through time.”

Even to a novice such as myself, I found risk going all over the place- simply because local, national and worldwide economics were going all over the place. And no matter what study is ever done, the consumer is absolutely loathe to take a loss. Further, and more importantly, is the loss when there is no more "time" to make up the difference. As stated in my book, if the client will live as long as Methuselah, there certainly will be an evening out of risk and return. But to the normal human being, they do not have the latitude of such time. I disagree with Ellis, " The crucial question is whether the investor will in fact, hold on.” Holding on suggests that losses sustained will even out given sufficient time. That is not real world for any retired "investor" who suffered significant losses in 2000- 2002. That gyration devastated entire portfolios. Suggesting that time will even it out does no good to hundreds of thousands of retirees who will die poorly is a poor rationale by planners, journalists and academicians(?) who live in some other world than I do.

Years ago I determined that "Ellis advises setting an Investment Policy with the maximum exposure to the stock market subject to the client’s tolerance for portfolio volatility and avoids the costly mistakes of attempting to add value by active investment management in any of its guises." and Ibbotson's “This information allows an investor to adopt a policy mix that, over time, would be expected to achieve the specified objectives.” was mostly bunk. The true fallacy was "an active asset allocation implies a situation where the expected asset class returns are in a temporary state of disequilibrium.” How would he, Markowtiz or literally anyone else correctly determine what was temporary until well after the fact and well after potential large losses (and extreme risks) were sustained by the naive investor? How temporary was 2000?

But, as with you, I got no place in presenting this to students (anybody) in the 90's. More importantly, one needs to realize that 90%+ of students do not have the requisite background, skills or mentality to do much more than use whatever software is marketed to them as the Saviour du jour. They are unwilling to do the hard work. They are unwilling to learn.

I will never teach a class for CFP's again. The interest is not in knowledge, expertise or real life application. The bulk of planners are little more than closet asset allocators bent on getting as many assets under static control with a 1% fee. Many should not be in business.

For those of you familiar with Bill Jahnke's work, here is the summary of a private work he just sent me. It refers to the fallacy of the buy and hold theory: (2004)

"In terms of determining an investment strategy we are pretty much where we were before the policy portfolio took over except that we have more computing power that permits more complex simulation of investment strategies in relation to long-term financial goals and an expanded set of investment vehicles to implement active asset allocation decisions. In terms of forecasting asset class returns, it is still as difficult as it has always been, but making forecasts from the supply side provides more realistic inputs for asset allocation, which will lead to better investment solutions, more realistic financial plans, and more successful financial outcomes for many clients. In a world where stable equilibriums and central values are myths, the policy portfolio is a crutch for those who prefer to operate in a fantasy world. The policy portfolio is not just obsolete; it was never a valid proposition. The policy portfolio deserves to be buried."

More from Jahnke: "............what emerges (in investment studies) is an overzealous desire on the part of some academics to defend the random walk model as part of a general advocacy of efficient market theory and to ignore or make light of empirical evidence inconsistent with the random walk model. The consulting community embraced the policy portfolio because it provided the basis for a number of profitable services and avoided the tricky business of providing market timing advice themselves. Doing so avoided the additional complexity of providing an investment management framework where asset allocation was actively managed. Most investment managers were happy to be slotted in specialized boxes, which allowed them to focus and to be judged according to their ability to outperform their specialized benchmark. Financial advisors and planners were happy to reduce the complexities of investment management and client service, not to mention the effort of attempting to time the market and its attendant additional business risk. The only loser in the policy portfolio game has been the client, because unrealistic return expectations are often used in financial plans and poorly constructed asset allocation solutions are presented as "cutting edge."

Employee Education: (2004) only 42% of workers have tried to determine how much money is needed to live comfortably in retirement. However, when participants did calculate how much they will need to maintain their lifestyle, 43% of workers made changes in their retirement planning as a result:.

What is an Exchange Fund? (2004) An exchange fund is a privately offered fund consisting of a highly diversified pool of securities. Individual investors typically trade a portion of their holdings in a single security for shares in the exchange fund. Because the investors trade their securities for shares in the exchange fund, there is no taxable event at that time. This deferral of the taxable event is a particularly valuable benefit where the investor has a low cost basis in the traded security and does not wish to recognize that gain and pay taxes on it currently.

The exchange fund is focused on attracting high net worth investors - the typical minimum investment or trade is one million dollars and the investor is often required to have a personal net worth of five million dollars or more in order to participate. For example, the exchange funds offered by Legg Mason require investors not only to meet the five million dollar net worth test (exclusive of such non-investment assets as their homes, automobiles and furnishings) but also to have annual earnings of at least $200,000 for the current and two preceding years. These requirements limit the types of investors who may participate in an exchange fund. Exchange funds are offered by a wide variety of banks and money managers.

Q. What advice would you give investors near retirement who lost a great deal of money and feel pressure to recoup those losses in a short time frame?

Geist: For folks close to retirement, the danger is that they'll attempt to make up very quickly for their losses. When this happens, people usually end up trading inappropriately and making shoot-from-the-hip decisions not based on long-term planning. The best thing that these individuals can do is not to change their style of investing. They need to realize that they're not going to have as much money as they did at the turn of the century. But that doesn't mean that they're not going to make significant money in what I believe are the beginnings of another bull market. It comes down to making sure your investing style matches your personality style, having the courage to get back into the market, and thinking medium to long term rather than short term."

While I certainly understand the elements of emotion to investing, I disagree with Geist in many areas since he assume that the consumer has the capability to pick stocks and funds. The point is that you have to know the fundamentals before you can invest in anything. How many stocks must you have in a portfolio in order to insulate it from unsystematic risk? And another- what happens to risk as time goes by?

Restricted Management Accounts. (WSJ 2004) As its name implies, a restricted management account places limits on an investor's control. The accounts involve a special agreement with a bank or trust company, giving the financial institution total discretion in investing the assets. During the term of the account, typically five years, the investor can't withdraw money without special permission. Moreover, investors can generally transfer the account's funds only to family members during that period.

The benefit from a tax perspective comes if you transfer the assets to your family members. Because of the accounts' restrictions, the assets could be valued at 20% to 40% less than they otherwise would be, which could mean lower gift taxes. And if the investor dies during the term of the account, there could also be a similar discount for estate-tax purposes.

David Sennett, vice president of Wachovia Trust, says that client interest in RMAs has jumped in the past year. The Citigroup Private Bank, among others, is working toward making them available to its clients, says a spokesman. Most RMAs have high minimums; Wachovia's have a $1 million minimum, for example.

However, RMAs could face legal challenges down the road. Proponents argue that the accounts should pass muster because an independent third party has control over the assets. "They are truly arm's-length transactions," says David Handler, a partner at law firm Kirkland & Ellis, who helped develop the technique.

Economic education: (NY Times 2004) In a survey, people were asked about their concern and knowledge of national economics. The good news is that three-quarters of people say it is either extremely important or very important to stay informed.

The bad news is that there is a great deal of confusion about basic facts relevant to policy. Almost half the public, and a quarter of those over age 55, thought Medicare already provided drug benefits for outpatients before legislation providing such coverage was enacted. More than half could not hazard a guess about the size of the budget deficit. The average person thinks 37 percent of Americans lack health insurance, more than twice the actual percentage.

From where do Americans learn about the economy? By far the most common source is television. Those who rely on television the most, however, tend to be among the least informed.

The second most common source is local newspapers, which were cited much more frequently than national or big-city papers.

Friends and relatives came in third, followed by political leaders, radio and economists. The Internet was next, although a sizable contingent listed it as their most important source.

"Treasury Inflation-Indexed Debt: A Review of the U.S. Experience," by Brian Sack and Robert Elsasser (2004) This article describes the evolution of Treasury inflation-indexed debt securities (TIIS) since their introduction in 1997. Over most of this period, TIIS yields have been surprisingly high relative to those on comparable nominal Treasury securities, with the spread between the nominal and indexed yields falling well below survey measures of long-run inflation expectations. The authors argue that the low relative valuation of TIIS may have reflected investor difficulty adjusting to a new asset class, supply trends, and the lower liquidity of indexed debt. In addition, investors may have had a benign outlook for inflation and may not have demanded much, if any, of an inflation risk premium to hold nominal securities. As a result, inflation-indexed debt has not yet lived up to one of its main purposes: to reduce the Treasury's expected financing costs. More recently, though, TIIS market liquidity and the breadth of investor participation have increased considerably, and the valuation of these securities appears to have improved.

Not so swift: (2004) Over the last 20 years, the stock market has averaged a 12 percent annual return. But according to a study by Dalbar Financial, individual mutual fund investors earned only about 4 percent. A survey by Vanguard finds participants in its 401(k) plans earn only about one-half the average—6 percent a year. It is almost impossible to believe, and unpleasant to contemplate, but practically all individual investors are below average.

Credit Scoring by Dick LePre This man is in the mortgage business and offers some timely info.(2004)

This paper investigates three common differences among DC plans that may lead to varying degrees of information overload. We hypothesize that information overload is one reason DC participants often choose the default options. In two experiments, we manipulate the display of the investment information, the number of choices offered, and the similarity of these choices. In addition, we measure the financial knowledge of the participants. We test how these factors influence the participant’s feelings of information overload, decision satisfaction and choice of the default. The main contribution of this analysis is that it explores the interaction between the individual’s tested financial knowledge and the manipulated plan features. In our study, women with relatively lower salaries and less education tend to fall into our low knowledge category. Our findings do show that changes to plan design can help some individuals. We find individuals with above average financial knowledge do report significantly less overload when given fewer investment choices. This confirms previous research that plan design is important. Our results also show that financial knowledge plays a large role in who opts for the default. We find that low knowledge individuals opt for the default allocation more often than high knowledge individuals (experiment one: 20% vs. 2%). Our findings suggest individuals with below average knowledge are simply overwhelmed by the investment decision in general. Altering the plan by offering investment information in a more easily comparable format or by reducing the choices offered does not attenuate the low knowledge individuals’ feelings of overload.

Bye, bye: Lipper says 98 funds have been liquidated this year 2004. An additional 133 have been merged into other funds. The number of funds tracked by the Investment Company Institute, the funds' trade group, has been falling since March 2002, when it peaked at 8,338. The ICI's list — which adds new funds as well as dropping dead ones — now has 8,121 funds.

Short Selling: (NY TIMES 2004) The Securities and Exchange Commission approved a new rule on short selling yesterday that for the first time in decades will allow some stocks to be sold short even though the price is falling. The original rule, which let investors sell most stocks short only when share prices were rising, was adopted during the Depression at a time when short sellers were blamed by some for the 1929 crash.

The S.E.C. agreed yesterday that for a year, beginning on Jan. 3, one-third of the stocks in the Russell 3000 - basically the 3,000 largest companies traded on American markets - would have the basic limitation on short selling removed.

On the New York and American Stock Exchanges, that limitation bars a short sale of any stock except at a price higher than the last different price. On the Nasdaq stock market, there is a somewhat similar rule based on the bid price of the stock.

For the stocks chosen to be part of the trial - every third one based on average volume - that rule would be suspended. During the year, the S.E.C. would study the trading in those stocks to determine differences in liquidity, volatility and the speed with which the stocks adjusted to changes in fundamental conditions. Of the stocks to be in the trial, 50 percent trade on the Big Board, 48 percent on Nasdaq and the remainder on the American Stock Exchange.

How to get out of stock: (The Journal of Portfolio Management, Christophe Faugere, Hany A. Shawky, and David M. Smith 2004) The professors determined that during the bear market months from April 2000 to December 2002, investors who fared the best - relative to their market benchmarks, at least - were those with restrictive rules that did not allow much leeway for hanging onto stocks for emotional reasons.

more than a third of the 4,332 institutional money managers in the study relied primarily on a strategy called "valuation level" selling. That is a fancy way of saying that they sold stocks because they became too pricey, based on measures like earnings or book value.

The study's authors regard such a strategy as highly disciplined and objective. Managers who relied on this method outperformed their chosen benchmarks by 0.46 percentage points a month or 5.5 points a year, on average, during this period.

By comparison, institutional managers who relied on more flexible sell strategies - requiring judgment calls on the health of a business - fared worse. They beat their benchmarks by just 0.08 percentage points a month or just less than 1 point a year, on average, during the downturn, despite outperforming the more disciplined sellers during the roaring bull market of the late 1990's.

What does this mean for investors who may not have the skills or the resources of professional money managers?

For starters, it is a reminder that some kind of selling discipline is better than none. "Without any kind of strategy, emotions will come into play and emotions are almost always wrong,"

Academic research tells us that individual investors have a knack for hanging onto money-losing stocks.

Information Ratio or (IR). (Rick Ferri 2004) The idea is to look at the average annual excess return over a benchmark (alpha) and divide it by the standard deviation of the annual alpha. The higher the number, the greater probability that the manager has skill.

Example #1. Assume a large-cap core manager beat the S&P 500 by the following percentage over a five year period; 1%, 0%, 1%, 0%, 1%. The average excess return is 0.6% and that series standard deviation of that number is 0.5%. Therefore, the information ratio is 0.6%/0.5% = 1.1 IR. Any number near 1.0 or higher is very good.

Example #2. assume a large-cap core manager beat the S&P 500 by the following percentage over a five year period; 5%, -1%, -2%, 0%, 1%. The average excess return is 0.6%, and the series standard deviation of that number is 2.7%. Therefore, the information ratio is 0.6%/2.7% = 0.2 IR. That number is less than 0.5%, so it is doubtful the manager has skill.

My comment: The formula considers a relatively short period of time- just five years. That said, it certainly does have value. But how would you know if the manager would continue that way? Further, I'd opt for a review of the returns around 2000- 2002. Simply losing less than an index fund (-40%) has been used by some managers to validate their ability to "better" the market. That doesn't hold water with me.

Bad hedging: (2004) Bill Jahnke In terms of performance data, reported hedge fund performance is upward biased, incomplete and inconsistent across database vendors. Historical returns must be viewed skeptically because most vendors of performance information merely provide a conduit for data supplied by fund managers without independent verification.

Another source of overstatement in returns is produced by survivorship bias. Database vendors supply cumulative returns for funds that are still reporting at the time of their compilation. Since the reason for ceasing to report performance is usually due to poor performance, cumulative returns for the industry are further upwardly biased. With 10 to 20 percent of hedge funds failing each year, the upward bias in reported cumulative returns is large, numbering several percentage points annually.

The very premise that hedge funds taken together can produce attractive returns net of cost, relative to the stock market as a whole, is highly suspect. Stock market returns are generated by the pricing of systematic risk factors, while hedge funds depend on the selection skill of managers to produce performance. The evidence to date in the mutual fund industry and institutional fund management is that selection skill is scarce and there is little evidence of statistical persistence of good investment performance. While markets are not efficient, they have proved difficult to beat, especially for investors facing high costs.

While the prospective returns offered by the hedge fund industry arguably do not look attractive, some would argue that a skilled financial planner can sort out winning hedge funds from the pack. This is not a good bet. Financial planning skill does not necessarily translate into skill at choosing investment managers. Given hedge funds’ lack of transparency and their performance inconsistency, there is little upon which a financial planner can base a prediction of future performance.

Those making the case for hedge funds based on their Sharpe ratio also fail to consider that there are other measures of risk that are of concern to investors. Hedge fund returns are exposed to an elevated probability of major loss, exhibiting significant negative skewness (a long left-hand tail) and excess kurtosis (a high probability of extreme outcomes). This means that standard deviation is an incomplete measure of risk, and the Sharpe ratio an inadequate description of the risk/reward relationship for hedge funds, which should be of concern to investors.

