The Investment Scientist

Archive for December 2011

Today is the last trading day of 2011. The S&P 500 closed at 1257, exactly the same close as in 2010! So, if your goal is wealth preservation, the market just did it for you.

Or did it?

From January to April, the market staged a four-month rally of 8.5% to peak at 1364 on April 29. For the next six months, it collapsed nearly 20% to bottom at 1098 on Oct. 3. Then, it staged a late rally to close the year at 1257.

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Last Monday, we took our newborn son to hospital for an MRI. He was found to have a lipoma corpus callosum, a very rare congenital tumor in the middle of his left and right brains.

Our pastor Lon Solomon has a daughter with brain damage. If it comes to that, we have an example to follow. Here is what he shared in Esquire magazine:

Jill was born perfectly normal. At three months she started having seizures, and they got worse. Eventually she lost the ability to speak. She’s probably had five thousand grand mals or more, and has serious brain injury. She’s sixteen now, and nonverbal. It took nine years, but finally the doctors figured out that she had mitochondrial disease. The mitochondria are the parts of your cells that produce energy, and hers don’t work right. Her brain doesn’t get enough energy. She used to have six or eight seizures a day. Once, she had nineteen. We never slept through the night.

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Behavior Gap

Credit: behaviorgap.com

In my previous article, “The perils of chasing hot fund managers,” I showed that the average investor in a mutual fund run by “star” manager Bill Miller would be better off buying and holding an S&P 500 index fund.

There is only one problem. Most index fund investors are not immune to the buy high and sell low tendency, as illustrated by the table below. Between 1991 and 2005, the Vanguard S&P 500 Index Fund (VFINX) returned an annualized 11.51%, but the average VFINX investor only earned a return of 7.96% during the same period.

1991 to 2005 annualized
VFINX fund return 11.51%

VFINX investor return

7.96%

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This week, a business woman came to my office for a second opinion financial review.

She explained why she came to see me: she bought a permanent life insurance policy because her financial advisor told her it is a great investment. She has been paying $3000 a month for that, and so far she has put in roughly $80k. Recently, she needed some cash and called to redeem the policy. Much to her surprise, the surrender value is only $1,300. She became suspicious of everything in her portfolio and wanted me to examine it for her.

It took me only five minutes to figure out that her financial advisor is screwing her, no punt intended.

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Bill Miller's Legg Mason Value Trust

On November 17, Bill Miller announced that he would step down as manager of Legg Mason Capital Management Value Trust (LMVTX).

From 1991 to 2005, under Miller’s stewardship the fund outperformed the S&P 500 index for an astounding 15 straight years. Since then, the fund has underperformed the index in all but one year, and by a significant margin.

So what’s the problem? The problem is many investors bought the fund only after Miller had become a mutual fund rock star, just in time for his hot streak to end. They missed much of his upward ride, but were fully onboard when the fund went down the toilet. See the table below. Read the rest of this entry »


Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

Twitter: @mzhuang

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