Most of us fondly remember summer vacation from our days in school.  For those still in school, or even for some working in education, summer might still be a time that’s marked by many weeks off.  Actually, it’s a popular season for most of us to consider taking some time off.

This might also apply to your stock investments.  That’s right, based on historical data, it seems as if they like to take summer break too.  This is why there’s a saying called “Sell in May and stay away”, referring to the concept of a summer swoon in stock prices.

The idea of sell in May and go away is based on the reality that over time, for whatever reason, stock prices have simply not performed well in the warm weather months here in the Northern Hemisphere.  A look at historical stock returns indicates that when looking at monthly performance for 40 years – from 1971 to 2010 – there are clear trends as follows:

As can be seen, beginning in May, market returns tend to slide into a period of poor performance historically.  Rates of return have been low in June, and trend lower each month until reaching a nadir in September. Ever heard of the September Effect?

Does this mean that every year stocks perform this way? No. Does this mean that I’m specifically recommending that anyone makes specific buy/sell decisions based on this data? No.

That being said, I think it’s good to be informed, and its food for thought when data reveals some interesting historical stock patterns.  Those returns in the colder weather months, from November through April, look pretty good when you remind yourself that these are simply monthly returns.  Who knows, maybe people have less recreational options and more time to spend focusing on business and investing during those cold months:)

What Do You Think?

Have you heard of the concept of sell in May and go away?

Why do you suspect that stocks have fared better in other months versus the summer months?

Do you think we can learn from historical trends and patterns in stock prices?

Planning for retirement is an important part of personal finance.  Money isn’t going to magically come crashing down from the sky, showering us with financial security in our old age. Rather, it’s up to us to make this happen.

This is why it’s important to make good decisions, while avoiding retirement planning mistakes.  When I think of my own big financial motivaton, it’s easy to take seriously the need to plan for retirement.  Nobody wants to end up old and stressed about money!

Along those lines, a recent article on Moneyland caught my eye. It discusses major mistakes people make in planning for retirement, and shares seven.  Below are the ones they’ve mentioned, along with my own commentary and thoughts on each.

1. Assuming you will have control over when you quit.  I agree with this one wholeheartedly.  Most people don’t factor in unforeseen circumstances, or other negatives that just happen whether or not we want them to happen.  I was once told second hand, years ago, about a guy who worked a company for a long time, like almost 30 years. A year before he was to quit and get full retirement benefits, they got rid of him. He never saw it coming and was crushed.  But hey, they saved themselves some money, right? Or, a person could get sick and be unable to work – I think many of us have seen this happen to people. Bottom line is that things happen.
2. Ignoring the tax impact of distributions.  The article mentions that almost half of workplace retirement participants cash out and deal with penalties. Are you kidding me? This speaks to the value of financial education, and the need to understand how to grow net worth.
3. Not saving enough for medical costs.  Totally agree.  I wonder if you agree with me that the average person, when younger, just doesn’t give enough thought to the reality that while they might be healthy now, they will likely have problems when older no matter what their best intentions are. Things break down when we get older, don’t think that eating very healthy, regular exercise, etc will be enough to prevent all problems.  Thinking about this reality, along with how high out of pocket costs can be, makes it paramount to save for medical costs that are far greater than anything you’re spending today.
4. Failing to lock up lifetime income.  I do agree that regular cash flow is very helpful, but am simply not sure that an immediate fixed annuity is a panacea, and certainly don’t expect that most of us should be counting on social security. The latter is especially true the longer you have until you actually retire.  Best to save, save, and save some more.
5. Retiring too soon.  This goes hand in hand with the next point on underestimating longevity.  Aside from social security income or pension (if you’re lucky enough to have one) concerns, when one drops out of the workforce when older, it can be tougher to get back in if needed.
6. Underestimating longevity.   If one outlives his or her money, there’s a positive involved: you’re living longer! Wouldn’t that be a good thing? Maybe it’s best to reframe thinking here, and think positively that we’ll each live a long time, but negatively about our ability to work in our older years.  In other words, there could be many years where we’ll be alive but unable to work.
7. Drawing down retirement savings too quickly.  This is where financial planning, relatively basic math, and some common sense can help a lot.  You don’t want to risk running out of money, which means we must continue to discern wants and needs in retirement.