According to proponents, a further advantage of investing in hedge funds is that their inclusion in a portfolio along with traditional stock, bond and cash investments will significantly improve a portfolio’s mean-variance characteristics. The piece de resistance in hedge fund marketing is the chart that shows an upward shift in the efficient frontier that occurs when hedge funds are included in a portfolio along with stocks, bonds and cash. The notion that investors should base investment decisions on the calculation of an efficient frontier is wrong. The financial concerns for most investors cannot be adequately addressed by mean-variance analysis of investment returns and an assessment of an investor’s aversion to portfolio volatility. The investment problem that most investors face is determining an appropriate investment solution to fund post-retirement consumption. The mean-variance characteristics of investment solutions on the efficient frontier do not naturally translate to the mean-variance characteristics of funding a multi-period, post-retirement consumption objective.

My comments- Along with this commentary, add in Long Term Capital. Two Nobel Laureates and 27 PhD's and the FED bailed them out to the tune of $3.6 billion.

NOTES: Data as of 1Q 2004. Third-party firms do not have a captive sales force and distribute their product through multiple channels but primarily with independent financial advisers and RIAs. Independent B-D's affiliated with a firm to provide technology, billing and other support, but the independent B/D pays for his own overhead and because of this he receives a much higher payout percentage.

Hedge funds: (NY Times 2004) A proliferation of hedge funds has made it harder for managers to wring value from the exotic techniques they employ. Citigroup Asset Management suggests that as the number of hedge funds has expanded, the quality of the average manager has fallen. For 11 of the strategies, the study found a "significant reduction" from one period to the next in the funds' "alpha."

estimates are that there are 7,000 managers worldwide controlling $850 billion. Many managers, like many of their investors, are arrivistes fleeing conventional asset classes like stocks and bonds.

"As long-only markets have had flat-to-negative returns in the last three years, fund managers are looking for ways to reinvent themselves. "There's a lot of experimentation going on."

And there is the rub. Anytime you hear "experimentation", recognize that they are experimenting with your money.

Lastly, "hedge fund investors should expect average annual returns of 6 to 8 percent".

Value stocks: (Russel Wild 2004) Historically, they have (supposedly) provided a greater return along with a greater risk. I say supposedly since it depends who does the numbers and the definition of even what value means. Anyway, assuming there was a positive correlation, it may not exist for much longer.

Most analysts give three potential explanations for value's outperformance. First: The value premium is a reward for higher risk. Second: It's the result of irrational exuberance. Third: It's just a fluke of history, nothing more, nothing less. Let's examine these in turn.

French, finance professor at Dartmouth isn't sure how things will shake out. "It is possible that part of the value premium has been the result of mispricing, and perhaps part of that mispricing will be corrected in the future," he says.

Russ Kinnel, director of mutual fund research at Chicago-based Morningstar, agrees that some correction seems likely. "The markets have changed. The Internet is allowing for a greater flow of information. The financial industry is more sophisticated. The markets are becoming more efficient." Therefore, he suggests the value premium will probably be less sweet in the future.

Indeed, some argue the value premium is already a relic. Ludovic Phalippou, a finance professor , recently studied the value premium and came to the conclusion that it is "a small, concentrated, and dying phenomenon." He holds that the only true value premium that still exists is found in the world of very small, thinly traded stocks, which tend to be ignored by institutional investors.

Markowitz theory: (Shane Finneran 2004) "At the Brandes Institute, we are not sure that returns, volatilities, and correlations can be predicted with the precision required by the Markowitz approach. In fact, we hesitate to embrace modern portfolio theory, and its reliance on forecasts of developments that we consider unpredictable is no small part of our skepticism."

Well, what't the problem? Planners and brokers bow to the theory as the savior for investors. True, the theory is valid BUT ONLY AT the TIME THAT THE PORTFOLIO IS INITIALLY IDENTIFIED. After that, everything changes- certainly correlations.

Take the S&P 500. The difference in the index’s returns for adjacent 10-year periods—such as 1953-1963 and 1963-1973—averages an annualized 4.9% over the half-century examined at right. In other words, from one decade to the next, the typical swing in per-year performance was nearly 500 basis points.

The volatilities of stocks and bonds also have varied over time. For the S&P 500, the annualized standard deviation of 10-year returns has tended to drift between 12% and 16% over the last 5 decades. For bonds, changes in volatility have been more pronounced, with 10-year standard deviations ranging from less than 5% to much more than 10% in select periods. In addition, historical correlation numbers also appear to offer limited predictive value: The 10-year correlation between the two assets averaged 0.18 during the 50-year time frame, but its value in individual decades dipped as low as -0.25 and reached as high as 0.5.

How might the instability of these numbers affect a real world investor? To find out, we examined the performance of five hypothetical “60/40” portfolios—with initial allocations of 60% to the S&P 500 Index and 40% to long-term US government bonds—formed at 10-year intervals between 1953 and 1993. Specifically, we compared the expected results of these portfolios (based on the assets’ previous 10 years of returns) with the portfolios’ actual results over the subsequent decade. As the chart at right shows, actual results often diverge from expectations. In four of the five 60/40 portfolios we studied, for example, expected 10-year returns and actual 10-year returns differed by close to 5% per year. While expected standard deviation and actual standard deviation (not shown) tended to be more closely aligned, we believe the overall results for these 60/40 portfolios demonstrate that investors who expect the future to behave like the past could be in for a surprise.

In 1952, Harry Markowitz wrote that the key to forecasting might be found in a mixture of “statistical techniques” and “the judgment of practical men.” After mathematically deriving tentative return, volatility, and covariance estimates—whether from historical data or somewhere else—investors could adjust these estimates “on the basis of factors or nuances not taken into account by the formal computations.” In essence, Markowitz acknowledged that anticipating the future could be as much an art as a science.

Inept planning: (WSJ 2004) The Spectrem Group said its study of 500 people shows that 62% of American households with $500,000 or more of investible assets had a formal financial plan in place. More than half -- 52% -- of these investors relied on sources other than individual financial planners to plot their financial road maps. Just 18% turned to independent financial planners, while the remainder set up their own plan. The margin of error is plus or minus 4.4 percentage points.

Nearly half of those polled paid nothing for their plan but instead received it as a perk of their patronage. But, the report warns, these "free" plans might not be independent or comprehensive. In addition, plans from brokers and other nonindependent financial planners are often generic, computer-based models not tailored to clients' goals

Many affluent investors aren't willing to pay more than $1,000 for their plans, and many don't want to pay anything.

The free reports have made many consumers see financial plans as a commodity rather than as a process.

Of the 62% of affluent investors who used financial plans, about half turned to an adviser they were already using for some purpose to help them make a financial plan. Their stockbroker, for example, may be the adviser they know best, and finding a new adviser who needs to be brought up to date on personal-financial affairs can be overwhelming

The number of certified financial planners has grown to 44,950 from 23,358 in 1991.

Gee I hate to tell them but the bulk of plans by "independent" planners are generally designed by computer software- certainly the asset allocation.

Repeated ad nauseam, a broker is one college class removed from a high school education; a CFP is only one college semester removed from a high school education. You cannot expect much with that level of knowledge.

So you want to add international stocks (AAII 2004) A chronological review of the findings on the benefits of international equity diversification demonstrates the varying impact of international equities on U.S. portfolios over time:

When foreign stock markets were outperforming the U.S. stock market in the 1950–1980 era, studies demonstrated the risk reduction and higher returns from international diversification.

The more recent studies that rely on mid-1980s to 1997 stock market returns show little benefit from international diversification.

The recent reversal in research findings in the literature is not surprising when one simply compares the average returns and risk (as measured by volatility) of the relevant stock indexes. From January 1970 through December 1985, the average monthly total return of MSCI’s EAFE index exceeded the average monthly return of the S&P 500 by 20 basis points, while the risk (volatility, as measured by standard deviation) of the EAFE index was just a few basis points higher. Therefore, over this time period, adding international stocks to a U.S.-based portfolio would have provided greater returns, with just a little added risk.

More recent data tell a different story. From January 1986 through December 2000, the average monthly returns of the S&P 500 exceeded the average EAFE index monthly returns by 32 basis points, while at the same time the risk was actually less than that of the international stock index (by 71 basis points). Adding international stocks to a U.S.-based portfolio over this time period would have lowered the overall portfolio’s return, and it would have increased portfolio risk. Thus, the long-term benefits of international equity diversification in U.S. portfolios may have disappeared in the late 1980s.

Seven Indexes Craig Israelsen (Brigham Young University) I have followed his work in Financial Planning magazine. He's good. Very insightful, good research, objective. I don't know if he is an "up and comer" in the industry or a well known analyst. But I think you will hear more about him in subsequent years.

Rows 9-23 show a number of active management protocols. Seven of them (in red) represent a core/satellite philosophy. The core asset is over-weighted, with the remainder of the assets spread out among other satellite holdings. In these cases, 20% of the investment was invested into the core index (requiring annual rebalancing to maintain the 20% weighting), and the remaining 80% was equally reallocated annually among the other six indexes (at 13.33% per index).

The rows in blue (12 and 19) are permutations of the core-satellite approach, where the core index at the start of each year was either the best or worst index from the prior year. The remaining six options (in black) reflect either a traditional rebalancing approach or a highly concentrated management protocol.

Column A contains the 26-year average annualized return (geometric mean). Column B is the standard deviation of the 26 annual returns. Standard deviation of return is commonly used as a surrogate for risk level. Column C contains a return-risk measure calculated by dividing Column A by Column B.

Column D is a useful--and novel--statistic. It's the arithmetic mean of 22 rolling five-year returns. For this particular data, the first five-year rolling return (calculated as a geometric mean) was generated using annual return data from 1978 to 1982. The next five-year rolling return covered the time from 1979-1983, and so on. Column E is the standard deviation of 22 five-year rolling returns, and column F is the return-risk measure using the five-year rolling return data.

Columns G and H indicate the number of times that a particular active management strategy had the highest (G) or lowest (H) five-year rolling return. Column F is highlighted in yellow because it was used to rank the indexes (rows 1-7) and the portfolio management protocols (rows 9-23). The core indexes along with the 15 active management protocols were ranked separately from high to low.

Morgan Stanley None $250,000 Account fees capped at $250; 2 fee-free IRAs; free online bill payment

Charles Schwab $10,000 Signature premium/ $500,000 Assigned brokerage team, special toll-free number, outside research, free bill-paying service

Fidelity Brokerage $2,500 $100,000 Lower commissions, free bill-paying service, quicker phone service

The Vanguard Group $3,000 $250,000 Advance notice of new funds, discounted commissions

John Bogle on the Value of International Investing. (2004) "In the long run it's reasonable to assume that international returns are likely to be similar to U.S. returns once you wash out the dollar. The problem with international is that 25% of all revenues and profits of all U.S. companies are international. So I don't think you're diversifying further.

Well, academics say the markets fluctuate differently, and that makes a big difference. I say anyone who wants to use reduced standard deviation as a reason for owning international has to be able to define standard deviation. If you understand that, then go ahead and invest in international.

But when markets fall apart, does international diversification help? Just when we need it most, international diversification lets us down. In this bear market the international MSCI EAFE index fell harder than broad U.S. indexes. What good did international do you? People like to use standard deviation as a measure of risk. But when it comes to international investing, I think risk should be defined by how risky the nation is. Is Mexico riskier than the U.S.? I say categorically yes. There's a lot of risk out there in international. Risk in international is defined by national stability, economic growth, culture, tradition, possibility of uprisings, and other things. So in my mind you're increasing the risk in a portfolio, not decreasing it as was your original goal. There's also currency risk in international investing.

I'll make a couple points. First, there are next to no consumer that has a clue to standard deviation. Second is the volatility of correlation. You don't know what it is until well after the fact. Lastly, the dollar has been weak right now. Will it stay that way? Do other currencies change irrespective of the dollar. Answer all those correctly and maybe you can do active allocation. But hardly anyone will get the answers.

A review of empirical research on performance of analysts, day-traders, forecasters, fund managers, investors, and stockbrokers (Patric Andersson, Center for Economic Psychology, Stockholm School of Economics)

Financial advisors, stockbrokers, and newsletter writers issue stock recommendations that may influence investment decisions of private (and professional) investors. People entrust their savings to mutual and pension funds run by professional investors, like money managers, with expectations that these fund would generate high yields and, preferably, break the stock market index. Like professionals who issue stock recommendations, money managers may base their investment decisions on forecasts, or judgments, provided by economists and financial analysts. These forecasts also play an important role for private investors who buy and sell stocks on a regular basis. The improvement of information technology has meant better possibilities (for instance through Internet) to buy and sell stocks for lower commission fees. A new breed of private investors tries to earn their livelihood from taking advantage of these possibilities. The professionals active on the stock-market are often referred to as financial experts suggesting that they are highly competent and able to attain superior performance (cf. Wärneryd, 2001). It should be noted that they may be called financial experts regardless of evidence that they perform well.

A question that ultimately arises is the following: How good are financial experts? More specifically, how good are they at forecasting, issuing stock-recommendations, and trading stocks?

In general, experience and seniority are poor indicators of expertise as these factors have been found to be weakly correlated with good performance (Bedard & Chi, 1993). Thus, the mere exposure of repeatedly performing tasks does not vouch for excellent performance.

Broadly speaking, expertise comes from two sources: inborn capacities (i.e., talents) and deliberate practice. It is widely assumed that talent is the major and most important determinant of expert performance, but an overwhelming body of research emphasizes the importance of deliberate practice (Ericsson & Charness, 1994). Individuals, who aim at attaining exceptionally good performance, must carry out practice activities in a goal-oriented and constructive fashion (Ericsson & Lehmann, 1996b). For example, 20-year old musicians deemed as true experts had devoted themselves to approximately 10,000 hours of accumulated practice, while amateurs of the same age had spent only 20 per cent of that amount (Ericsson, Krampe & Tesch-Römer, 1993). The significant role of deliberate practice for attaining expert performance has also been confirmed in a variety of domains like chess, sports, and music; for reviews see (Ericsson, 1996b). At present, few research projects have focused on investigating the importance of deliberate practice for reaching excellence in business-oriented domains.

In the early 1970s, Einhorn (1974) suggested that expert judges ought to be able to produce reliable and stable judgments. Specifically, he claimed that experts should make identical, or at least similar, assessments when faced with identical information; i.e., high levels of within-subjects and between-subjects agreement.

Research has generally shown that experts in various domains seldom generate better predictions than novices who have received some training, and that experts are completely outperformed by simple statistical models.

Recently, a new measurement of expertise was introduced. This measurement rests upon the assumptions that experts should be able to discriminate among information as well as to make consistent judgments and that taking the ratio of discrimination over inconsistency can adequately identify experts. However, the measurement does not take into account the quality of judgments meaning that research subjects may be deemed as experts despite producing consistent but inaccurate conclusions.

However, the measurement does not take into account the quality of judgments meaning that research subjects may be deemed as experts despite producing consistent but inaccurate conclusions.

in well-defined tasks, experts can rely on their extensive experience and outperform non-experts, but this advantage is lost or reduced in unstructured task with the result that experts and novices perform equally poorly. This point is illustrated by the findings of a classic study of chess involving two types of chess players, masters and amateurs, who recalled board positions where the chessmen had been placed in accordance with a real game and in a random way (see Ericsson & Smith, 1991). In the real game condition, the masters recalled more positions correctly than the amateurs, but in the random condition the two groups scored equally poorly.

In conclusion, expertise does not only depend on talent and experience but also deliberate practice.

The stock-market is hypothesized to be efficient. Fundamental for modern finance is the

theory of efficient capital markets that bluntly postulates that all publicly available

Once new information is revealed, the prices are rapidly adjusted as an immediate response. The prices are assumed to mirror the intrinsic values of the securities. With regard to stocks or shares, the intrinsic value is basically rational expectations of the present value of the listed company’s future fundamentals, which are dividends and earnings growth, discounted for any inflation.

The movements of security prices follow random walks, implying that it should be impossible to use current price series to predict future price series. If players on the stock-market could hypothetically predict future prices with some accuracy, they would be able to profit on their knowledge, but the forces of competition and rationality would immediately react and soon the prices would have been adjusted.

