Investing Basics
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Index vs Managed Funds
The portfolio manager of an actively-managed fund tries to beat the market by picking and choosing investments. The manager performs an in-depth analysis of many investments in an attempt to outperform the market index such as the S&P 500. Conversely, on the other end is the Index fund.
Index funds are considered to be passively managed. The manager of an index fund tries to mimic the returns of the index it follows by purchasing all, or almost all of the holdings in the index. They tend to have lower fees than actively managed funds.
The potential to outperform the market is one advantage that actively-managed funds have over index funds, and this notion of outperformance is attractive to investors. However, evidence that actively-managed funds can consistently outperform their relevant index is difficult to find. It’s even more difficult for an individual investor to pick the actively-managed fund that will outperform the index in a given year and most of the time actively managed funds underperform index funds. Many years as much as 85% of active fund managers underperform the S&P 500 index, making index funds more attractive option.
Which one performs better?
According to Vanguard, for the 10 years leading up to 2007, the majority of actively-managed U.S. stock funds underperformed the index they were seeking to outperform. For instance, 84% of actively-managed U.S. large blend funds underperformed their index, and 68% of actively-managed U.S. small value funds underperformed, as well. The case is even worse for actively-managed bond funds. In that case, almost 95% of actively-managed bond funds underperformed their indexes for the 10 years leading up to 2007.· Furthermore, being consistent can be even more difficult for active fund managers.
For the period of December 31, 1992 to December 31, 2007, only 41.6% of actively-managed U.S. large company funds that beat the S&P 500 in a particular year were able to beat the S&P 500 in the next year. After three years, only 9.7% of the original group was still beating the index. The numbers are similar for actively-managed small cap funds and emerging market funds. Also, actively managed funds have higher management fees.
One has Higher Fees:
Actively-managed funds start at a disadvantage when compared to index funds. The average ongoing management expense of an actively-managed fund costs 1% more than its passively managed cousin. The expense issue is one reason why actively-managed funds underperform their index.
Another issue is that the portfolio manager of an actively-managed fund (who is in search of extra returns) buys and sells investments more frequently than an index fund. This buying and selling of stocks by the active manager (known as turnover) results in taxable capital gains to the fund shareholders, provided the fund is owned in a non-retirement account and it results in higher taxes for these fund investors.
The evidence shows that there are good active managers, but finding such managers in advance of their outperformance is difficult.· Therefore, those investors who decide to use index funds are likely to outperform most actively managed mutual funds (especially when the index funds lower fees are considered) while taking on lower risk, and tax obligations.
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Dollar Cost Averaging Dollar Cost Averaging Example:
What if you have $16,000 you want to invest in a mutual fund. The date is December 1, 2009. You have two options: you can invest the money as a lump sum now, walk away and forget about it, or you can set up a dollar cost averaging plan and ease your way into the fund. You opt for the latter and decide to invest $4,000 each quarter for one year. So, you start with the first $4,000 on Dec 1, 2009 when the S&P 500 mutual fund is below 1,100. Then, on March 1, 2010, the fund is still below 1,100 and you buy in at another low point. Next, on June 1, 2010 the fund is around 1,050 when you put in your third $4,000. Then the last $4,000 goes into the fund 3 months later on September 1, 2010 and the fund is again around 1,050, giving you more shares than in the first two purchases. Essentially, all of your purchases were between the purple lines below. Conversely, if you had put all the $1,600 into the fund in December 1, 2009, you ould have purchased the shares at a higher price than you would have purchased them had you used Dollar Cost Averaging.
What is Dollar Cost Averaging?
Dollar cost averaging (also known as DCA) is an investment strategy that may be used with any type of investment. It works by investing equal amounts regularly and periodically over specific time periods, like $100 very month, in a particular investment or portfolio. By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high. The point of this is to lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time. Instead of investing assets in a lump sum, the investor works thier way into a position by slowly buying smaller amounts over a longer period of time. This spreads the cost basis out over several years, providing insulation against changes in market price.
Dollar Cost Averaging and Long Term Investing:
Long term investing done via Dollar Cost Averaging is beneficial to investors because it can lead to positive gains in the stock market with very little risk. This happens because investing for the long term in the stock market can result in an average annual gain of 12% over the long term. This is based on the fact that the S&P 500 has returned an average annual return of 12 % since 1926. With this kind of return an investor can expect their investment to double every six years. This is concluded by using the rule of 72; divide any return into 72 and you get the number of years it take to double an investment. Hence, 72 divided by 12 equals: 6. Therefore, it’s easy to see that long term investing is something that every investor should do. This can be done easily with dollar cost averaging. |
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What is Technical Analysis?
Technical analysis is a method of security analysis discipline of forecasting the direction of prices through the study of past market data, primarily the price and volume.