Personally, I’m a long way from retirement. But I try to keep in mind that I’m working for myself today, and the needs of the “future me” of 30 years from now.  When that so-called future version of ourselves is older, creaky, has less energy, is less employable, and  might not be able to work – we’ll be thankful for the savings that took place when much younger.

My Questions for You 

Have you given thought to any of these 7 mistakes? How do your views align with mine on this topic?

Have you seen others make these types of mistakes?

Do you have any additional ones to add?

Money and psychology are often interrelated. One area in which the two come together is in the case of cognitive dissonance. It’s a phenomenon that’s applicable in many areas of life, but it can occur in the world of money and personal finance as well.

First off, why am I bringing up the topic? I’ve been thinking a bit lately about the notion of being persistent and how it can be an important aspect of trying to increase net worth, and the role it plays. One aspect of this is being persistent with trying to remove barriers to success, including those are more psychological in nature.

Anyway, this brought to me the concept of cognitive dissonance. This essentially refers to situations where a person might have two thoughts, ideas, or concepts that are in sharp contrast to one another. This contrast can result in frustration, anxiety, irritation, or other psychological conflict. The person is then motivated to try to lessen this dissonance through modifying beliefs or creating new ones.

Here’s an example, outside of personal finance: a person who likes to eat fast food on a daily basis. The person enjoys trips to fast food establishments, but also realizes that such food is not the most nutritious. With those conflicting thoughts, the person might rationalize how he’s healthy anyway so it won’t affect him, or that there is too much hype regarding supposed negative consequences to fast food. Or, in one case I actually heard someone say years ago, “When I get old, there will probably be a pill to cure anything anyway”.

How can this apply to personal finance? Here are 4 ways that cognitive dissonance can impact our money decisions:

Cognitive Dissonance and Shopping

• A person buys a new car, without reviewing any published ratings, and has issues with it
• A friend buys a new car, talks about how well it rated, and has no issues with the car
• The first person rationalizes that the other person is more knowledgeable about cars anyway, so he probably knew what to buy instinctively

Cognitive Dissonance and Real Estate

• A home buyer falls in love with a home and stretches to take out the maximum loan she will be offered
• She knows that stretching to buy a home can be quite risky for one’s finances
• She then decides that most people have dreams that mean a lot personally, so it’s okay to sometimes just go for what you want – and this was one of those times

Cognitive Dissonance and Investing

• A stock buyer pays $50 per share for an investment in a company
• The stock price drops to $45 per share on bad earnings reports, prospects for the company don’t look very good, and most analysts think the stock has the potential to drop much further
• Despite this news, the investor decides to hold on to the stock with the belief that what goes down usually comes back up – carrying out the disposition effect in the process.

Taking these examples into account, I’ve been thinking of this concept in terms of building wealth.  My approach to this has been to think positively, though occasionally I slip into the following thinking:

• I would like to have enough wealth someday to have freedom and financial independence
• However, I’m seemingly a long, long, way from getting to that point.
• Therefore, I sometimes think “Well, many people end up working later in life than they want to anyway, so it wouldn’t be so bad or unusual if that ended up happening with me”.

See the issue here?

It’s gotten me to think that being able to side step such thinking can potentially be quite helpful in reaching goals. Being able to utilize critical thinking skills can be a better approach.