As a result of the so-called random walks of security prices, there is little use of attempting to predict future prices on the basis of current prices, because all pieces of publicly available information are in fact already considered. Accordingly, it is not possible to persistently beat a random selected portfolio of stocks. In other words, efficient markets seem to be examples of unfriendly environments with respect to the potentially poor possibilities of attaining good performance of experts.

Over the years, behaviorally oriented economists have discovered several anomalies in the theory of efficient markets.

One such anomaly is that prices may follow mean-reverting patterns rather than random walks. In particular, it has been found that securities with decreasing (increasing) past performance (i.e., prices and returns) tended to rise (drop) in the future (Thaler, 1992). The idea of price reversals has not been widely accepted. Supporters of efficient markets have argued that this anomaly is an artifact derived by inappropriate data analyses (Fama, 1998); an argument that researchers in behavioral finance obviously believe is incorrect.

Inspired by psychological research on mood, a recent study analyzed stock exchange data and weather statistics from 26 countries and found that sunny days were associated with greater stock returns (Hirshleifer & Shumway, 2003).5 In short, behavioral economists have provided evidence that stock-prices are somewhat predictable and that stock-markets are not perfectly efficient.

In conclusion, from a theoretical point of view the stock-market seems to involve characteristics that might make it difficult for financial experts to perform well.

* the theory of efficient markets does not really rule out the presence of superior performance. Some players on the stock-market may possess private information that is unknown to others. Such insiders may be able to consistently obtain abnormally high profits. From a theoretical perspective, it should be possible to achieve superior performance without insider information. The theory postulates that the average player is not capable of systematically beating the market. Consequently, the players on the stock-market have different skills with regard to judgment and decision-making. Players having excellent (i.e., above average) skills will outperform, or profit on, those players with poor (i.e., below average) skills.

Proponents of the theory of efficient market have argued that it is difficult to successfully exploit the anomalies. Malkiel (2003) referred to an experienced money manager, who complained: “I have yet to make a nickel on any of these supposed market inefficiencies”

financial experts can be divided into two categories. The first category includes those financial experts who solely predict the future course of stock-market and related issues such as predicting the performance of listed companies (e.g., forecasts of earnings per share). Examples of such experts are newsletter writers, analysts, advisors, and stockbrokers. Although there are many differences between them, the main task of these experts is to produce forecasts or give profitable stock recommendations. The second category concerns those financial experts who make decisions about trades and investments in stocks and other securities. To this category belong professional and private investors, who not only need to predict the stock-market but also make decisions. These two categories of financial experts are consistent with the view by Shanteau (1988) who distinguished between advice-giving and action-taking experts. Thus, the financial experts face the two kinds of tasks: form judgments about the future or make decisions to trade stocks.

Modern research has confirmed the findings of Cowles (1933, 1944) and, consequently, shown the inability of financial experts to predict the stock market. In the early 1970 Stael von Holstein (1972) performed an experiment on whether feedback about accuracy could improve probabilistic forecasting of stock price changes. Contrary to what could be expected based on common sense, he found no evidence that the participating financial experts made more accurate forecasts after receiving feedback. In fact, an overwhelming majority of the participants made worse predictions than a uniform forecaster. Research has also tried to link forecasting errors to various characteristics of financial analysts like experience, reputation, environment, and information search patterns. As regards the relationship between forecasting errors and experience of predicting EPS, there are inconsistent findings.

Another type of characteristics found to be associated with forecasting errors is reputation.

the reviewed studies suggest that financial analysts are poor at predicting the general course of the stock market, but they do provide moderately accurate EPS forecasts. Experience seems to lead to slightly better forecast.

Contemporary research has provided mixed evidence on the quality of financial experts’ stock-picking ability. On the one hand, there are studies indicating that their ability is poor. It has been shown that writers of investment letters do not attain superior performance, the abnormal returns are in fact close to zero (Jaffe & Mahoney, 1999 ; Metrick, 1999).

Stock-picking ability could also be estimated by other types of publicly available recommendations issued by experts, such as stock advice in business magazines (e.g., Barron’s Annual Roundtable), newspaper (e.g., Wall Street Journal), and brokerage reports.

These recommendations seem to be somewhat inaccurate. On average, the abnormal returns of such recommendations for a period spanning six months to three year are estimated to be around zero.

a study reported that investors can indeed profit from stock recommendations issued by the average financial expert (Barber, Lehavy, McNichols & Trueman, 2001). Specifically, the study showed that purchasing stocks with the most and the least favorable recommendations among experts (i.e., highest level of consensus versus lowest level of consensus) yielded abnormal returns of 4.1 and -4.9 per cent, respectively.

Following consensus sell-recommendations yielded also abnormal returns. Investment strategies that capitalize on the average recommendation require, however, high trading activities. When considering transaction costs, those strategies yielded abnormal returns of zero per cent (Barber et al., 2001). Besides, it is unlikely that the general public can profitably rely on the stock advice issued by financial experts, because institutional investors are often able to trade before the recommendations have been publicly disclosed.

Furthermore, a study of the stock picking ability of 65 prominent money managers (i.e., so called financial superstars) showed that only three managers succeed to outperform.

the benchmark (i.e., matched securities) for a period lasting about 500 days after the buy recommendations have been initially published (Desai & Jain, 1995). For a 500-day holding period, the abnormal returns ranged between 16.4 and 4.6 per cent. As the finding could not be established with statistical certainty, Desai & Jain (1995) concluded that it is very difficult to identify money managers with superior stock-picking abilities. It should be noted that they seemed to be slightly better at giving sell recommendations (Desai & Jain, 1995). Thus, not even so-called financial superstars managed to identify stocks that performed consistently better than appropriate benchmarks.

To sum up, the reviewed studies paint a gloomy picture of financial experts’ allegedly superior stock-picking ability. It appears that the financial experts are, on average, not so good at picking profitable stocks. But they generally perform better than chance. most studies of fund and money managers point to the conclusion that they are not able to consistently attain good performance (i.e., outperform relevant benchmarks).

In conclusion, the reviewed studies suggest the following tendencies of financial experts.

• They have difficulties in accurately predicting the future course of stock market.

Their predictions of earning per share fall often above or below the actual outcome.

Fund managers seem to be unable to persistently attain returns that outperform appropriate benchmarks.

An overwhelming majority of day-traders loses money, but there is minority who is capable of persistently earning a substantial amount of money on buying and selling stocks on a daily basis.

Downtime: (Ned Davis Research) The stock market decline, which lasted 183 calendar days, was the second-longest price "correction" in a bull market since 1900. The only other decline in a bull market that dragged on longer dates to 1947-48, when stocks went south for 236 days. The median correction is 37 days.

Analysts blame the market's troubles on the fact stocks had such a good year in 2003, when the S&P 500 gained 26%. All the positives heading into this year, such as strong earnings, were already baked into prices. (That is a standard rationalization.) As the year progressed, stocks faced more head wind: record oil prices, a weak job market, a slowing economy, political uncertainty and fears of terrorism. That increased risks, hurting prices.

Growth versus value: A growth stock's earnings are expected to increase faster than those of the market as a whole, and a growth stock usually has a high price-to-earnings ratio. Typically, growth stocks are not dividend payers.

A value stock is one that analysts think has good fundamentals but has been ignored by the market or beaten down because of some bad news that hides basically good prospects. A value stock's price-to-earnings ratio is generally low, and it typically does pay dividends.

the price-to-sales ratio of the Russell 1000 growth index, divided by the price-to-sales ratio of the Russell 1000 value index, produces a ratio showing that growth stocks are the cheapest they have been since Russell began collecting this data in 1979. Inversely, by this measure, value stocks are the most expensive they have been since then.

The low premium on growth stocks is partly attributable to their steeper fall in the three-year market slide that began in 2000. From its peak on March 2, 2000, to its low on Oct. 7, 2002, the Russell 1000 growth index fell 64.2 percent. The value index dropped 36.2 percent from its peak on May 21, 2001, to its low on Oct. 9, 2002.

The high cost of value stocks can also be explained by many investors' flight to safety in the value sector as the markets plunged. And investors have stayed there this year. Russell's value index is up 4.6 percent through Friday and is now just 1.9 percent from its record high. The growth index is down 1.9 percent for the year and is still 101.3 percent from its all-time high.

"The Impact of Population Aging on Financial Markets" A number of financial market analysts have argued that the aging of the "Baby Boom" cohort contributed to the rise U.S. asset values during the 1990s, and that asset prices will decline when this group reaches retirement age and begins to draw down its wealth. This paper explores the importance of changing demographic structure for asset returns, asset prices, and the composition of household balance sheets in the United States. Standard models suggest that equilibrium returns on financial assets will vary in response to changes in population age structure. While the direction of the effect of demographic changes is not controversial, the quantitative importance of such changes for financial markets is open to debate. The paper presents several strands of empirical evidence that bear on this issue. First, it describes current age-specific patterns of asset holding in the United States, and finds that asset holdings rise sharply when households are in their 30s and 40s. Aside from the automatic decline in the value of defined benefit pension assets as households age, however, other financial assets decline only gradually during retirement. When these data are used to project asset demands in light of the future age structure of the U.S. population, they do not show a sharp decline in asset demand between 2020 and 2050. This finding calls into question the "asset market meltdown" view. Second, the paper considers the historical association between population age structure and real returns on Treasury bills, long-term government bonds, and corporate stock. The evidence suggests only modest effects, if any, of a changing demographic mix. Statistical tests based on the few effective degrees of freedom in the historical record of age structure and asset returns have limited power to detect such effects. There is a stronger historical correlation between asset levels, as measured for example by the price-dividend ratio, and summary measures of the population age structure. Once again, however, the results are sensitive to choices about econometric specification. These empirical findings provide modest support, at best, for the view that asset prices could decline as the share of households over the age of 65 increases.

people’s behavior tends to change as their circumstances change, undermining consistency over time and context. This lack of consistency is not a fault; rather, it is a remarkable defining capacity that allows us to engage in complex social situations. Moreover, as psychologists and neuroscientists agree, although individuals perceive themselves to be unitary creatures, that impression is likely illusory. While the evolved subsystems that make up the human brain do communicate, in many contexts one system or the other tends to dominate. In some circumstances, for instance, emotions and drives can control our “thinking,” radically changing our preferences, our taste for risk, the degree of empathy we feel—in effect, profoundly altering our “rationality” and our perception of utility. Somewhat ironically, moreover, it is the unconscious behaviors that are (relatively) predictable. It is consciousness or cognition that introduces the element of unpredictability in human behavior. All told, given the structure of our brain, it is unlikely that humans will behave as if they are consistently maximizing any single utility function. Rather, their utility function will seem to vary with their circumstances.

Economic theory should reflect how people actually think, feel, and behave. Although the rational model is often a good first approximation to how people make economic decisions, human behavior has proven to be far more complicated than the canonical paradigm assumed by economics. The complexity derives from human evolution. The human brain did not evolve simply to maximize the types of problems framed in modern economic discourse.

"Do Stock Prices Really Reflect Fundamental Values? The Case of REITs" Real estate investment trust (REIT) stock prices deviate substantially from net asset values (NAV). Using REIT data since 1990, we find large positive excess returns to a strategy of buying stocks that trade at a discount to NAV, and shorting stocks trading at a premium to NAV. Estimated alphas from this strategy are between 0.9% and 1.8% per month, with little risk. Trading costs and short-sale constraints are not prohibitive and the results strengthen when we control for differences in liquidity or the extent of institutional ownership. We find that some variation in P/NAV makes sense, as premiums are positively related to recent and future NAV growth. However, there appears to be too much volatility in P/NAV, giving rise to potential profits from short-term mean reversion. The closed-end fund literature has some similar findings on stock price deviations from fundamental value, but compared to closed-end funds REITs are much larger and have much higher insider and institutional ownership. These differences suggest that REIT premiums and discounts reflect more than just small investor sentiment, which is a common explanation of why closed-end fund prices deviate from their fundamental value.

Hedge funds: (Burton Malkiel 2004) In 1990, about $50 billion was invested in hedge funds; today, the amount is estimated at $1 trillion.

"Hedge funds in aggregate," Van Hedge Fund Advisors boasts on its Web site, "in most multiyear periods, have provided both superior returns and lower statistical risk than the S.& P. 500 or mutual funds."

The catch, according to Professor Malkiel, is that the information on performance is voluntarily provided to the organizations who track the funds. Because a good record helps attract investors, funds have a tendency to start reporting results only after they have achieved some success. Funds that are losers right out of the gate may never be represented in the database.

Furthermore, when funds start reporting, they have the option of "backfilling" their data, or providing information on returns for previous months. If a fund was successful in preceding months, it has an incentive to backfill its data to increase its attractiveness to investors.

This process creates a "backfill bias," because better results are overrepresented in the database. It is as if the Boston Red Sox waited until 2004 to report their World Series success, while the Yankees started in 1923; both franchises would look like smashing successes.

Hedge fund returns: Burton Malkiel of Princeton University and Atanu Saha of the Analysis Group are asserting that the returns of hedge funds may be lower than commonly advertised, possibly making them a riskier choice for investors.

The study analyzed the TASS database, which is run by hedge fund group Tremont Capital Management. The two academics claimed that because of backfill and survivorship biases within hedge fund indices, investors should look at such an index with a skeptical eye.

Backfill bias, the authors assert, occurs because hedge funds report performance on a voluntary basis. Managers quite often will retroactively report returns if they are positive, while often failing to do so if returns are negative. Looking at incidences of such practices, Malkiel and Saha found that backfilled returns were more than 5% higher annually than those that were not backfilled.

Survivorship bias also warps the actual performance of hedge fund investments. While most hedge fund databases reflect the returns of hedge funds currently in existence, most do not include hedge funds that have failed (the study also asserts that only a quarter of funds in existence in 1996 are still around today). It is common, the authors assert, for funds that are failing to stop reporting their returns for the months before they go under This makes it so only funds who are currently enjoying a successful run are included in an index, biasing the results so as to not include the entire hedge fund universe.

The study cites the ubiquitous Long-Term Capital Management, a massive Greenwich-based hedge fund that infamously tanked in 1998, as a prime example of such action. Although the fund lost 92% from October 1997 to October 1998, it failed to report any of the losses to hedge fund databases, skewing the returns of the industry as a whole. Although it was still losing money, hedge fund databases would not pick up on a fund such as Long-Term; so any hedge fund index that purported to speak for the entire universe would be incorrect in its performance reporting.

Critics contend that every index has this problem. They also point out that not all funds with positive returns report their performance either, since they may not be seeking further capital or may just strictly abide to the industry standard of intense secrecy.

Overall, the study contends that funds that survived outperformed a combination of live and dead funds by nearly 4% over a period stretching from 1996 to 2003. Earlier studies pinned this number at anywhere between 0.6% and 3.6%

Fund researchers classify funds based on the types of securities they hold. Within the universe of stock funds, for instance, there are funds that invest only in U.S. issues and those that invest in foreign stocks. Holdings may be mostly large stocks or small ones, fast-expanding "growth" companies or seemingly cheap "value" ones. Some funds focus more narrowly on a single industry or one foreign nation.

Look at the bigger picture before weighing the particular fund. Your investment portfolio should include a mix of stock funds for their potentially high returns and bond and money-market funds for their lower risk. Through your stock funds, you should hold companies of different sizes and types around the world. If you are looking at a fund that buys small growth stocks and you've already got four such funds, it's probably time to say no. Take very little risk with money you will need within a few years.

Too often, it's hot performance -- and nothing else -- that makes investors consider a fund. Be wary if a type of fund has been shooting the lights out for the past few years; it may be due to cool off. Think instead about types of funds that are underrepresented in your portfolio or have been going through a period of weak performance.

You obviously don't want a fund that has been a perennial laggard compared with other, similar funds. But a fund that is the past year's star in its category may have gotten there by taking extra risk or through luck. Favor funds that have been solid performers versus peers for longer periods such as three, five and 10 years.

