Thursday, October 6, 2011

"When the facts change, I change my mind. What do you do?"

Bespoke Investment Group provides a large amount of interesting, thought provoking market data.  On Wednesday 10/5 they had a post about recent market volatility.  You can read their whole post and better see their conclusion graphically at their website here . However, the key bit of info CCI found interesting was the following:

"Up 8.31%. Down 7.34%.  Up 5.34%.  Down 5.68%.  Up 7.38%.  Down 8.70%.  Up 7.34%.  Down 10.14%.  Up 6.65%. Those are the swings the S&P 500 has seen over the last thirty trading days."

That nets to a little over a 1% loss. Of course that was published before Thursday's 1.8% gain in the market. WOW. That is an exciting way to achieve .........nothing. 

I think this type of data should make an investor question their theory on equity investing.  Modern (circa 1952) portfolio  theory is based on many assumptions including that equity performance will be something like an annualized 8% gain with a standard deviation of 15.  I wonder what the SD for this zero return of the last 30 days might be? Perhaps this volatility is just unique past 30 days.  However, I'd guess ( not audited) that over the past 12 years the S&P has had something like an average return of zero with a standard deviation of 20.  So perhaps this is not really that unusual any more.

So why do so many investors blindly believe the advice from the financial services industry that says:  traditional passive portfolio theory is "good" and more active trading is "bad

Paraphrasing the famous quote from the title of this post:

When the underlying assumptions change this dramatically,  I change my approach to investing. 
What do you do?

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