What I’m suggesting is to stop and analyze a situation for a moment, and:

1. Identify if we’re facing such conflict
2. Think through, with an object mind, different points of view
3. Come up with a better path for us to take with our actions

For example, in the situation above, instead of just capitulating to the thought of working later in life, why not take a view such as this: “It’s going to take focus, determination, hard work, and perhaps a little luck – but if I put my mind to it, I can do it. After all, others are able to do it!”

Bottom line is that we shouldn’t let psychology stand in the way of success. Rather, let us find ways to use an understanding of psychology to help us reach our aspirational goals!

My Questions for You

Have you experience this phenomenon when it comes to money or in other aspects of life?

Have you seen any others display this tendency?

How do you think we can use critical thinking and psychology to help us make good decisions, assess situations effectively, and move forward to achieving our goals?

The publishing world is replete with strategies for buying stocks. There have been countless books written on the topic, and many blogs and other sites have published tips and strategies for buying stocks. Ultimately, the goal of such advice is generally to help people beat the market averages and earn a healthy rate of return.

I ran into an article in Kiplinger’s that covered this topic, but noted the tips it included as being new rules.  I took a look, read through them, and had some thoughts of my own.

Here are their tips, paraphrased, with my own thoughts added:

Buy when markets are weak, sell into strong markets

Essentially, this strikes me as a buy low, sell high approach but said a bit differently. I would have to agree with that approach, as one of the very basic tenets of doing business! However, it’s not always that simple.  I’ve written about the disposition effect before, where people tend to sell their winners too quickly and hold the losers too long.

Essentially, it seems like in today’s markets it’s not just a matter of looking at price points relative to some benchmark, and deciding to buy or sell. Rather, there can be momentum involved, and if one is trading actively, perhaps that could be kept in mind. We don’t want to cash out too early and miss riding the wave, and we don’t want to bail out too late after its clear the stock is not coming back.

Focus on Dividends

The article says it well, essentially noting that with dividends you can make money even in situations where markets aren’t rising much.  I think there’s something to be said for companies that regularly pay dividends, and I suspect that the dividends themselves are an often overlooked component of stock market returns by the average investor.

Set Low-Ball Limit Orders

I like the thinking here, where if a stock has been soft lately, a limit order of 3% off its present price could potentially turn out to be a beneficial move. It does seem to be the case that with a more volatile market, investors get edgy on certain news reports and stocks in general can swing by a percentage point or two.  As I’ve noted before, it seems like markets overreact to news often enough, thus providing buying opportunities.

Avoid highly charged, boom or bust mutual funds

I agree with this. It does seem to be the case with many investors, where a mutual fund’s high level of performance in one year will create an incentive to invest, but it might be too late. A fund that performs exceptionally well in one year might be a loser in subsequent years. Personally, I tend to prefer index funds anyway, as the low expense levels end up helping quite a bit with overall returns.

My Questions for You

What do you think of each of these tips?

Have you applied these approaches in your investment efforts?

Do you have any additional tips to add?

Score some stock returns for us!

As many of you might know, if you’ve been following Squirrelers, I sometimes delve into data to identify trends and find insights.

For example, I’ve looked at stock market returns by month to identify which months perform best/worst. Another example, among others, was analyzing how the best companies to work for have had excellent stock performance in the past. Whether stocks or other areas of personal finance, it’s often interesting to slice and dice data to to find some information that might be useful in some form or another.

In this case, I thought I’d look at some data from another angle, this one more just for fun.  With the football postseason in high gear, I set out to identify trends related to the Super Bowl and stock market returns.

Objective

Are there any trends we can identify by looking at who won the Super Bowl in prior years, and how the stock market performed in those years?

Methodology

I first collected information on who participated in the big game since it first kicked off in 1967, and which team won or lost. Then, I pulled stock market data from each year since then, and calculated the annual return for the market. Specifically, I used the S&P 500 to analyze stock performance.

In looking at the data, the natural split seemed to be by conference: NFC or AFC. Organizing it by which team won the championship in any given year, I was able to pull together tables. Keep in mind that through the 2011 game, the NFC has won 24 championships, and the AFC (or old AFL, for the first few years of the title game) has been victorious 21 times.