Among stock funds, funds holding large "value" stocks tend to be fairly sedate while those with small "growth" stocks are more likely to soar and swoon. In the bear market that began in 2000, many investors found they didn't have the stomach to hold onto the most volatile funds. You can get an idea of a fund's riskiness by looking at its best and worst three-month periods or the magnitude of its ups and downs over the past few years. For comparison, the big-stock Standard & Poor's 500-stock index lost 22% in 2002 and gained more than 28% in 2003.

Be wary of small-stock funds that have posted great results and then ballooned in size as new investors rushed in. Because small companies have limited shares outstanding, the manager of a greatly enlarged fund may have to buy many more stocks or shift the fund's focus to larger stocks. Be cautious also if a mutual fund has recently lost a highly regarded portfolio manager.

Various charges, including the portfolio manager's fee, are subtracted from a fund's assets and thus reduce your return. But because "you don't pay the bill yourself," many people fail to pay attention to those costs, says Nancy Smith, a fund consultant and former Securities and Exchange Commission official. For comparison, the average U.S.- stock fund pays 0.71% of assets each year for portfolio management; this and other charges add up to total expenses averaging 1.51%, according to Morningstar.

Brokers and other financial advisers can be paid in many ways, from annual fees that you pay directly based on your portfolio's size to far-less-visible charges that are built into the annual expenses of the funds your broker recommends. If the fund has an annual "12b-1" fee, for example, it may be going to pay the broker.

Many funds offer multiple share classes that pay the selling agents differently. Depending on how much you are investing and how long you hold your investment, one share class may be much better for you than another. Two regulatory Web sites, www.sec.gov and www.nasd.com, have detailed explanations and calculators that can help you select a share class.

You want to do business with fund management firms that put investors' well-being ahead of their own business interests. Many financial advisers look for fund companies that have low fees, that avoid introducing trendy funds and that have portfolio managers and executives who invest their own money in the funds. Think carefully about fund firms that have been implicated in the past year's fund-trading scandals.

Bond Defaults (Moodys 2005) just 0.7 percent of companies with rated bonds defaulted last year. That was less than half the rate of 2003 and a fifth of the rate back in the recession year of 2001.In 2004, for the first time since 1997, Moody's raised more corporate ratings than it lowered.

Typically most bonds rated Caa or lower when they are issued default within a few years. Consider the class of 1998, the last year large quantities of such bonds were sold. More than 40 percent of the bonds defaulted within three years, and by now 74 percent of them have done so.

Those buying low-rated bonds get relatively little extra yield now, because interest rate spreads over high-quality bonds are small. Spreads have been tight before, but not when the overall level of interest rates was as low as it is now. The result is cheap money, which has helped to finance both leveraged buyouts and payments to equity holders. In such cases, the buyers of the junior bonds assume the risks of stockholders, but get limited returns.

low-rated bonds make up 20 percent of outstanding speculative bonds, more than twice the 1998 level.

The market risk premium is one of the most important but elusive parameters in finance. It is also called equity premium, market premium and risk premium. The term 'market risk premium' is difficult to understand because it is used to designate three different concepts: 1) Required market risk premium, which is the incremental return of a diversified portfolio (the market) over the risk-free rate (return of treasury bonds) required by an investor. It is needed for calculating the required return to equity (cost of equity). 2) Historical market risk premium, which is the historical differential return of the stock market over treasury bonds. 3) Expected market risk premium, which is the expected differential return of the stock market over treasury bonds. Many authors and finance practitioners assume that the expected market risk premium is equal to the historical market risk premium and to the required market risk premium. The CAPM assumes that the required market risk premium is equal to the expected market risk premium. However, the three concepts are different. The historical market risk premium is equal for all investors, but the required and the expected market risk premium are different for different investors. We also claim that there is no required market risk premium for the market as a whole: different investors use different required market risk premiums.

Asset Allocation: (WSJ 2005) This was identifed in my book and here at my site at least 6 years ago. But finally The WSJ does a study on life mutual funds. The managers promise a ready-made portfolio of stock and bond funds that gradually becomes more conservative as the investor gets closer to retirement.

The allocation, however, varies from fund to fund. For investors expecting to retire in 2030, Vanguard Group's fund provides a blend of 80% stock funds and 20% bond funds. The 2030 fund run by T. Rowe Price, however, intends to hold 90% stocks, based on the firm's research suggesting that investors need to rack up higher returns to amass the sums of money needed for retirement at a time when people are living longer.

Some lifecycle funds are designed to provide income and stability for people already in retirement, and the variations among these are even greater. Vanguard's version holds 20% in stock funds, 75% in bond funds and 5% in a money-market fund; Putnam Investments' fund is a mix of 25% stock funds, 45% bond funds and 30% in a money-market fund.

T. Rowe Price, meanwhile, offers a fund for retirees with 40% in stocks, 30% in bonds and 30% in short-term bond and money-market funds. Retirees can also hold on to T. Rowe Price target-date funds, which continue to shift toward a more conservative mix for 30 years after retirement, eventually reaching 20% in short-term bond and money-market funds, 60% in other bond funds and 20% in stock funds.

There are considerable differences in the underlying investments as well. Vanguard's target-date funds hold just four or five of its broadest-based index funds, as a way to keep costs to investors low and avoid the risk that comes with having active management of a fund

Fidelity's 2030 fund holds 18 actively managed Fidelity funds, seven of which are large-cap funds and five of which focus on international stocks. Barclays takes a middle road, investing its funds in "enhanced index" funds, where portfolio managers make bets on individual stocks in an index in an effort to slightly exceed the index's performance. Wells Fargo Funds, meanwhile, takes the unusual approach of investing in individual stocks and bonds, rather than its funds.

Some fund companies also levy an additional charge to investors, on top of fees they collect for running the underlying funds. Putnam charges investors an extra 0.05% of assets and Fidelity adds 0.08%. That money can add up. In the 12 months ended March 31, Fidelity collected $15.3 million for the asset-allocation services provided for its 10 target-date funds.

Fidelity says the added fee is justified by the additional work the Freedom Funds portfolio manager does, making the target-asset allocations called for by the firm's model and adjusting the mix based on his view of the market. "That's the greatest added value we provide," says John Sweeney, a senior vice president of mutual-fund product development at Fidelity. Putnam, meanwhile, says the additional fee covers the costs of running the target-date fund as well as portfolio management.

However, many others, such as American Century Investments, Vanguard and T. Rowe Price, don't charge an additional fee.

Earnings and the market: (2005) Since 1927, according to data from Ned Davis Research of Atlanta, the market has performed best during quarters when earnings are as much as 25 percent below year-earlier levels. When earnings are growing strongly, as many expect them to do this year, the market has tended to have below-average performance.

The reason that the overall market usually fails to react more favorably to rapidly rising earnings is not that earnings growth is bearish itself. The problem, the professors say, is that such growth usually leads to higher interest rates. When rates rise, the net present value of future earnings, cash flow and dividends automatically falls, and this generally causes the market to decline.

Ned Davis Research says that since 1927, the Standard & Poor's 500-stock index has risen at a 28 percent annualized rate - nearly triple its historical average - during quarters in which earnings were 10 to 25 percent lower than where they were in the periods a year earlier.

This bullish effect vanishes, however, when earnings are falling too much. Ned Davis Research found that during those few quarters since 1927 when earnings were more than 25 percent below their year-earlier levels, the S.& P. 500 declined at a rate of 28 percent, annualized.

An implication of the professors' study is that the market's performance is likely to be below average this year, because of the consensus expectation for double-digit profit growth accompanied by rising interest rates. S.& P. estimates that per-share operating earnings of the S.& P. 500 companies in the first quarter will be 14 percent higher than in the year-earlier period. Earnings for all of 2005 are projected to grow 12 percent. In quarters since 1927 when profit growth has been in the neighborhood of what S.& P. is projecting this year, according to Ned Davis Research, the S.& P. 500 has appreciated at an annualized pace of 5.8 percent. That is about half the market's long-term average rate.

Turnover: (2005) Many academics think that high portfolio turnover can cost as much as 100 to 200 basis points a year.

New investments?: (2005) A survey of more than 1,000 pension funds, endowments and foundations by Greenwich Associates found their exposure to U.S. domestic stocks and fixed income securities falling and holdings of international stocks and alternative assets on the rise. U.S. pension funds, endowments and foundations are moving more assets into international stocks, hedge funds, high-yield bonds and emerging markets debt in an effort to meet their obligations.

I see a problem here if individual investors hope to emulate that mix. I will dismiss emerging funds for this commentary. As regards hedge funds, one must read the commentary by Bill Jahnke on hedge funds . "In terms of performance data, reported hedge fund performance is upward biased, incomplete and inconsistent across database vendors. Historical returns must be viewed skeptically because most vendors of performance information merely provide a conduit for data supplied by fund managers without independent verification.

Next let's focus on high yield bonds. Readers may note that I use these and suggested a decent amount in an improving economy. But a problem arises later on if the spread between treasuries and high yield narrows- and it has done so quite extensively. The general comment is that with rising rates overall, the total yield on such bonds this year cannot appropriately compensate for the inherent risk of default and low ratings. I have already suggested adjustments to portfolios.

As regards international stock, there is a lot of commentary on what type of correlations such stocks have over time. Not very consistent. Check out what happened from 1994 to 2000. Admittedly they have done well over the recent term. But that was due to the dropping (and still dropping) dollar. I did not utilize these very much since a great number of U.S. stocks are international and I thought that might be enough. Not so- the returns for international funds has been high. However, will the dollar continue to drop- certainly as we have seen? I think not. I do not see a high use of these in anyone's portfolio.

Sell???: (WSJ Zacks Investment Research 2005) stocks with large proportions of "sell" recommendations from Wall Street analysts have lately performed better than those with plenty of "buy" or "hold" ratings and no sell ratings at all.

Despite some analysts' awareness of the problem, they clearly have trouble with their ratings. The problem has gotten worse lately, even after the Wall Street stock-research scandals. After the market's bubble, e-mail messages showed that some analysts had put buy ratings on stocks they privately ridiculed. Brokerage firms had to pay millions of dollars in settlements and promised to change their ways. Analysts were pressured to issue more sells. Wall Street firms assured clients that, henceforth, a buy would be a real buy, and when an analyst lost faith in a stock, he or she would issue a sell.

On the face of it, things did change. For a brief period in 2000, just as the stock bubble was bursting, 95% of the stocks in the S&P 500 had no sells at all. No stock had more than one sell rating. That soon changed. Today, only 38% are without sell recommendations. Of the 62% with at least one sell, 9% have five sells or more.

the period when buy-rated stocks have recently performed best was during the stock mania of the late 1990s, when out-of-favor stocks were being abandoned and it was hard to find sell-rated stocks at all. From 1991 through 1996, the stocks with the most sell ratings outgained those without any sells. But from 1996 through 2000, those with no sells outpaced those with the most sells -- possibly in part because there were so few sell-rated stocks to measure. Since 2000, even though Wall Street supposedly has become more discriminating, the sells are leading again. In 2003-04, for example, the sells rose 36% on average, while the buys rose just over 25%.

A study shows that analyst forecasts for corporate profits in a wide group of large and small companies have been off over the past 30 years by an average of 40%, either above or below the actual result.

Baby boomers and the stock market: (NY Times, James M. Poterba, an economics professor at the Massachusetts Institute of Technology 2005) There is commentary that as the baby boomer retire, they will have to start cashing in all their stocks. Without new workers to buy all the stocks, the stock market will decline.

But "Predicting the effect of population patterns on the stock market is not an exact science. Immigration, for example, may significantly reduce the proportion of people in retirement, making predictions based on current data inaccurate. And if population trends ever do cause the market to decline, more foreign investors may enter the market in search of bargains, reducing or even reversing the damage. "

"Given the imprecision of his statistical tests, however, he is willing to allow that the huge number of baby-boom retirees may reduce the market's annualized return by about one-half of 1 percent over the next couple of decades."

Well, that is a decline but not one that will seriously impact the market. The more pressing issues of the HUGE budget deficit will dwarf any of the problem.

The chart shows a general upward trend in correlation through time. However, we see that the correlations between international returns and U.S. returns were higher in the 1920s, 1930s and 1950s than they were in the 1980s and 1990s. This points out that—contrary to popular opinion—recent correlations between U.S. and international assets are actually lower (and not higher) than some past correlations.

Mutual money: (2005) Mutual funds paid out an estimated $163.1 billion in income and capital gains distributions in 2004, says Tom Roseen, senior research analyst at Lipper, the mutual fund tracker.

Those payouts mean that fund shareholders gave about $9.8 billion to the tax man, Roseen says. Stock-fund shareholders alone paid $5.7 billion. The bill would have been larger, but many shareholders invest through tax-deferred accounts, such as corporate 401(k) plans. And relatively few taxpayers are in the maximum 35% tax bracket.

Since 2002, income distributions are up 77%, short-term gains distributions rose 340% and long-term gains jumped 539%. Most of the stock-fund distributions were from small-company stock funds, which have fared well the past five years.

But it's off a low base. The bear market of 2001-02 hit funds so hard that precious few had gains to distribute. Distributions fell to $95.1 billion in 2002 from $376.7 billion in 2000.

In the long term, the effects are even worse. For example, a $10,000 investment in Dodge & Cox Stock would have become $43,400 after 10 years in a tax-deferred account. Had you paid taxes on your account each year, however, you'd have $36,500 — nearly $7,000 less, assuming you were in the 35% tax bracket.

Reflections on the Efficient Market Hypothesis: 30 Years Later, Burton G. Malkiel, "This hypothesis is associated with the view that stock market price movements approximate those of a random walk. If new information develops randomly, then so will market prices, making the stock market unpredictable apart from its long-run uptrend.
(I disagree- see Benoit Mandelbrot).

Malkiel continues, "In recent years, many financial economists have come to question the efficient market hypothesis. At least ex-post, there seem to be several instances where market prices failed to reflect available information. Moreover, periods of large-scale irrationality, such as the technology-internet “bubble” of the late 1990s extending into early 2000, have convinced many analysts that the efficient market hypothesis should be rejected. In addition, financial econometricians have suggested that stock prices are, to a significant extent, predictable on the basis either of past returns or of certain valuation metrics such as dividend yields and price-earning ratios." "Surely, if market prices often failed to reflect rational estimates of the prospects of companies, and if markets consistently overreacted (or under-reacted) to underlying conditions, then professional investors, who are richly incentivized to outperform passive investors, should be able to produce excess returns."

Percent of large capitalization equity funds outperformed by index ending December 31, 2003

Index funds tend to outperform by two percentage points. Comparison of returns: Average equity fund versus indexes

The 10 best actively managed funds during the 1960s achieved rates of return almost double that of the index but those same funds underperformed the index during the decade of the 1970s. Similarly, the best funds of the 1970s underperformed during the 1980s and the winners of the 1980s achieved below average returns during the 1990s.

Index funds tend to outperform actively managed funds in international as well as in domestic markets. Figure 3 presents a comparison of actively managed European equity funds compared with the Morgan Stanley Capital International (MSCI) Europe stock market index. While in many individual years, 50% or more of the active managers do beat the index, the longer-term results confirm our findings for the United States. Over a 10-year period ending December 31, 2002, over 80% of the actively managed funds underperformed the index. Figure 4 presents a 10-year performance distribution for European active managers similar to the comparison shown in Figure 1. Again, we see that over 80% of the active managers do worse than the index and only four managers were able to beat the index by 400 basis points or more.

Switching from security to security accomplishes nothing but to increase transactions costs and harm performance. Thus, even if markets are less than fully efficient, indexing is likely to produce higher rates of return than active portfolio management. Both individual and institutional investors will be well served to employ indexing for, at the very least, the core of their equity portfolio.

