When you consider that only 9% of the actively managed large-cap mutual funds beat the S&P 500 index over a 10, 5, and 3 year period is easy to see why people are favoring lower-cost passive managed funds. Clearly picking out the active manager who is lucky enough to beat his index is a needle-in-the-haystack endeavor and if you get it wrong it can be costly.

This is only one of the reasons we favor passively managed funds that rely on academic research to add value rather than luck.

Marshall Duke and Robyn Fivush, two research psychologists, set out to learn why some families hold together, raise self-confident children and seem to be happier than others. They discovered that the more children know about their family history, the more they were able to deal with challenges. The key is to share family stories. Not just the stories of success but the stories of the ups and downs. Tell the stories of the failures and recoveries, of the family members who were not successful as well as those who have made contributions to society.

Perhaps an effective way to use the money success brings is to hire a free-lance writer to write the family history.

Of course many people want a rule-of-thumb when considering long-term investing. So, consider that over 95% of the time when the stock market, as measured by the S&P 500 index, has suffered a major drop it has fully recovered within 3 years. This suggests that 3 years would be a good rule-of- thumb when thinking about long-term investing.

The primary criticism that Helaine Olen writes about in her book, “Pound Foolish: Exposing the Dark Side of the Personal Finance Industry” is that people’s ability to earn is ignored. Her concerns are well founded and that is why career management should be considered an asset class to be managed with as much care as any other investment and savings plan.

Michael P. Haubrich, CFP® has developed a “Career Asset Management Model” to address this issue. Part of the model includes creating a working capital fund. This cash build up is used to fund skill maintenance and development activities, fund job changes and fund career sabbaticals.

There is much more to assessing the value of a career and to managing that career but the working capital fund is a good starting point.

A team a researchers at Yale created a maze that randomly dropped food pellets in two opposing sides. Only the game was rigged so that 60% of the time the pellets would end up on one side and 40% on the other side. When they dropped lab rats into the maze the rats quickly learned to go only to the side that rewarded them 60% of the time.

A virtual version of the experiment was repeated with Yale undergrads. Humans are hard wired to find patterns even when patterns don’t exist so that is what the Yale undergrads tried to do. The result was that they were rewarded only 52% of the time.

Stock market returns are random. As a result, when we spend time and money seeking out the non-existent patterns we end up getting rewarded less frequently than those investors who understand and work with the system rather than trying to beat it. In short, it is better to own the market than it is to try to beat the market.

Our brains are hard wired to look for patterns. If you want to prove it, all you have to do is remember a time when you looked up at a random collection of water molecule called a cloud and thought you saw a familiar animal. Pattern recognition is very valuable when you have to decide if the movement of the tall grass is the result of a predator or prey. However it can trip you up if you are trying to decide whether to invest in Microsoft or Google and when you are trying to decide to invest in consumer staples or health care. In fact, searching for patterns in the random movement of stock prices is the best way to generate inferior performance.

Today, active traders are laden down with meaningless information and charts that they pay very big trading costs to obtain in hopes of making money in a harsh investment environment.  A lucky few actually make money trading (at least in the short run) but all research shows that the vast majority lose money; some their entire net worth. Who makes money consistently? – Those firms that supply information, charts and trading platforms.

The concerns are over-blown. What the researchers have discovered is that we have a wide assortment of thought processes that serve us well for the most part. However, like any process, thought processes have limitations and the researches are very clever at designing experiments to exploit those limitation.

If you want to make better Financial Life Planning and investment decisions, start by learning about your thought processes. Then learn about their limitation and ways you can work around those limitations. Most often we can fool the researchers simply by asking the right questions.

The wild swings in the equity markets and the general downward trend over the past several months makes investing in equities a scary propositon these days. Behavioral  scientists tell us that the pain of a loss is twice as great as the joy of a gain. So, our natural reaction is to pull out of the markets and wait for things to settle down.

Of course there is a lot of research that shows that those who pull out of the market tend to do so at the bottom of the cycle and do not get back in until close to the top of the cycle. In other words the result of giving in to our emotions is to sell low and buy high.

Overcoming hardwired cognative reactions is very difficult at best. The only way to overcome this is to be aware of our natural tendencies and to arm ourselves with historical information.

To that end I want to share with you the chart above that is produced by Dimensional Fund Advisors.  The chart is backward looking and shows the duration and magnatude of the bear markets and the bull markets starting in 1926. There are a few lessons that can be learned from this chart:

• The average duration of the bull markets is approximately 88% greater than the average duration of the bear makrets.
• The gains during the bull market are substantially greater than the losses during the bear markets.
• There are significant market declines during bull markets and significant gains during bear markets indicating that the long-term trends are not obvious to market observers until well after the fact.
• The chart suggests the importance of maintaining a disciplined long-term investment approach. Reacting emotionally to short-term movements creates a risk of making ill-timed decisions.

At Allison Spielman Advisors we want to put you at ease about your money. So, if you have concerns or questions or if you just want to talk about your portfolio, give us a call.

“They had worked up a list of companies that they suspected would suffer from a spooked market. Ford, HCA, Energy stocks. As the trader watched his screens, he saw that those companies’ bond prices were trading 8 percent to 10 percent below their expected range. It didn’t make any sense: Ford’s finances hadn’t changed over the weekend. HCA – a large hospital chain – hadn’t stopped admitting patients. It was as if investors were dumping anything with a hint of risk, and, paradoxically, rushing to Treasuries, the very securities that S&P had just downgraded.”

I think this quote from a Sunday article in the New York Times, talking about the reaction of Western Assets – a large bond manager – sums up this past week’s investment markets very well. “It didn’t make any sense…” yet, active fund managers and active traders were trying to figure out how to capitalize on the news story of the hour. During the next couple of days the Dow Jones Industrial 30 index shot up over 400 points as traders sniffed buying opportunities, then dropped over 200 points as the Fed suggested the U.S. economy might be weakening, then shot up again as traders considered the Fed’s statement that they would hold interest rates low for the next two years, then dropped 400 points as traders renewed concerns for European debt and banks, then…”

At Allison Spielman Advisors we think it makes sense to invest rather than speculate. Investing involves making your excess capital available for the production of goods and services. Speculating means trying to capitalize on the random, unpredictable and unmanageable news stories of the hour and the way other traders will react. When we invest we refuse to take action based on wild emotions. Instead we attempt to capture the long-term trends that a large and growing body of academic research suggests will generate more consistent, positive results for our portfolios.

We have not made any changes in our portfolios in. We had a few rebalancing transactions planned and we have decided to put those off for a bit until the markets settle down. The widely watched measure of market volatility – the VIX index – had shot up to 40 compared to the more normal level of 20. When the VIX gets closer to 20 we will go ahead with any planned transactions that are designed to add stability and avoid the whipsaw effect of short-term trading.

Looking ahead we will continue to study the movement of the investment markets to look for long-term opportunities that may enhance our portfolio’s performance. We will also be talking with the managers at DFA and at PIMCO to fully understand how they are reacting and where they see opportunities.

As I mentioned last week, we truly appreciate the confidence you express in Allison Spielman Advisors and we will be diligent in our efforts to earn that confidence.

By the Way: click on the “Investing” tab to see an updated description of our investment approach.