Results

The first table shows the results by seasons the NFC won, and the second table does this for seasons the AFC won.

As can be seen, there is a notable difference in stock market returns based on which conference emerges with the victorious team.  Clearly, there is a Super Bowl Effect – which might as well be referred to as an NFC Effect.

Years where the NFC wins the game end up with an average return of 11.06%.  When the AFC wins the game, market returns average just 3.95%.   Additionally, when the NFC wins, the stock market is more likely to have an overall positive year: 83%, vs 67% when the AFC wins.

Takeway: GO NFC!

OK, this is all in fun. Plus, the sample size isn’t that great in terms of total numbers. 45 years of data seems like a lot, but it’s not a huge data set. Besides, correlation doesn’t mean causation! But hey, if you don’t have any particular rooting interest in the game – and if your favorite team isn’t there (like me) – why not cheer for a potential winning outcome for the market!

My Questions for You

Have you heard of the Super Bowl impact on the stock market?

Who are you going to be pulling for in the Super Bowl?

It’s a popular question among some personal finance enthusiasts: is it better to invest in index funds or individual stocks? There can be evidence pointing in multiple directions, though it’s become more popular of late to focus on index funds.

Personally, I’ve been leaning that way. My approach has evolved to having index funds as a foundation for stock investing, with some opportunistic purchases along the way, based on market events and historical anomalies.  With respect to the latter, regular readers of Squirrelers have seen period analysis I’ve done with provides reasoning for occasionally making such purchases. Just to point to 2 examples, analyses done on stock market returns by month as well as market reactions to the japan tsunami disaster can show how there are times where there truly are opportunities to jump  in.

That being said, as I mentioned up front, I’ve been liking index funds – and regular investments in them whether large or small. With that in mind, I set out to do an analysis of comparing individual stocks from “best company” lists to the S&P 500.

Hypothesis – Phase I

My original hypothesis was that if you looked at a list of so-called top companies, or best companies, etc – you’d find that they probably don’t do much better than the S&P 500 as a whole in terms of stock returns. Therefore, if you invested in an index fund with low turnover and low expenses, you would do better than you would with more active trades or just buying a bunch of individual stocks. In this case, I’m basing this on changes in stock price.

Methodology – Phase I

The steps I decided to take involved looking at a list of top companies, as I alluded to earlier, and comparing stock performance to broader markets as a whole.  In order to do that, I searched for top companies, and located a list of Business Week’s top global companies. I chose the 2009 list of top 40 companies, as that would give me 2 years of data afterward for which I could use in my comparison.

The article was dated October 1 of that year, so ended up selecting October 2009 through September 2011 as my 2 year analysis period. Additionally, in looking at the 40 companies in the list, I actually included the ones that were publicly traded on U.S. exchanges. This meant that the analysis consisted of 14 companies.

What I did was to take the 14 companies and calculate the change in stock price during that 2 year period for each one. Additionally, I did the same thing for the S&P 500 during that time period. Then, I did a simple average of the 14 calculations and compared to the S&P 500 results for those two years.

Results – Phase I

Here are the findings:

As I looked at the results, it appeared that the hypothesis did not turn out to be correct. Interesting.

Rather, it looked like the basket of analyzed companies from the 2009 best company list significantly outperformed the S&P 500. In fact, the increase in stock prices over that time period was 28% for the best companies, versus 10% for the broader market basket.  Now, if you look at the list, there were two clear outliers: Amazon and Apple. Fair enough. However, even when those 2 companies are removed from the analysis, the remaining 12 still have a 12% increase, which outpaces the 10% of the broader market.

Well, then. So much for the idea that an index would be better than some list of best companies!