“I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when Graham and Dodd was first published; but the situation has changed . . .

[Today] I doubt whether such extensive efforts will generate sufficiently superior selections to justify their cost . . . . I’m on the side of the ‘efficient market’ school of thought.”

Here is the fallacy and the correctness of Malkiel. The issue about excess returns can be taken as a relative value since very few professional investors beat the index. So let's take a look at professional investors. Effectively none even know the fundamentals of investing (those having a series 7. Even MBAs). Hence any positive activity may be reflected by simple luck. So now let's review the actual returns of the market during the last few years.

Year	Vanguard Total Return	Vanguard 500 Index
1993	10.62	9.89
1994	-0.17	1.18
1995	37.79	37.45
1996	20.56	22.88
1997	30.99	33.19
1998	23.26	28.62
1999	23.81	21.07
2000	-10.58	-9.06
2001	-10.97	-12.02
2002	-20.96	-22.15
2003	31.35	28.50
2004	12.52	10.74
12 year average annual return	10.66	10.88
Annual standard deviation	18.88	19.43

Literally every table of returns notes the one year standard deviation. The standard deviation for the 12 years reduces to 5.43%. Sound great over 12 years. Is that the figure that analysts use to entice you to invest? Absolutely. But what is your actual risk of LOSS. "A standard deviation in the average return over the 12 year period will effect final wealth by a factor of (1- .0543) to the 12th power = .531. That means that final wealth will be less than one half its expected value."

"The lesson is that one should NOT use the rate of return analysis to compare portfolios of different size. Investing for more than one holding period means that the amount at risk is GROWING. This is analogous to an insurer taking on more insurance policies. The fact that these policies are independent of each other does not offset the effect of placing more funds at risk. Focus on the standard deviation of the rate of return should NEVER obscure the more proper emphasis on the possible dollar values of a portfolio strategy".

So the whole idea of returns, risk, efficient market and random walk goes out the window real quick when you could end up with half of your projected money. Take a look at 2000- 2002. At least 40% of an asset base went bye bye. More with more aggressive pickings such as the dotcoms. And if you were just retired at that point, you are pretty much history. Your principal will never get back to an acceptable level since you are depleting your asset base every month.

I do not necessarily disagree with the use of index funds. But I look to Mandelbrot and the selective adjustment of investments to remove unnecessary risk. That there was some loss in equities in 2000 is essentially a given. But after that it gets to being absurd. Professional investors need to address economics. Economics identifies risk. Then you reduce your exposure to equities in (at least) 2001 and you never are exposed to 2002. Even given that Malkiel is correct- who cares? Risk determines what you need to do. If you are just going with a buy and hold, bend over. Therein lies the fallacy with 98% of all writings.

Risk- (Mandelbrot 2005) "A portfolio is efficient if it produces the most profit with the least risk. Thus for each level of risk you contemplate, you can devise an efficient portfolio that will yield the highest possible profit. And for each level of of profit you target, there is an efficient portfolio with the lowest possible risk. If you plot all these portfolios on a graph, they will form a smooth, rising curve; go-go and risky portfolios towards the top, boring and safe ones down below."

O.K., let's assume that is all fine. But the point I look at is that there is a unlimited number of time frames to plan the risk around. And each one changes shortly thereafter. The efficient frontier at the beginning of 1999 was a lot different than that of 2000; that was a lot different than that of 2001................than that of 2005. Each time frame has a different set of risks- hence a different set of equities and bond mix. If you planned on a buy and hold of an "efficient portfolio" in 1999 you would not even be close to the risk scenario of mid 2005. The theory is applicable. The real life application is nil.

The hedge fund industry has literally exploded in size in the past three years; going from about $500 billion U.S. just back in 2003 to over a $1 trillion U.S. last year, and it also continues to be a constant source of entertainment for me. I got my first hedge fund client over 20 years ago, and I used to have to explain to my colleagues what the heck one even was since they were relatively few in number and received no mainstream press at all. Nowadays, they are buying a $270 million dollar, Michael Jackson loan package from Bank of America and voting to oust the head of Germany's largest stock market. It has been intriguing for me to observe firsthand the maturation and acceptance of this once clandestine group of money managers.

To be truthful, some of the statistics I have observed in the past few months have been staggering. Let me share a few of them with you:

--On an average day, between 30% and 35% of ALL trading on the London Stock Exchange is hedge fund related.

--It is estimated that in excess of 75% of quoted, convertible bonds are now held by hedge funds.

What has also been remarkable are the types of investors who I have personally observed putting their money into hedge funds. Sometimes with less than stellar results too. I was just in Bermuda last week and read an article in The Royal Gazette about the Ohio Bureau of Worker's Compensation managing to lose $215 million in a hedge fund that only invested in U.S. Treasury securities. If you cannot help but wonder how one manages to lose $215 million in U.S. Treasuries, you might find it even MORE interesting that the Bureau of Worker's Compensation had only invested a total of $225 million in the fund in the first place, so the loss is actually an unfathomable 95% of their total investment. Welcome to the world of extreme leverage and to the world of hedge funds where performance numbers tend to be eye popping whether the numbers are positive or negative ones.

Credit Default Swap". To set this story up, let's pretend that you currently have $100 million to invest and you've examined these General Motors bonds and think that everything is actually going to work out fine. You also think that the 5.00% spread that the bonds are paying compared to Treasuries is quite handsome and you decide to take your $100 million out of Treasuries and invest it into the GM bonds.

As your broker who is always trying to "add value" for his clients, I call you with a wonderful idea. "Leave the $100 million in those Treasuries," I say, but I suggest that you might want to enter into a credit default swap. Here's how it goes:

--The swap will be on a "notional" value of $100 million. The $100 million is more truthfully a fictional amount of principal that we are going to use to decide who owes whom money. Neither of us actually pays

$100 million, and we are likely to never be exposed to that much total risk either. On day one, when we enter into this swap agreement, no money changes hands. We just sign the contract and we're on our way.

--I am going to pay YOU the 5.00% (500 basis points) difference between those GM bonds and the comparable Treasuries. And I mean just PAY you the 5.00% on $100 million, which when combined with your investment in the real Treasuries brings your rate of return up to the level of the GM bonds themselves.

--What you are going to pay ME is any decline in price that occurs should GM default on those bonds, or if a rating agency downgrades them. That means if the bonds have their ratings reduced and decline in price by 10%,

then you will owe me that 10% x $100,000,000, or simply $10 million. Basically, I am paying you the 5.00% to take the GM credit risk off of my shoulders and onto yours, and the $10 million loss you suffered there was exactly the loss you would have realized if you'd just went out and bought the General Motors bonds you'd wanted to in the first place.

If you can't help but wonder why someone would be willing to pay 5.00%, as I suggest, instead of just selling the bonds; what if I'm a big mutual fund company or insurance company with a substantial business relationship with GM? How would it look if I suddenly began selling all the GM debt that I hold? By paying you the 5.00%, I have simply reduced MY return to the level of U.S. Treasuries and brought YOUR return up to the level of the General Motors bonds.

As the rumors circulated that GM might be getting downgraded, the credit spreads that were getting paid to accept this risk in a credit default swap became bigger and bigger; to the point where it was so juicy that many hedge fund managers couldn't resist themselves any longer. By simply agreeing to accept the General Motors credit risk they would immediately begin receiving cashflows without tying up ANY money at all during a year when hedge fund managers have found it increasingly difficult to find profits.

Now keep in mind that hedge fund managers tend to be some of the most sophisticated and intelligent money managers on the face of the earth, and I'm stating this with total earnest. They knew full well the risk they were taking on and they immediately knew they would need to find a way to hedge themselves to protect if a downgrade were to actually take place on the debt. Sure, they were enjoying a fat stream of payments for accepting such a risk, but if the debt did really get downgraded they would be facing substantial losses.

What caught their eye was the level of General Motors stock, which has dropped to around the $26 level. Surely, if the corporation's debt were downgraded, the stock would have to get its clock cleaned as well, so the decision was made to short sell the stock.

Remember that the concept of short selling would be to borrow some GM shares from someone (rent the shares actually) and then sell the borrowed shares at the $26 price. If the downgrade comes, let's say that the stock collapses further to perhaps $20 per share, and at this point the hedge fund buys the shares back and pockets the $6 difference between the $26 they sold the stock for and the $20 they had to spend to repurchase it. The hedge funds would need these profits on the short sale to reimburse themselves for the losses they would suffer on the credit default swap. If the downgrade never comes, they enjoy the huge cashflows on the swap, and the renting of the stock for the short sale ends up being a cheap insurance policy.

Well, as you may remember, the downgrade on GM debt DID happen and those fund managers sustained heavy losses on the credit default swaps and felt one of their kneecaps shatter. Thank God they'd entered into the short sale on the stock since they will badly need those profits to help offset the huge hickie they just incurred.

Oh oh. Who could have ever imagined that during such a dark chapter in General Motors history, some 88 year-old billionaire would honestly launch a $31 per share tender offer to buy as many GM shares as possible, causing the stock price to immediately jump to $32 and it is currently residing above $34. Ouch!! For those same hedge fund managers who had just gotten one kneecap broken on the credit default swap, they were suddenly feeling the other kneecap bursting as their "insurance" of a short sale of stock blew up completely on them.

But such is life in the fast lane of the world's financial markets. How often are tender offers made for the stock of companies who seem to be limping slowly into the dustbin of corporate history? I can't honestly remember a comparable incident, but it doesn't matter really. What I can vividly remember is the hundreds and hundreds of times that things have occurred in the financial markets that nobody could have ever anticipated, but managed to happen anyway. Ultimately, the markets always have a way of showing even the best and the brightest that they are nowhere as smart as they sometimes think they are.

Discounted Cash Flow Fallacy: (2005) The discounted cash flow method is now widely used as a valuation method for income producing real estate (and stocks) in many countries. In fact, it is generally accepted that the method yields a fair value estimate in the spirit of the new accountancy standards. This method is very useful indeed, but does suffer from some limitations. These include the facts that (1) the value of the property is needed to compute the discount rate, (2) the discount rate is assumed to be constant during the entire holding period, and (3) uncertainty is not explicitly taken into account.

Hedge a hedge: (NY Times 2005) Andrew W. Lo, a finance professor at the Sloan School of Management at the Massachusetts Institute of Technology, has been studying hedge fund failures and risks, and he says that another hedge fund industry shakeout is likely in the near future.

Lo has come to a disturbing conclusion: that smooth returns, far from proving that hedge funds are safe, may be a warning sign for the industry.

hedge fund investments are less liquid now than they have been in 20 years. His work shows that the same pattern of investing preceded the 1998 global hedge fund meltdown and the 1987 stock market crash.

Lo argues that while a hedge fund crisis appears to be sudden and to be caused by unforeseen events, the breakdown is only the late stage of the problem. As more hedge funds compete for the same slice of the pie, he says, their managers feel that they have no choice but to "leverage up," juicing their returns by borrowing more money to make bigger investments.

Fund movements: (NY Times 2005) professors conclude that mutual funds regularly make transactions that can set boom-and-bust cycles into motion. One such transaction is a "fire sale," which the researchers define as occurring when a fund must sell a stock very quickly, regardless of price. Another move, called a forced purchase, is the reverse: it occurs when a fund must buy a stock right away.

Two factors conspire to make such transactions frequent in the fund arena. The first is significant and sudden inflows and outflows. A fund that finishes at or near the bottom of quarterly or yearly performance rankings, for example, will almost certainly receive a large number of redemption requests. In contrast, a fund that comes out near the top of the rankings can expect heavy inflows of new money.

Big outflows and inflows do not necessarily cause fire sales and forced purchases. But they do if a fund manager tries to keep cash balances low at all times, which is the case for a large majority of stock funds.

A fund that receives many redemption requests will have to sell some of its positions to honor them, even when the prices of its stocks are unfavorable. And a fund that receives lots of new cash will feel pressure to put that money to work right away. Usually, the professors say, managers in this situation buy more shares of stocks that their funds already hold.

The price impact of these moves can be so large, the professors say, that it can lead to even more forced purchases or fire sales in future months. The cycle occurs because the performance of these funds will be either helped or hurt by the price changes caused by their initial quick buying or selling. That, in turn, will help them continue at the top or bottom of the rankings.

After studying mutual fund holdings, as well as inflows and outflows, from 1990 through 2004, the professors concluded that these patterns of momentum and subsequent reversal were regular and sizable. They found that stocks sold in fire sales lagged behind the market by about 10 percent during the quarter when those sales were heaviest. And stocks bought in forced purchases outperformed the overall market by about 8 percent in the quarter when that buying was strongest.

During the next quarter, however, the trends started to reverse: the stocks that were initially sold in fire sales bottomed out and then started to beat the market, while the stocks that were initially bid up by forced purchases began losing their market-beating momentum. In the 12 months after the quarter with the heaviest forced moves, stocks in the initial market-lagging group beat the market by about 6 percent, on average, while stocks in the previous market-beating group underperformed the market by about 4 percent.

Clueless (Paul Farell 2005) Here are some comments about why people make investment mistakes (and otherwise). My comments follow

1. Distrust all data Here's a fast-moving scenario: The Wall Street Journal quotes a Morgan analyst. Bill Gross is on CNBC. Bloomberg tests Bernanke's inflation strategy. Your stock-picking software signals a "buy!" Your brain sees a pattern, a trend. Big mistake! Why? Kahneman doesn't say don't trust the data, he means don't trust what your brain is doing with data! Brains love seeing things that aren't there, inventing epic dramas. Makes them feel in control (brains hate being clueless).

Me- Depends on the data and how it is distributed. If you look at the yield curve, it has not emotion to it at all. Same with productivity, GDP, employment numbers and so on. There is NO emotion to investing- that's how I do it. Unfortunately, consumers are swayed by marketing and their teeny little brains. And trusting golf buddies. Yuck!

2. Cool it big shot!- Chasing fads and hot investments makes Wall Street drama queens feel important. But even stupid ideas like dotcoms win in bull markets. Psychologists say overconfidence is our biggest saboteur. You win some, think you're a genius, take bigger risks, wind up a loser. It's just a market cycle. You really don't have a clue what's next.

Me- fine. But you HAVE to evaluate economic cycles. If you do not read the Fed, you are not an investor.

3. Distrust all gurus!- All gurus, all the time. In print, cable, online. They're hustlers selling you something. Period. See every talking head, naked on stage, wearing a big "used-car salesman" name tag. Their so-called "advice" is a sales pitch. Now, notice how your brain still wants to believe in them.

Me- Fine again. But Greenspan is not a guru. There are others. Try the Hulbert letter for independent analysis.

4. Stop the obsessive counting Behavioral psychologists note that investors who check their accounts often are more anxious and, ironically, bigger losers. Kahneman's pretty blunt: Looking at your stocks and funds every day is not only dumb, it's "the worst possible thing you can do!"

Me- absolutely true, but most people do exactly that. Long term trends are the issue. Become obsessive about being a reader. And then think.

5. It's the portfolio, stupid -Kahneman calls it "global framing," focusing on the whole rather than worrying about gains and losses in individual assets. Create a well-balanced portfolio diversified enough so that losses in one sector are spread against the returns of the rest of the portfolio.

Me- Generally works. Generally. But look at 2000- 2002. Sure some bonds would have offset some of the 45% losses- but not enough for most retirees. Diversification also means escaping the wrath of extreme down turns. It can be done. It should be done.

6. Autopilot investing -Sorry folks but your brain is a very, very bad computer; irrational, clueless, extremely vulnerable to mistakes. Junk it! Get an upgrade, like Kahneman's "permanent autopilot portfolio." Then set your savings up so new money is automatically transferred from your bank into your portfolio. Get your error-prone brain out of the loop.