Technical analysis employs methods and trading rules based on price and volume transformations, such as the relative strength index, moving averages, regressions, inter-market and intra-market price correlations, business cycles, stock market cycles and through recognition of chart patterns like candlestick charts. It is commonly used as a method to find trends in stock prices.
Benefits of Technical Analysis
Technical analysts believe that prices trend directionally up, down, or sideways or some combination. The basic definition of a price trend was originally put forward by Dow Theory.
An example of a security that had an apparent trend is AOL from November 2001 through August 2002. A technical analyst or trend follower recognizing this trend would look for opportunities to sell this security. AOL consistently moves downward in price. Each time the stock rose, sellers would enter the market and sell the stock; hence the "zig-zag" movement in the price. The series of "lower highs" and "lower lows" is a tell tale sign of a stock in a down trend.] In other words, each time the stock moved lower, it fell below its previous relative low price. Note that the sequence of lower lows and lower highs did not begin until August. Then AOL makes a low price that does not pierce the relative low set earlier in the month. Later in the same month, the stock makes a relative high equal to the most recent relative high. In this a technician sees strong indications that the down trend is at least pausing and possibly ending, and would likely stop actively selling the stock at that point.
Technical vs Fundamental Analysis:
Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. Technical analysis analyzes price, volume and other market information, whereas fundamental analysis looks at the actual facts of the company, market, currency or commodity. Most large brokerage, trading group, or financial institutions will typically have both a technical analysis and fundamental analysis team. In the 1960s and 1970s it was widely dismissed by academics.
Technical analysis is widely used among traders and financial professionals and is very often used by active day traders, market makers and pit traders. In the foreign exchange markets, its use may be more widespread than fundamental analysis. This does not mean technical analysis is more applicable to foreign markets, but that technical analysis is more recognized as to its efficacy there than elsewhere.
Evaluating Technical Analysis
According to Jeremy Siegel, author of Stocks for the Long Run,: “recent studies have been done on technical analysis, and the results have been surprisingly positive.” Furthermore, according to Professor Peter Navarro, author of The Modern Scholar, “Technical and fundamental analysis should be used for stock picking. You need to use both fundamental and technical analysis...it prevents investing traps like investing on emotions...Track the Technical characteristics of your stock to prevent these traps.”
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What is Technical Analysis?
Technical analysis is a method of security analysis discipline of forecasting the direction of prices through the study of past market data, primarily the price and volume.
Technical analysis employs methods and trading rules based on price and volume transformations, such as the relative strength index, moving averages, regressions, inter-market and intra-market price correlations, business cycles, stock market cycles and through recognition of chart patterns like candlestick charts. It is commonly used as a method to find trends in stock prices.
Benefits of Technical Analysis
Technical analysts believe that prices trend directionally up, down, or sideways or some combination. The basic definition of a price trend was originally put forward by Dow Theory.
An example of a security that had an apparent trend is AOL from November 2001 through August 2002. A technical analyst or trend follower recognizing this trend would look for opportunities to sell this security. AOL consistently moves downward in price. Each time the stock rose, sellers would enter the market and sell the stock; hence the "zig-zag" movement in the price. The series of "lower highs" and "lower lows" is a tell tale sign of a stock in a down trend.] In other words, each time the stock moved lower, it fell below its previous relative low price. Note that the sequence of lower lows and lower highs did not begin until August. Then AOL makes a low price that does not pierce the relative low set earlier in the month. Later in the same month, the stock makes a relative high equal to the most recent relative high. In this a technician sees strong indications that the down trend is at least pausing and possibly ending, and would likely stop actively selling the stock at that point.
Technical vs Fundamental Analysis:
Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. Technical analysis analyzes price, volume and other market information, whereas fundamental analysis looks at the actual facts of the company, market, currency or commodity. Most large brokerage, trading group, or financial institutions will typically have both a technical analysis and fundamental analysis team. In the 1960s and 1970s it was widely dismissed by academics.
Technical analysis is widely used among traders and financial professionals and is very often used by active day traders, market makers and pit traders. In the foreign exchange markets, its use may be more widespread than fundamental analysis. This does not mean technical analysis is more applicable to foreign markets, but that technical analysis is more recognized as to its efficacy there than elsewhere.
Evaluating Technical Analysis
According to Jeremy Siegel, author of Stocks for the Long Run,: “recent studies have been done on technical analysis, and the results have been surprisingly positive.” Furthermore, according to Professor Peter Navarro, author of The Modern Scholar, “Technical and fundamental analysis should be used for stock picking. You need to use both fundamental and technical analysis...it prevents investing traps like investing on emotions...Track the Technical characteristics of your stock to prevent these traps.”
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