Hypothesis – Phase II

After taking a look at the preceding analysis based on the aforementioned best companies list, I thought it might be worth it to try again with a different list of companies. Maybe then we could see if we got a different result. I didn’t originally plan to look at another list, but this “Phase II” seemed like a good idea to continue this line of thought. Again, recall my original thought that index funds would perform just as well.

Methodology – Phase II

In this second scenario, I examined the list of Fortune’s best companies to work for, also from 2009 to keep things consistent with the prior analysis. Here, the date noted was February 2009, so I used data from February 2009 through January 2011. In this case, I went from the top of the list down, and selected companies that were publicly traded. Additionally, I chose 14 companies in order to align with the assessment of the Business Week list, and chose the highest ranking ones starting from the top.

As I did previously, I took this set of companies and calculated the change in stock price during that 2 year period for each one while doing the same thing for the S&P 500 during that time period. Once again, I did a simple average of the 14 calculations and compared to the S&P 500 results for those two years.

Results – Phase II

Here are the findings:

First of all, this was a period of an extraordinary rebound in the market. That’s evident in the 56% return in the S&P during this 2 year time period. Granted, most people saw their portfolios tumble in value prior to that time period, so this was a market recovery in some ways.

That being said, the performance of the top 14 traded companies on the list of best companies to work for showed a 140% increase in stock price, easily exceeding the 56% gain of the S&P 500 during that time.

This second list had only one company in common with the first one: Google. The rest of the companies were different.

Overall Implications

Putting it all together, it appears that the hypothesis that index funds could match “best company” list performance didn’t find it’s way into the results. Rather, the best company lists outperformed the market average by a broad margin.

Now, I suppose that there could be other lists that under perform the market. If those were viewed in a stand alone analysis, we might be having an entirely different conversation. So, we can’t jump to any conclusions that such lists always outperform the market. I doubt that would happen, as rule anyway.

However, it does lend some credence to the notion that perhaps there are some types of companies that just do perform better than others, based on pre-defined criteria. Maybe the reality that these were companies that were perceived to be well-run and/or good employers is indicative of their potential to beat expectations and increase in value?

My Questions for You

What do you think of the idea that investing in companies that are regarding as well-run and great employers can help yield better returns than investing in the broader market?

What criteria do you use to evaluate companies in which you might invest?

Where do you stand on the issue I brought up in the first two paragraphs, where I expressed the view that index fund investing is a great primary foundation, with other investments made only made opportunistically?

I was talking to someone very recently about general business topics, and and we ended up briefly delving into a discussion on international markets. As a part of this discussion, I mentioned that I have been wanting to increase my exposure to non-US markets, but am currently well under 10%.  My comments were that I thought I need to revisit this ratio.

The guy with whom I was talking paused for a second, furrowed his eyebrows, and then stated that he didn’t believe he had any direct international investment. He went on to comment that he’s fine with that, because how was he “supposed to know what consumers in China want?” He used China as a proxy for any market distant from the U.S. Essentially, he was saying that he didn’t understand foreign markets, so why invest in them? Right away, it seemed to me like he had a home country bias.

There’s an old maxim that you should “invest in what you know”. It’s a general philosophy that was a big part of Peter Lynch’s teachings. Lynch is probably best known for being the acclaimed manager of the Fidelity Magellan fund, as well as for authoring several popular investment books.  Lynch has probably forgotten much more about investing than many of us will ever know. In other words, he knowledgeable. Clearly, Lynch achieved quite a bit of success, so there’s obviously something to the the application of this principle of investing in what you know. Furthermore, he’s just an example to point to – there are scores of investors who take this approach. Yes, just like the guy with whom I was having the aforementioned discussion.

Now, I might not be someone to dispute this approach….but then again, I’ll do it anyway:)

My view on the idea of sticking to what you know is that it has merit, but it can be misapplied and taken too far.

If somebody asks me to make a big investment in a bauxite mining operation, as an example, I’d pass. Now, it just might be a great opportunity, but since I know absolutely nothing about that business, I wouldn’t make such an investment. In that case, I’d stick to what I now, or at least avoid what I don’t know.