Me- don't always agree. Autopilot means different allocations in different economies. Too much stuff changes. Autopilot in 1999 is entirely different than 2005. Not even close

7. Limits on casino betting- Think about CNBC's frenetic "Mad Money" program. Now, if you're an investor with a hyperactive teenager's brain, next time you have a sane moment, lock up 90% of your portfolio. Can't touch it. Limit your self-sabotaging gambler's brain to the other 10%. When that's gone, walk off stage and enjoy a very long Pinter pause.

8. Trust yourself -Well, do you? When the curtain falls, when applause dies down, when the lights dim in your little theater, when you are stuck alone with box-office receipts, win or lose, will you walk out into the night your head high, no matter what, proud of your performance?

Me- very few people can trust themselves. Reading and thinking are not part of consumer effort. Actually, reading and thinking are not part of most advisers and analysts.

Harsh? Then how is it that American Express put out bogus software used at least in Tennessee and perhaps the country. How is it that they only provided the positive statistics of investing which violates Rule 2210? And it goes on.

WHO NEEDS HEDGE FUNDS? (2006) the number of hedge funds has risen from around 500 in 1990 to an estimated 8000 in 2005. Over the same period, assets under management are estimated to have increased from $50 billion to $1 trillion. In this paper we develop and demonstrate the workings of a copula-based technique that allows the derivation of dynamic trading strategies, which generate returns with statistical properties similar to hedge funds. We show that this technique is not only capable of replicating fund of funds returns, but is equally well suited for the replication of individual hedge fund returns. Since replication is accomplished by trading futures on traditional assets only, it avoids the usual drawbacks surrounding hedge fund investments, including the need for extensive due diligence, liquidity, capacity, transparency and style drift problems, as well as excessive management fees. As such, our synthetic hedge fund returns are clearly to be preferred over real hedge fund returns.

Initially, hedge funds were sold on the promise of superior performance, the story being that hedge fund managers. long experience and proven investment skills were a virtual guarantee for superior returns. Especially high net worth investors proved sensitive to these arguments and fuelled much of the early growth of the industry. Towards the end of the 1990s the story began to change, however. No longer were hedge funds sold on the promise of superior performance, but more and more on the basis of a diversification argument, pointing at hedge fund.s relatively low correlation with stocks and bonds and the beneficial effects on risk and return from including hedge funds in the traditional investment portfolio. The reason for this rather remarkable change in sales tactics was twofold. Firstly, starting in the late 1990s, hedge fund performance took a turn for the worst, with every next year being worse than the year before. According to the HFRI Fund of Funds Composite Index, the average fund of funds only returned a meagre 3.85% over the first ten months of 2005. Secondly, driven by historically low interest rates, substantial losses in the equity markets, and keen to be seen taking action, institutional investors started to look more seriously at hedge funds as well. Given institutions. emphasis on risk management, the hedge fund story changed to accommodate this new clientele1.

Much of investors. current interest in hedge funds derives from the fact that traditional asset classes seem to lack opportunity these days. Stock markets are still hesitant, bond prices will come down when interest rates go up again and the yield curve is flattening. With fresh memories of double-digit returns, this has driven investors towards commodities, emerging markets, credit-based structures, and of course hedge funds. Having generated high returns in the early years, the average return on hedge funds over the last 10-15 years has been quite impressive and many investors seem more than happy to use this as a guide for future returns. Given today.s low interest rates, low risk premiums across the board, as well as the current size of the hedge fund industry itself, a repeat of the last 10-15 years is extremely unlikely, however. Investing in alternatives comes with many drawbacks, including due diligence, liquidity, capacity, transparency and style drift problems, and excessive management and incentive fees. As long as investors believe they will be rewarded with (close to) double-digit returns, they will take these problems for granted. However, when reality kicks in and investors realize that hedge funds are no longer the money machines they once were (thought to be), their attitude will undoubtedly change. The above drawbacks will become more and more important and may ultimately become a reason to say farewell to hedge funds altogether and migrate to other alternative asset classes like emerging markets for example, which has shown stellar performance over the last 3 years. In fact, according to HFR, during the third quarter of 2005 funds of hedge funds were confronted with their first net outflow of funds, in the amount of $1.2 billion31.

Very interesting articles- shows how to do the same thing as a hedge fund without all the extraneous features (high fees, lack of liquidity, lack of transparency and more). Many of these new articles are from the Cass Business School in England and represents some leading edge commentary.

Is Stock Picking Declining Around the World?," (2006) Yep. In the 1960's, for example, the earliest decade in the study, the ratios differed so much that the authors estimate that stock picking accounted for as much as 80 percent of all trading volume. In the current decade, by contrast, they estimate that it accounts for just 24 percent.

They repeated these calculations for 42 foreign stock markets, though back just to 1995, because there was less data for them than for the American market. They found that stock picking had declined in almost all those markets as well, accounting for less volume from 2000 through 2004 than it did from 1995 through 1999.

that stock picking was more prevalent in emerging countries than in developed countries. For example, they say, it accounts for some 80 percent of the trading volume in the Chinese stock market.

If stock picking has become so rare in the United States, shouldn't it be easier for stock pickers to find market-beating stocks? After all, the market becomes less efficient in setting stocks' prices as fewer investors are trying to beat it. In other words, is it possible that indexing has become too prevalent?

The researchers say they think that the answer is no. According to a complex model that they developed, the stock market becomes remarkably efficient even when relatively few investors are trying to beat it - as few as 1 in 10, in fact. That means that even while stock picking has declined sharply in recent decades, enough investors are still engaged in the pursuit that the rest of us should avoid it ourselves.

Me- for anyone that wants to try, tell me what diversification is. No one should even attempt stock picking if they do not know the fundamentals.

Age related funds- (2006) I referenced this in my book in that how is it possible that the various fund families have widely different allocations for the same time frame. Here are some examples from Forbes

Fidelity	Percent of Equities
Target Date	2005- 44.7%	2025- 74.1%	2040- 84.6%
Target Age	65	45	30
Putnam Target Date	2010-36.5	2025- 77.5	2045- 92.7
Target Age	60	45	25
TIAA CREF Target Date	2010- 49.1	2025- 64.1	2040- 79.2
Target age	60	45	30
T Rowe Price Target Date	2005- 57.2	2030- 89.7	2025- 89.7
Target Age	65	40	25
Vanguard Target Date	2005- 32.5	2025- 58.1	2045- 87.9
Target Age	65	45	25

If there was a consistency in risk/reward, there could never be that much difference in the percentage. Look at the variability. So which one is correct? Who did the analysis? Lastly, will they work for the time frame? Nope- the world changes too much, too fast.

So you want to invest in gold: (Economist 2006) In the past five years the price of gold has doubled. This week in Asian trading it briefly surpassed $500 a troy ounce—a level last breached in 1987. You can almost feel the bugs' excitement as the message sinks in: gold is back.

This being gold, the resurgence has brought forth all manner of alarming prophecies. The price is an omen of rampant inflation; bonds are doomed; the dollar is about to fall prey to the United States' reckless deficits; the euro will shortly be revealed as a worthless creation of bureaucrats.

The world is an unpredictable place. But, with the possible exception of a fall in the dollar, not much of the above catalogue of doom looks likely; and none of it has much to do with gold's good run. The dull truth is much less bullish for gold. Investors have put money into a wide range of metals, and precious metals' prices, including gold's, have risen with the base. Meanwhile, gold remains fundamentally unattractive. It yields nothing and central banks are sitting on vaultfuls of the stuff that they want eventually to sell. Gold bugs hope that $500 is the threshold at which mainstream investors will start once again to take an interest in the metal. Caveat emptor.

Men vs. women (NY Times 2006) Psychologists have found that among individual traders, men tend to make riskier bets than women. For the new study, the researchers looked at all actively managed domestic equity mutual funds in the United States over the 10 years through 2003. They eliminated from their database any funds that were managed by teams. Instead, they focused exclusively on funds managed by one man or one woman; about 11 percent of those were run by women.

Just as the previous research had shown for individual traders, the study found that male fund managers took more aggressive bets.

Previous studies found that, among individual traders, men were more likely than women to be overconfident in their abilities and thus trade too much. The researchers found a similar result among fund managers: the average fund managed by a man had a turnover rate that was 10 percent higher than that of the average fund managed by a woman.

But raw returns of funds managed by women were slightly lower than those of funds managed by men, on average, evidently because women tended to manage their funds more conservatively. On a risk-adjusted basis, the two groups' performances were about equal.

researchers found no justification for investors to prefer mutual funds managed by men. In fact, when building portfolios, investors may find that funds managed by women are better.

* within the context of making asset allocations for 401(k) retirement plans, women on average invest more risk averse than men. Similar results are reported by Jianakoplos and Bernasek (1998) who find that household holdings of risky assets are significantly lower for single women than single men. Using account data for over 35,000 households from a discount brokerage, Barber and Odean (2001) document that women tend to hold less risky positions than men within their common stock portfolios.

* more style-consistent funds tend to outperform less style-consistent funds. Therefore, investors should also be concerned about the style consistency of the respective fund they put money in. Concerning gender differences in style variability, Powell (1988) suggests that female managers in other industries follow more consistent management styles than male managers over time.

* Barber and Odean (2001) find that men trade 45 percent more than women. This reduces their net returns by 2.65 percentage points over time

Downside Risk (2006) Economists have long recognized that investors care differently about downside losses versus upside gains. Agents who place greater weight on downside risk demand additional compensation for holding stocks with high sensitivities to downside market movements. We show that the cross-section of stock returns reflects a premium for downside risk. Specifically, stocks that covary strongly with the market when the market declines have high average returns. We estimate that the downside risk premium is approximately 6% per annum. The reward for bearing downside risk is not simply compensation for regular market beta, nor is it explained by coskewness or liquidity risk, or size, book-to-market, and momentum characteristics.

The word "average" in "average annualized return" may be part of the problem because it triggers that arithmetic averaging method we've all been overtaught. But even though "average" is synonymous with "mean," one mean or average is appropriate for investments while the other is not.

The too-casual observer using an arithmetic mean method might conclude that the average annualized return over this two-year period equals zero. You would add the numbers and then divide by the number of numbers.

Now, let's put dollar figures into the example and see if the arithmetic mean holds up. Assume a $1,000 initial investment.

Clearly, the two-year average annualized return cannot be zero if the starting account value was $1,000 and the ending account value was $750 two years later. What then is the average return in this scenario? On a financial calculator, we would enter the following:

The two-year average annualized return is -13.397%, which can be proven by the following:

The financial calculator solved for the geometric mean, not the arithmetic mean. All data providers, such as Morningstar, Lipper and Ibbotson, compute the geometric mean when reporting "average annualized return."

A client asks for your help in calculating the "average return" for the Manhattan Transfer Fund over a three-year period. Summing the three returns and dividing by three yields the following average:

The 15.67% above is an arithmetic mean. The math (the sum of the numbers divided by the number of numbers) is correct, but the application is wrong. When numbers, such as test scores, are simply added, calculating the arithmetic mean is appropriate.

Investments grow in a multiplicative, rather than an additive, manner, however. To gauge the growth of an investment, numbers should be multiplied in sequence to get the geometric mean.

To calculate the three-year average annualized return (or geometric mean) of the Manhattan Transfer Fund for the client you first need to compute the three-year cumulative return:

(Some fund companies report or advertise cumulative returns, which can be misleading because they are always higher than the average annualized return. However, the average annualized return is much more useful for comparing performance with other assets, and hence is the industry standard.)

The Manhattan Transfer Fund had a cumulative return of 51.47% over these three years. With that information, we can compute the three-year average annualized return or the geometric mean.

PV = -1 (representing a Present Value investment of $1, which should be entered as a negative number)

Thus, the average annualized return of the Manhattan Transfer Fund is actually 14.84%, not 15.67%.

When solving for "i" (or "i/yr") on a financial calculator (for example, Hewlett Packard 12C, Hewlett Packard 10B or 10BII, Texas Instruments BA II+, etc.) we are solving for the geometric mean.

The geometric mean is the return that, if held constant, will generate the stipulated future value over the stated period. In this example the stipulated FV was $1.5147 and the time period was three years.

OIL: The last refinery built in the U.S. opened for business in Louisiana in 1976. Many oil company executives have declared that the age of cheap energy is over. They believe this is true because we have extracted nearly all of the crude that was easy to find and easy to refine. To understand $70 oil there is no need to prove that there is 1.2 trillion barrels in global reserves, as some experts suggest. What matters is that since 1986 we have been burning more oil than we discover, and that since 1998, there has been a fragile balance between supply and demand.

This is an extensive article by John Serrapere- one of the best on oil prices past, present and future.

The deficit (Economist 2006) For several years now, economists have been watching American consumers with the same mixture of astonishment and anticipation that wide-eyed fans bring to endurance sports: amazing that they’ve made it so far, but how much longer can they go on like this? Strong consumer spending has underpinned America’s robust economic expansion, even as most other industrialised countries have struggled to get their economies back on track. But consumers have been running down savings to sustain this level of spending; the personal savings rate has actually been negative since June. Booming house prices and low interest rates have enabled consumers to take on more debt without suffering much, but with interest rates now climbing, Americans have begun to feel the pinch. Data from the Federal Reserve show that the percentage of household disposable income devoted to servicing debt was a record 16.6% in the third quarter. (Egads)

We examine the relation between US stock market returns and the US business cycle for the period 1960 - 2003 using a new methodology that allows us to estimate a time-varying equity premium. We identify two channels in the transmission mechanism. One is through the mean of stock returns via the equity risk premium, and the other is through the volatility of returns. We provide support for previous findings based on simple correlation analysis that the relation is asymmetric with downturns in the business cycle having a greater negative impact on stock returns than the positive effect of upturns. We also obtain a new result, that demand and supply shocks affect stock returns differently. Our model of the relation between returns and their volatility encompasses CAPM, consumption CAPM and Merton's (1973) inter-temporal CAPM. It is implemented using a multi-variate GARCH-in-mean model with an asymmetric time-varying conditional heteroskedasticity and correlation structure.

Going down? (2006) The share of American households owning corporate equities declined for the first time in a decade in the three years between 2001 and 2004, the Federal Reserve said Thursday. Not only did fewer families own stocks in 2004, their average holdings fell abruptly, despite the fact that the major U.S. stock indexes had recovered to 2001 levels by the end of 2004

The report showed that median income and median net worth grew in the period at a slower pace than seen between 1995 and 2001. Debt levels increased, but so did real estate holdings.

In 2004, the percentage of households with direct ownership of stocks dropped to 20.7% from 21.3% in 2001. The share of families owning stock either directly or indirectly through a mutual fund or retirement account fell to about 49% in 2004 from a record 52% in 2001.

Among those who owned stock directly, the median value of their directly owned holdings dropped to $15,000 from $21,300 in 2001, the Fed said. The figures are adjusted for inflation.

The median is the halfway mark, with half the families holding more and half holding less.

Indirect holdings increased in value. The median holdings in mutual funds rose to $40,400 from $37,300. The median holdings in retirement accounts rose to $35,200 from $30,900.

Among those who own stock directly, most had ownership in just a few companies, with 59% owning three or fewer; 34% owned just one company. Slightly more than a third of stock owners held shares in the company they worked for.

Among households earning more than $129,000 (the top 10% of income), 55% owned stocks directly, down from 60.9% in 2001. The median value of their direct holdings increased to $57,000 from $53,300.

Among those households earning less than $18,900 (the bottom 20%), direct ownership rose to 5.1% in 2004 from 3.8% in 2001. The median value of their holdings declined, however, to $6,000 from $8,000.

Median incomes increased 1.6% to $43,200 on an inflation-adjusted basis in the three year period. Median wages, adjusted for inflation, fell 6.2%.

Median net worth increased 1.5% to $93,100 from 2001 to 2004, down from a 10.3% gain in 1998-2001 and 17.4% in 1995 through 1998.

Median net worth increased by about $1,400, with the gains concentrated in real estate. The median value of residential real estate rose to $160,000 from $131,000.