However, there are other legitimate examples of when it’s good to ignore the ”buy what you know” approach:

1. Mutual Funds. If somebody asks me to make small investments across a representative set of companies traded in the stock market, I’ll think about it. Why? Well, isn’t that what index funds are, more or less? I might not know a lot about these companies, but I know enough to say that historically, stocks have earned a rate of return that well outpaces inflation.  That’s enough to get me to buy stocks in a ton of different companies, all through an index funds. Index funds are a great example of how taking the “invest in what you know” approach can go too far. If you follow that approach too closely, you’d miss out on all the advantages of investing in funds.  Including funds that hold positions in companies that you know nothing about.
2. Investing in a Company other than Your Employer.  I’ve heard of several people who simply wanted to invest in the stock of their employer, because it’s what they know (or so they think). In post from the early days of the blog, I shared the story about a guy who invested everything in the company stock. He told a large gathering at a retirement party that he invested everything in the company stock over the years and that it worked for him, so we should consider doing it too. Surprisingly, he got an ovation for that. Meanwhile, I sat quiet thinking that he was so totally wrong. Maybe he got lucky with his investments, but it’s very risky to put all of one’s eggs in one basket. You already have employment risk in a company, why add investment risk too
3. Investing in International Stocks. This applies to the guy I mentioned above, who might want to at least consider diversification. A prior post I wrote a while ago discussed the topic of international stocks and diversification. In that post, I referenced another article which stated that at the time, the U.S. held 43% of global stock value, yet American investors hold 70% of their stock portfolios in American companies. Frankly, I’m surprised it’s that low! What’s also interesting is that the United States’ share of the world stock market value was 90% back in 1945, and has since declined to the 43% figure I mentioned above. This phenomenon of home country bias is not exclusive to the U.S. either, as it’s been seen in even more drastic terms in some other countries, as I noted in the prior post. Yes, it seems like we all need to realize that’s there’s a world out there!

My Questions for You:

Do you prefer to strictly invest in what you know, or do you branch out?

If you do branch out, do you follow each of the 3 approaches above?

Do you know anybody who carries a home country bias with investments?

Are there certain specific days that are better than others, when it comes to investing? It just might be that there’s historical evidence of a pattern of  better stock market returns on certain days than others.

As regular readers might notice, I occasionally like to dive into the data to find trends about stock market returns.  While I generally focus on more of a passive, index fund strategy, I do think that it’s also interesting to find patterns that might give us an edge if we choose to be a bit more active.  This way, we may have something to tip the odds in our favor a bit.

A prior analysis I did on monthly stock market returns showed how there are some historical patterns that seem to indicate better stock performance in some months than others. A subsequent analysis on the September effect delved further into that particular month, indicating that September is historically poor performing relative to others.  The premise held up the very next month after the post, as the market plummeted by over 7% in that 30 day period.

This got me thinking – if we could go beyond identifying monthly stock returns, and instead looked at daily stock returns, could we find any discernible patterns? In other words, are there certain days that provide better returns than others?

As I did before, I pulled raw historical stock market data from the S&P 500 index. This time, I just looked back to 2000, but I changed the data points to daily. I had to set up the spreadsheet with a variety of formulas, so it took a bit of time to convert the raw data into a place where I could generate some insights.

But when I got done, I found something interesting:  Stocks tend to go up, higher than they otherwise would, on the first trading day of the month.

Essentially, looking back since 2000, it’s clear that there have been more first days of the month that went up versus those than went down. So, from January 2000 to November 2011, the breakout was as follows:

• “Up” first trading days of the month: 90
• “Down” first trading days of the month: 52.

Interesting. It became clear that first trading days of the month tend to have stock price increases, more so than stock price declines. But what about the actual returns themselves?

I broke out the different types of classifications of trading days and totaled them as follows:

• First trading days of the month: 143
• Other trading days of the month: 2,837

Then, I did a simple calculation of taking the average daily return (up or down), summed them, and divided by the total number of days in each respective category. Granted, this isn’t a weighted average, but a direct simple sum and divide approach. Here are the results:

• First trading days of the month: 0.192% average daily return
• Other trading days of the month: -0.005% average daily return

Now, this was even more interesting. The first trading days of the month yielded an impressive average of a 0.19% daily return. If that seems small, remember that it’s for an average day. Just a day. By projecting out over a larger number of days, we can see that getting returns like that is pretty good! All the while, when removing these first days from the mix, and looking at all other days – we can see that the market fell short of breaking even.

Implications: It seems like while there’s certainly variability in the data, the first day of the trading month tends to outperform the average of the other days. Thus, perhaps there should be consideration given to this data when deciding when to buy or sell market baskets of stocks. Maybe buying toward the end of the month makes more sense, and selling soon after the first few days of the month makes sense.

I’m not completely sure why this phenomenon takes place, but it could be because there are more institutional investors putting money in the market at the beginning of the month, 401(k) plans putting in money at predetermined times, or maybe inherent optimism at the beginning of a new time period – much like people get fired up with resolutions at the beginning of a new year. Who knows?

It turns out that some others have discovered this concept of the first day of the month effect too, as I subsequently found out after doing this analysis. Well, that’s ok  :)  Of course, I still think that there’s a potential opportunity here that’s really been flying a bit under the radar. This isn’t discussed too often in personal finance circles. 

My Questions for You: 

What do you think of this effect? Is it something you’ve considered when making buying/selling decisions?

Why do you think that this clear pattern exists? There must be a logical explanation, right?

Show Me the MONEY!!

I don’t hear too many people talking anymore about how S&P downgraded the AAA credit rating of the United States. Remember that event? It wasn’t too long ago.

When it happened, it was a jolt that impacted many people. Even some people who barely follow the news had heard about this. Once that happened, it seemed like some kind of watershed moment that signified the potential peril that the economy of the United States was in.  Many people were concerned about the impact of the credit rating drop on the stock market.

The news hit on Friday, August 5, 2011.  I recall that weekend, people talking about how our terrible financial management as a country was finally having a clear impact, and that things would never be the same in the U.S.  There were probably a few people that feared an impending stock market apocalypse.

I mean, this just seemed so shocking: the United States credit rating downgraded from AAA?

Well, the following day of trading here in the U.S., Monday August 8, was quite turbulent. The S&P 500 dropped from 1,199.38 to 1,119.46, representing a 6.7% decline in stock prices.

Yeah, that scared the heck out of a lot of people.

I remember a conversation that weekend, where we were talking about how it was going to be that upcoming Monday. There was plenty of chatter in the personal finance blogosphere about it. We knew there would be some immediate impact.

That being said, there were some others that were really getting into a panic. A number of people talked about how stocks would plummet. I remember one individual talking about how he thought there might be a free fall. One blogger discussed pulling out of the market entirely, and putting money in cash.  Several of us tried to dissuade him.

Just over 2.5 months later, are we all talking about this? At all?

Now, I’m not minimizing what this downgrade represented. It wasn’t good. However, what I’m saying is that in reality, we tend to have short-term memories.

We just don’t talk about this as much anymore, in general personal finance circles. AAA companies in the market or not, this topic hasn’t been discussed as much. What was a crisis that got people panicked to the point of talking about pulling out of stocks entirely, is just not the hot topic of the day. The buzz – negative or not – is toned down quite a bit.

As of the most recent close, the S&P 500 stood at 1238.25. This is an increase of 10.6% since the S&P downgrade of U.S. Stocks.

Additionally, this increase means that the S&P 500 is actually higher as of this writing, 2.5 months later, than it was right before the credit downgrade. It’s actually increased 3.2% since then!