Among whites, median net worth increased about 9% to $140,700. For nonwhites and Hispanics, median net worth rose about 30% to $24,800.

Among those families in the bottom 20% of income making less than $18,900, net worth fell about 11% to $7,500. For the 10% of families making more than $129,000, median net worth increased about 4% to $924,100.

The percentage of households with debt rose to 76% from 75%, while the percentage of households that said they saved money fell to 56% from 59%.

The amount of debt held blossomed. The median amount owed rose by 34% to $41,300. The share of families with a home equity line of credit nearly doubled to 8.6%. Overall, 48% of families had debt backed by real estate, up from 45%

Dumb money: Mutual fund flows and the cross-section of stock returns. (2006) in 1999 investors sent $37 billion to Janus funds but only $16 billion to Fidelity funds, despite the fact that Fidelity had three times the assets under management at the beginning of the year. Thus in 1999 retail investors as a group made an active allocation decision to give greater weight to Janus funds, and in doing so they increased their portfolio weight in tech stocks held by Janus. By 2001, investors had changed their minds about their allocations, and pulled about $12 billion out of Janus while adding $31 billion to Fidelity.

Our main result is that on average, retail investors direct their money to funds which invest in stocks that have low future returns. To achieve high returns, it is best to do the opposite of these investors. We calculate that mutual fund investors experience total returns that are significantly lower due to their reallocations. Therefore, mutual fund investors are “dumb” in the sense that their reallocations reduce their wealth on average.

Our results contradict the “smart money” hypothesis of Gruber (1996) and Zheng (1999) that some fund managers have skill and some individual investors can detect that skill, and send their money to skilled managers. Gruber (1996) and Zheng (1999) show that the short term performance of funds that experience inflows is significantly better than those that experience outflows, suggesting that mutual fund investors have selection ability. We find that this smart money effect is confined to short horizons of about one quarter, but at longer horizons the dumb money effect dominates.

Are Commodities Futures Too Risky for Your Portfolio? Hogwash! (2006) In this paper we produce some stylized facts about commodity futures and address some commonly raised questions: Can an investment in commodity futures earn a positive return when spot commodity prices are falling? How do spot and futures returns compare? What are the returns to investing in commodity futures, and how do these returns compare to investing in stocks and bonds? Are commodity futures riskier than stocks? Do commodity futures provide a hedge against inflation? Can commodity futures provide diversification to other asset classes?

Are commodities really that risky? A shortage of data has left that question unanswered. Until now. Using the most comprehensive data on commodities futures returns ever assembled, Wharton finance professor Gary Gorton and K. Geert Rouwenhorst, finance professor at the Yale School of Management, have reached a surprising conclusion: Commodities offer the same returns as investors are accustomed to receiving with stocks, which are typically viewed as safe enough for ordinary investors.

We explore the macro/finance interface in the context of equity markets. In particular, using half a century of Livingston expected business conditions data we characterize directly the impact of expected business conditions on expected excess stock returns. Expected business conditions consistently affect expected excess returns in a statistically and economically significant counter-cyclical fashion: depressed expected business conditions are associated with high expected excess returns. Moreover, inclusion of expected business conditions in otherwise standard predictive return regressions substantially reduces the explanatory power of the conventional financial predictors, including the dividend yield, default premium, and term premium, while simultaneously increasing R2. Expected business conditions retain predictive power even after controlling for an important and recently introduced non-financial predictor, the generalized consumption/wealth ratio, which accords with the view that expected business conditions play a role in asset pricing different from and complementary to that of the consumption/wealth ratio. We argue that time-varying expected business conditions likely capture time-varying risk, while time-varying consumption/wealth may capture time-varying risk aversion.

What Explains Household Stock Holdings? (2006) This is an empirical study of the determinants of stock holdings using data from the U.S. Survey of Consumer Finances from 1992 to 2001. There is a great heterogeneity in the way households form their portfolios. Stock ownership is positively correlated with various measures of wealth, age, retirement savings, and having sought financial advice. It is negatively correlated with holdings of alternative risky investments, such as investments in private businesses, and with the willingness to undertake non-financial investments in the future. While we can predict reasonably well who holds stocks, we have less predictive power about the share of stocks owned by those who hold positive amounts.

It's time for a fresh look, a new perspective, on investment performance evaluation because performance evaluation is still conducted in much the same way today as it was 30 years ago. While peer groups and indexes have painted fuzzy evaluative pictures, a modern-day application of classical statistics unifies these two approaches to better differentiate success from failure. Portfolio simulations create a framework for comparing what actually happened to what could have happened, providing fair and accurate evaluations.

ABSTRACT: The authors begin by describing the legal and financial factors which have increasingly driven clients, particularly those in "high risk" businesses or professions, to consider asset protection issues as part of their estate planning. They then address the fraudulent transfer laws, applicable in virtually every American jurisdiction, and show how asset protection planning may be incorporated into estate planning without violating those laws. The core of the article describes the categories of asset protection strategies generally available to planners under federal and state statutes, state constitutions and common law. It specifically does not address so-called "offshore trusts." While the details and application of these strategies vary widely from jurisdiction to jurisdiction, the authors have attempted to set forth the categories of techniques in a way that will provide practitioners with a template for identifying and applying the techniques available in each jurisdiction.

EIAs: (Mitchell Maynard) Any historical analysis should be considered within its context. In the case of using historical hypothetical backtesting of the Nasdaq100 index, the extreme stock inflationary period of the late 1990's is an aberration that should be factored out. Otherwise, I would be concerned that any advisor providing a hypothetical analysis of a crediting method that uses this index would be in danger of presenting to their client a scenario that has little likelihood of being reproduced.

Fund turnover- (WSJ 2007) portfolio turnover, which peaked in 2000 and 2001, is at its lowest levels in at least 10 years. Median turnover was 58% this year for the nearly 3,900 distinct funds with such information available, down from 64% when fund-researcher Morningstar Inc. started closely tracking the data in 1996. A turnover of 58% suggests a fund holds its stocks for about 20 months.

Funds in the bottom 25% in terms of turnover have seen two to three percentage points more in returns than those in the top quartile for the past one-, three-, five- and 10-year periods. The average turnover for funds that beat their peers annually over the past 10 years was 63%, while those that lagged behind peers posted 88% turnover.

Mutual-fund managers offer a slew of reasons for the decline. Turnover levels have returned to earth after rising in 2000 and 2001, when median turnover hit a peak of 75%.

Funds that saw the biggest turnover drop invest in fast-growing small and midsize companies. Here median turnover declined from close to 100% in 1996 to between 60% and 65% this year. The only area that saw an increase in turnover was "large value" funds focused on big reasonably priced companies. There, median turnover has increased seven percentage points in the past 10 years to 56%.

The trend is similar for internationally focused mutual funds, where average asset-weighted turnover for actively managed funds has dropped to 44.5% now from 66% in 2001,

The power of words in financial markets: soft versus hard communication,a strategy method experiment (Corgnet Bruce, Angela Sutan, Arvin Aashta 2007) The main objective of this paper is to analyze the impact of non-informative communications on asset prices. An experimental approach allows us to control for the release of non-relevant messages. We introduce the release of messages in standard experimental asset markets with bubbles (Smith, Suchanek and Williams 1988) through a strategy method experiment. We conjecture that a priori uninformative messages can significantly impact the level of asset prices. Uninformative communications may be used by boundedly rational subjects to compute the fundamental value of the asset. In addition, rational agents may anticipate such an effect and adapt their strategy to the messages received. We asked 182 subjects to construct strategies about their action in a standard experimental asset market environment. Our analysis sheds light on the possibility of manipulation and stabilization of financial markets by influential agents such as financial “gurus” or central bankers.

Here is an idea of a computerized plan that was offered to me. The risk tolerance is absurd (2007)

I am patient with my investments and can accept periods of negative investment returns and portfolio losses.

2. I consider myself an aggressive investor and seek above average investment returns.

3. Not including the amount I plan to invest, I have adequate liquid assets (cash and cash equivalent) to support myself and dependents for 6 months or more.

4. I have prior investment experience with stocks, bonds and international investments and I understand the concept of investment risk.

5. I am confident I will not need to withdraw money from my investments for at least 10 years.

8. There are more than two dependents who rely on my income and investment holdings for financial support.

9. I get concerned if my investments fall in value day-to-day or month-to-month.

Managing a 401(k) Account: An Experiment on Asset Allocation (2007) The study reports the results of an asset allocation experiment in which subjects managed an endowment of money over a 20 "year" time period. While grounded in theory, the study takes an applied look at the ability of subjects to efficiently and effectively make asset allocation decisions similar to those found in 401(k) accounts. The main conclusions are as follows. First, efficient portfolios are more easily created when the set of assets to choose from is carefully constructed. Thus, financial engineers should be given the responsibility for choosing the assets available to plan participants and ensuring that combinations of these assets will fall on the efficient frontier. If followed, this advice would likely significantly reduce the amount of individual company stock offered in Defined Contribution (DC) plans in place of well-constructed low cost index funds from multiple asset classes. Second, if the assets selected for inclusion in DC plans allow the investor to easily create portfolios on the efficient frontier, then the challenge for the investor is not how to get onto the frontier but where to locate on it. The simplistic surveys that are commonly used by DC plan providers to determine risk tolerance and to recommend asset allocations are woefully inadequate for this task. More sophisticated and theoretically driven instruments must be created to educate investors on the risks and the benefits available at different points along the efficient frontier.

2/13: ASSET ALLOCATION LINK: (2007) Descriptive statistics for asset class return distributions are compared to inferential statistics produced by Monte Carlo simulations to illustrate that the assumption of normality and constant correlation can understate the risk associated with a given portfolio.

During the early 50’s, Harry Markowitz [1952] sparked a revolution in investment management industry by demonstrating mathematically the benefits of diversification. Relying on linear programming techniques, he showed that the first two moments (Mean and Variance) of an asset’s return distribution along with its covariance among other assets could be used to construct optimal “hind-sight” portfolios. Subsequent work demonstrated that Markowitz’s portfolio selection model (the “Model”) could be populated with forecasted inputs and used to assist with the investment strategy process.

The Model is a very effective tool, but it should not be viewed as the only answer. Here the question asked is, “What if the Model understates the risk associated with a given policy?”

* Common sense indicates that positive surprises would be welcomed while negative surprises…disappointing. As such, the trick to superior results is as simple as exposing yourself to assets with frequent positive surprises while avoiding assets with frequent negative surprises. Unfortunately, there is no way to knowing for certain what waits behind moments one, two, three or four. More often than not, negative surprises outnumber the positive ones, and positive surprises can even set us up to be disappointed by negative surprises, lulling us into becoming over exposed to risk.

Table 1 illustrates how the Model can hide higher moments, resulting in unrealistic expectations on the part of investors.

The descriptive statistics describe the actual monthly return distribution over the seventeen-year period from January 1982 through December 1998 of four asset classes individually and a composite in which each asset class received equal weighting.

The simulated, or inferred statistics illustrate the mean, standard deviation, minimum and maximum monthly return for each asset class and an equal weighted composite produced by a Monte Carlo simulation utilizing the descriptive statistics as input variables. Based on the simulation, we would expect the diversification effect of the low-correlated assets to provide considerable downside protection for our composite, the worst case being no greater than negative 15%. However, the worst case over the sampled period was in fact negative 29.69%, relatively 100% worst than a mean-variance simulation would have lead us to expect, even if we had forecasted the mean, variance, and correlation variables perfectly. Such a dramatic understatement of risk would surely alarm most investors, causing many advisors to loose face or even a few clients. The simulation underestimated the worst case for asset classes (1 through 4) by a relative 51.63%, 75.88%, 25.08% and 99.32% respectively. (Notice that the underestimation was less severe for funds possessing descriptive distribution closer to normal.) Of course the reason for such a dramatic difference between our simulated and actual composite outcomes goes beyond the effect of each individual asset class’s higher moments; additional uncertainty is introduced by the correlation measurements.

* the Model assumes correlation measurements are constant across the entire holding period when in fact correlations fluctuate across time, usually increasing at the most inopportune times. Assuming static correlation measurements and normal expected return distribution, the Model identifies optimal mixes of assets that minimize the risk associated with each level of return, but when major corrections occur across asset classes simultaneously, the pain resulting from downside beyond what was originally inferred can be particularly sharp.

Markowitz’s study demonstrated the important concept of diversification. However, when vested with a great deal of overconfidence, the Model becomes a “clever black box” that conveniently spits out optimal allocations while masking potentially disturbing events. It can be argued that investors’ willingness to pursue a more aggressive policy would be reduced if they had a more realistic assessment of the uncertainty that accompanies such a policy.

Markowitz himself suggested that utilizing measures of risk that focus more on downside would likely improve the value of a given analysis, and Blazer [1995] presents an exhaustive treatment of alternative measures (alternative to variance or standard deviation) that help highlight the importance of downside risk. Additionally, rather than assuming normality, which implies with 99% certainty that our worst case will be no more than 3 standard deviations from the mean, advisors could utilize the wisdom of Tchebychev, who’s theorem demonstrates that the 99% certainty level is not likely to be reached until after 7 standard deviations from the mean (A considerable difference). I am fond of saying, “I don’t mind if you let me down, as long as you let me know beforehand that such a possibility exists.” Unfortunately, some practitioners have a vested interest in perpetuating the “exactness” of the Models, or at least their version of the Model. As such it is likely that the acceptance of uncertainty will be a long time in coming.

THE INTELLIGENT ASSET ALLOCATOR by William Bernstein Another must read. (A couple chapters may not come up but the rest is OK)

If a fund started in the first quartile, there was a 61% chance that it will remain in the first quartile in the next year ranking. Likewise, If a fund was in the lowest quartile rank it was very likely it would have stayed in the 4th quartile in the following year (62%). Increasing the time interval from three to five years produced very similar results (71% and 67% respectively). In contrast, the Sortino and Sharpe rankings showed a 38% and 42% chance on remaining in the first quartile and a 29% and 38% probability of staying in the 4th quartile.

Active versus Passive (Frank Sortino) Information Ratio; Sortino ratio; Upside Potential Ratio; Omega Excess

John Sturiale Consistency Ratio SCR is an evaluative measure which is ideally suited for the analysis of equity mutual funds. The SCR seeks to identify funds which have historically provided superior performance relative to their most appropriate benchmark index.