Think about it – despite all the panic, if you would have invested in the market right before the credit downgrade became widespread news, you could have seen your investment increase in value. Actually, 3.2% in just over 2.5 months is a pretty good return. We could have made money on this!

What does this tell us about how the stock market reacts to bad news – and then bounces back?

We actually saw a similar occurrence after the tragic Japanese tsunami earlier back in March 2011. The Nikkei plummeted from 10,254 right before the Tsunami (on March 11), down to a close of 8,605.15 two trading days later.  By March 31, the Nikkei was back up to 9,755. Clearly, there was a big bounce back in fairly short order – despite all the problems, including some involving nuclear plants. The markets there have since gone up and down (more down of late), but there’s no doubt that the market jumped back up off the canvas within no time after the events there.

My Questions for You:

Were you nervous about the markets after the credit rating downgrade news came out? Have you thought about this much less lately?

What do you think about the notion that the markets overreact to bad news, and these such times just might represent great buying opportunities?

Or, is that we just have short-term memory, and markets recover too quickly?

When it comes to investing in stocks, some of us like to be highly active stock pickers. Others among us like to invest passively, even to the point of a “set it and forget it” strategy.

One example of active vs passive can actually be indirect, through mutual funds.  In this example, as many of us know, we aren’t exactly picking the investments in a fund. Rather, the fund manager is picking the investments. Sometimes, these funds can actively trade many stocks. So even though we buy into mutual funds at a price per share (based on the net asset value) similarly to how we do a stock, there can be tons of trades going on with our money even if we ourselves don’t sell anything. The fund manager is behind the scenes making the moves, making this an active strategy of sorts.

On the other hand, if we buy a mutual fund that’s simply index-based, there’s very little activity involved. An S&P 500 index fund, for example, is set up to mirror the performance of the actual index. The brain work is taken out of the process, and there isn’t a fund manager’s acumen influencing the performance of the fund. It’s all based on how the individual stocks in the fund perform.

This of course brings us to the established, oft-discussed topic of index funds vs. actively managed funds. Thinking about it based on what we’ve discussed above, we’re really choosing between:

• Professional fund manager input into our investment; or
• No professional input, just independent stock performance guiding our investment

On the surface, it just seems logical that all things being equal, a professionally managed fund should outperform one that’s not professional managed, right? We’re often told about the virtues of index funds, and passive investing, but shouldn’t there be value to having a professional guide the stock picking within a fund?

Well, maybe there isn’t always value to a a professional actively managing a fund.

An article I saw on Moneywatch further supports the case for index funds over actively managed funds. According to this article, data from Standard & Poors shows that active fund managers have been consistently outperformed by index-based benchmarks. This finding is across cap size and covers the last 3 years.

Here’s the extent of the disparity with these actively managed funds:

• Large-Cap focus: 64% were outperformed by the S&P 500
• Mid-Cap focus: 75.1% were outperformed by the S&P MidCap 400
• Small-Cal focus: 63.1% were outperformed by the S&P SmallCap 600

Thus, for all the extra fees that are being paid, investors are getting nothing back. In fact, one could say that investors are getting punished for going with actively managed funds!

Now, there are some funds that clearly do outperform the market. However, the majority haven’t been doing so.

Personally, I’ve been a fan of index funds, but have a mix of index and actively managed funds.  At this point, it’s hitting home that maybe I should jettison the actively managed funds and replace them by adding additional investment in index funds?

I suspect that many people (including me, apparently), have previously found index fund investing to be “average” or lacking risk taking or a pursuit of wealth.  Who wants to be average, right?

Well, maybe average actually means winning in this case!

My Questions for You:

If you own mutual funds, do you focus on index funds?

What do you think about the notion that the pursuit of average, in terms of market returns, is actually a winning strategy in some ways?

Why do you think people pursue actively manage funds, despite the evidence that index funds outperform them?