Financial Derivative Markets: Hedging, Speculation, Arbitrage, and Risks Associated with Derivatives Among the most innovative financial markets in recent years are the markets for financial derivatives. Financial derivative markets include markets for forward contracts, future contract, option contracts, interest rate and currency swaps, and credit derivatives. In the financial derivative markets, the risk of future changes in market prices or yields attached to various assets is transferred to someone else, an individual or institution, willing to bear that risk. A forward contract is an agreement between parties to buy or sell an asset on a certain future date for a certain price. In forward contract, one party takes a long position and agrees to buy the underlying asset on a specific date for a specific price. The counterparty takes a short position and agrees to sell on the same date for the same price certain asset. The price specified in a forward contract is the delivery price. Credit risk is implicit in every forward contract because there is always the possibility that the counterparty might not honor the obligation. A futures contract represents the right to trade a standard quantity and quality of an asset at a specified date and price. Future contracts differ from forward contracts in that the size, delivery procedures, expiration date, and other terms of the futures are the same for all contracts. This standardization allows futures contracts to trade on organized exchanges, which provides liquidity to market participants. Futures contracts have a number of useful applications. They can be used to hedge risk in the spot or cash market; to speculate on the future price of an asset; to arbitrage the difference between the two prices. The value of a futures contract is determined by the value of underlying asset and the principle of arbitrage. An option contract gives the holder of the option the right, but not the obligation, to buy an asset, in the case of a call option, or sell an asset in the case of a put option, at a specified price during a specific time period. The price at which the asset is bought or sold is the exercise or strike price. Because the option contract does not obligate the holder to transact, it provides unique payoff possibilities. There are two types of options: European and American. European options can be exercised only at expiration. American options can be exercised at any time. Most options traded in the United States are American options. Swaps represent privately negotiated or OTC securities. In a swap, two or more parties (institutions; the counterparties) contract to exchange cash flows in the future according to some prearranged formula. Mainly, market participants create swaps to hedge volatility in the financial markets. A simple way to understand a swap is to view a swap as a series of forward contracts. A credit derivative is a privately negotiated contract with payoffs linked to a credit-related event, such as a default or credit rating downgrade. Credit derivatives offer a flexible way to protect against credit risk and provide opportunities to enhance yield by purchasing credit synthetically. Derivative financial instruments can be used for three different purposes: hedging, speculation, and arbitrage. Hedgers concern themselves with reducing or eliminating risk. Speculators show interest in profiting from movements in the price of the derivative financial instruments. Arbitragers attempt to profit from price discrepancies in the cash and futures markets. Trading of financial derivatives is not without its own special risks and costs. Although derivatives can be used to help manage risks of other instruments, they also have risks of their own

Inefficient Markets and Passive Investing (2007) Good article. If prices in the stock market are not efficient, and investing is a skill-based game, then disadvantaged or low-skilled investors who try to actively manage their portfolios will consistently lose to players with an advantage. If we reverse the premise of this paper and assume that the stock market is perfectly efficient, then advantages don’t matter–it’s all luck–and less-skilled players have the same one-in-three chance of beating the market as anyone else. In other words, market efficiency protects the less-skilled investor from consistently making bad investments because all stocks are fairly priced. There is, on the other hand, no such protection in a market where stocks are routinely mispriced. The active investing majority that underperforms the index will tend to be the same year after year. Thus, the argument for indexing is even stronger for most investors if the stock market is not efficient. The game of poker provides, in some respects, an instructive analogy. Poker is a zero-sum game, similar to active investing compared to indexing, and poker combines luck and skill, consistent with the assumption of a less-than-perfectly efficient market. The old saying of professional poker players applies to those deciding to remain in the active investing game. “If you don’t know who the mark is, get up and leave the table, it’s you.”

I do believe the markets are inefficient and the dotcom era points that out. Very little made sense. By the same token, it is difficult to find the unique inconsistencies in order to get a higher return. That said, that is not the issue in my mind. It is the risk that is being taken, efficient or inefficient , in order to get the return.

INVESTING: (2007) The paper’s goal is to determine whether workers in the eight countries would have obtained higher expected retirement incomes, with smaller risk of catastrophic investment shortfalls, if they invested part of their retirement savings in foreign stocks and bonds. Consistent with past theoretical and empirical findings, the results show that workers could have improved expected financial performance by investing in foreign as well as domestic equities.

For retirement savers in most countries, though not the United States, naïve overseas investment strategies would also have reduced the risk of catastrophically poor investment performance. In all countries, retirement savers who selected a global portfolio allocation along the efficient frontier could obtain better average pensions with lower risk of very small pensions than savers who restrict their investments to the domestic stock and bond funds.

Using estimates derived by three Federal Reserve economists, Campbell and Kräussl (2005) estimate that in 2003 only 14% of Americans’ equity investments were foreign stocks (see also Thomas et al. 2004). This is far below the fraction that would be allocated under modern theories of optimal portfolio allocation. One explanation might be that savers are ignorant of the benefits of global investment diversification or have an exaggerated view of the risks associated with foreign holdings.

The carry trade strategy involves selling forward currencies that are at a forward premium and buying forward currencies that are at a forward discount. We compare the payoffs to the carry trade applied to two different portfolios. The first portfolio consists exclusively of developed country currencies. The second portfolio includes the currencies of both developed countries and emerging markets. Our main empirical findings are as follows. First, including emerging market currencies in our portfolio substantially increases the Sharpe ratio associated with the carry trade. Second, bid-ask spreads are two to four times larger in emerging markets than in developed countries. Third and most dramatically, the payoffs to the carry trade for both portfolios are uncorrelated with returns to the U.S. stock market.

Equity premium: Historical, expected, required and implied (2007)Equity premium designates four different concepts: Historical Equity Premium (HEP); Expected Equity Premium (EEP);Required Equity Premium (REP); and Implied Equity Premium (IEP). We highlight the confusing message conveyed in the literature regarding equity premium and its evolution. The confusion arises from not distinguishing among the four concepts and from not recognizing that although the HEP is equal for all investors, the REP, the EEP and the IEP differ for different investors. A unique IEP requires assuming homogeneous expectations for expected growth (g), but we show that there are several pairs (IEP, g) that satisfy current prices. We claim that different investors have different REPs and that it is impossible to determine the REP for the market as a whole, because it does not exist. We also investigate the relationship between (IEP - g) and the risk-free rate. There is a kind of schizophrenic approach to valuation: while all authors admit different expectations of equity cash flows, most authors look for a single discount rate. It seems as if the expectations of equity cash flows are formed in a democratic regime, while the discount rate is determined in a dictatorship.

Mutual Fund Taxes (2007) - Taxable mutual fund investors surrendered at least $23.8 billion to Uncle Sam in 2006 for doing nothing more than buying and holding their funds! Over the last ten years taxable mutual fund investors have lost each year on average 17% to 44% of their load-adjusted returns to taxes. In Lipper's "Taxes in the Mutual Fund Industry--2007," we provide the tools, background, and benchmarks taxable investors and their advocates can use to better understand the impact Uncle Sam has on shareholder returns and ways to apply those concepts to wring out extra returns from taxable mutual fund portfolios.

- Mutual fund distributions hit a record high in 2006! Regulated investment companies distributed $418.5 billion, breaking the record set in 2000.

- Lipper estimates that taxable mutual fund investors surrendered over $23.8 billion to the taxman in 2006--an increase of 56% from 2005 but still behind the estimated amount paid in 2000 (the drop in tax rates has really helped).

- Short- and long-term distributions from equity funds jumped 79% and 86%, respectively, from their levels in 2005. Taxable equity fund shareholders surrendered at least $14.408 billion to the taxman because of short- and long-term capital gains.

- Tax burden continued its rampage on taxable fixed income funds. The drag on performance that was due to taxes was approximately two to three times that of the expense ratio.

- Good news: Over the last few years the impact of tax drag on equity funds has lessened. Ten-year tax drag on equity fund performance has declined from being, on average, two times the expense ratio to being about 92% of the expense ratio in 2006, but the tide has turned--the one-year tax burden jumped to 130 basis points!

- Comparing tax-managed funds against their nontax-managed counterparts in four Lipper equity classifications, we found tax-managed funds kept more of their pre-tax wealth and provided, in many cases, above-classification average before- and after-tax returns.

EMERGING STOCK MARKET LINK - The CAPM Challenge With a double-digit growth rate in total market capitalization over the last decade, emerging stocks are becoming an increasingly important investment category. Emerging market equities behave in a different way from equities traded on developed capital markets. In the literature, there is usually a consensus on at least four distinguishing features of emerging market stock returns: (1) volatility is high, (2) correlations with developed market returns are low, (3) returns are predictable to a certain extent, (4) third and fourth moments matter. However, opinions differ about average attractiveness of realized returns in emerging markets, depending on the period studied, the region, and the methodologies. This paper surveys the wide literature around marginal and expected moments of the distribution of emerging stock returns. It reviews literature findings in a structure per statistical moment. Then, it examines the potential consequences on the applicability of the CAPM in emerging markets. Finally,it exposes avenues for further research identified from the survey.

Studying emerging stocks market returns often means dealing with imperfect, incomplete or short lived data. Commons issues are 1) lack of transparency, 2) illiquidity, 3) survivorship bias and 4) short history.

Return Persistence and Fund Flows in the Worst Performing Mutual Funds : (2007) We document that the observed persistence amongst the worst performing actively managed mutual funds is attributable to funds that have performed poorly both in the current and prior year. We demonstrate that this persistence results from an unwillingness of investors in these funds to respond to bad performance by withdrawing their capital. In contrast, funds that only performed poorly in the current year have a significantly larger (out)flow of funds/return sensitivity and consequently show no evidence of persistence in their returns.

REbalancing (NY Times 2007 ) Say you started investing at the end of 1984, in a portfolio consisting of 60 percent stocks, 30 percent bonds and 10 percent cash. And further assume that you never rebalanced this portfolio back to that 60-30-10 ratio. Instead, you did what a surprisingly large percentage of individual investors do: you let the market take your investments for a ride.

Through the end of June, this strategy would have earned an average annual gain of 11.1 percent since 1984. Now, had you started in 1984 with the same strategy, but this time rebalanced your portfolio annually, you would have earned nearly as much on your investments: 10.7 percent a year, on average.

But at the same time, that portfolio would have been 18 percent less volatile, based on standard deviation

Unfortunately, a vast majority of individual investors fail to take that simple step. According to a new study by Hewitt Associate only 18 percent of workers who invested in a 401(k) retirement plan rebalanced their portfolios last year.

This is about in line with historical trends, as only 17 percent of 401(k) investors rebalanced their accounts in 2005 as well as in 2004,

Understanding Index Option Returns (2007) This paper studies the returns from investing in index options. Previous research documents significant average option returns, large CAPM alphas, and high Sharpe ratios, and concludes that put options are mispriced. We propose an alternative approach to evaluate the significance of option returns and obtain different conclusions. Instead of using these statistical metrics, we compare historical option returns to those generated by commonly used option pricing models. We find that the most puzzling finding in the existing literature, the large returns to writing out-of-the-money puts, is not even inconsistent with the Black-Scholes model. Moreover, simple stochastic volatility models with no risk premia generate put returns across all strikes that are not inconsistent with the observed data. At-the-money straddle returns are more challenging to understand, and we find that these returns are not inconsistent with explanations such as jump risk premia, Peso problems, and estimation risk.

Quant funds: (2007) As elegant as the models are, they cannot predict unpredictable events, or human panic, some traders say. Further, some say, too many quant funds are full of myopic brainiacs, overly reliant on their tools.

"Most are idiot savants brought to industrial proportion," Nassim Nicholas Taleb and author of the book on improbability, "The Black Swan.".

"They are very smart in front of a textbook but not smart enough to understand very elementary things in reality.

Taleb believes in monkey-wrench events that shatter the models of the quant-jocks. He says their algorithms don't adequately account for huge, rare anomalies, such as the current surprise credit crunch. Or the Russian credit crisis in 1998 that nearly put the superstar quant fund of the time, Long-Term Capital Management, out of business in a matter of days, saved by cash infusion organized by the Federal Reserve.

The sentiment is reminiscent of the demise of Enron, a company said to have been designed by geniuses but run by idiots. The oil-and-gas trader used next-generation financial tools designed by brilliant mathematicians. But they couldn't overcome the inept and criminal actions of the management.

The allure of a unifying, perfect mathematical formula is powerful; it is an alchemy for the enlightened age. Math's universal principles underlie and suffuse everyday life and the workings of the cosmos, offering a glimpse of the eternal. In the frequently irrational financial markets, mathematic models offer the hope of cool reason and certitude, a sort of godlike wisdom.

In the 1998 film "Pi," a troubled math genius who sees patterns in the newspaper stock tables tries to create the Algorithm for Everything. He and his work are simultaneously hunted by a Wall Street firm that seeks its predictive powers, and by orthodox Jews, who believe it could unlock the mind of God.

The quant funds thrive on volatility -- it's how they make their profit margins. But recent weeks have proved too volatile for some of the funds, many of them highly leveraged, which seemingly all at once got spooked into seeking liquidity. When they ended up seeking liquidity by selling the same stocks, the Aug. 9 plunge happened, analysts speculate, resulting in the Dow's second-largest one-day slump of the year.

"It became increasingly transparent that many of the highly sophisticated quant funds employed similar investment approaches and held similar core holdings," Thomson Financial wrote in an analysis of the role of the 25 largest quant funds in the market meltdown. "This resulted in the funds selling similar long stocks and covering similar short positions."

For instance, the most broadly held stock among the top quant shops, Thomson reported, is Exxon Mobil. Shares of the oil company dropped

TIPS: (2008) When designing investment portfolios within a long-term strategic asset allocation context, the authors maintain that TIPS (Treasury Inflation-Protection Securities) should be evaluated as a separate, distinct asset class. These securities possess unique characteristics that are not directly available through other investment vehicles. Their most significant benefit lies in the fact that they provide a direct hedge against one specific measure of inflation (i.e. the non-seasonally adjusted Consumer Price Index for all urban consumers; CPI-U); which allows investors to maintain real purchasing power and hedge against future nominal increases in the overall domestic price level. In addition to their obvious appeal to investors guarding against increases in inflation, TIPS may also appeal to a broader audience by virtue of their relatively low correlation with other traditional asset classes. The authors demonstrate that TIPS offer potentially significant diversification benefits, establishing them as a viable asset class to be considered when constructing a long-term asset allocation policy.

We provide an approach to forecasting the long-run (unconditional) distribution of equity returns making optimal use of historical data in the presence of structural breaks. Our focus is on learning about breaks in real time and assessing their impact on out-of-sample density forecasts. Forecasts use a probability-weighted average of submodels, each of which is estimated over a different history of data. The paper illustrates the importance of uncertainty about structural breaks and the value of modeling higher-order moments of excess returns when forecasting the return distribution and its moments. The shape of the long-run distribution and the dynamics of the higher-order moments are quite different from those generated by forecasts which cannot capture structural breaks. The empirical results strongly reject ignoring structural change in favor of our forecasts which weight historical data to accommodate uncertainty about structural breaks. We also strongly reject the common practice of using a fixed-length moving window. These differences in long-run forecasts have implications for many financial decisions, particularly for risk management and long-run investment decisions.

Predictable Returns and Asset Allocation: Should a Skeptical Investor Time the Market? Are excess returns predictable and if so, what does this mean for investors? Previous literature has tended toward two polar viewpoints: that predictability is useful only if the statistical evidence for it is incontrovertible, or that predictability should affect portfolio choice, even if the evidence is weak according to conventional measures. This paper models an intermediate view: that both data and theory are useful for decision-making. We investigate optimal portfolio choice for an investor who is skeptical about the amount of predictability in the data. Skepticism is modeled as an informative prior over the R^2 of the predictive regression. We find that the evidence is sufficient to convince even an investor with a highly skeptical prior to vary his portfolio on the basis of the dividend-price ratio and the yield spread. The resulting weights are less volatile and deliver superior out-of-sample performance as compared to the weights implied by an entirely model-based or data-based view.

From 1980 to 2004, the assets of stock funds increased 90 times, from $45 billion to $4 trillion. During that same period, fees paid by investors and collected by fund managers via fund management companies soared from $288 million to $37 billion. What’s more, the fund managers received their fees regardless of whether the prices of the stocks they selected went up or down.

Not surprisingly, mutual funds continue to multiply like rabbits. By the beginning of 2007, there were about 4,800 mutual funds with $6 trillion invested in stocks and $3 trillion more invested in bonds and money market funds.

Averages don't tell you much at all. Retire in the early 1970s, starting with $750,000 and taking out $35,000 each year, and on average you'll do just fine. But that average is meaningless.

Shown here are the year-end balances of three identical portfolios. One starts in 1973 (red), another in 1974 (blue), and the third in 1975 (green). So much for relying on averages!

Date:	2008-01
By:	Jonas Dovern Christina Ziegler
URL:
In this paper we analyze the power of various indicators to predict growth rates of aggregate production using real-time data. In addition, we assess their ability to predict turning points of the economy. We consider four groups of indicators: survey data, composite indicators, real economic indicators, and financial data. Almost all indicators are found to improve short-run growth forecasts whereas the results for four-quarter-ahead growth forecasts and the prediction of recession probabilities in general are mixed. We can confirm the result that an indicator suited to improve growth forecasts does not necessarily help to produce more accurate recession forecasts. Only composite leading indicators perform generally well in both forecasting exercises.