Making the market work for you in 2011

We are now one week into the 2011 and it’s probably about time for some reflection on the year that just concluded and some planning for the new one just starting. Looking back, the performance of major indices, such as the US based S&P 500 has been more than decent at 12,78% (15,06% including dividends reinvested), with the broader MSCI All-World Ex-US delivering a handsome 13,2%.

Needless to say, these appealing results were readily available with little risk and negligible cost to holders of diversified index-funds such as the Vanguard Total Stock Mkt Idx Adm VTSAX. To quote from Tori Amos´ classic 1994 tune, it has been a “pretty good year”.

And so it seems that despite the turbulence and volatility of recent times, the heated debate in the US around the new Financial Regulation bill, the second round of “quantitative easing” (a.k.a. money printing), and the near complete obliteration of our global financial system as we know it, capital markets performed and provided your average, namely passive participants with a healthy return on their money. Faced with this picture my thoughts turned once again towards the rationale for active investing. Back in June 2010, I argued steadfastly in the face of heavy odds for the benefit of trying to be above average in the investing playground particularly as “average” since the beginning of the century had come to mean, “sub-par” in real terms.

Not so anymore it seems. If the last 12 months´ numbers are not convincing enough and in fact you think, ¨I could do much better than that by picking winning stocks myself or by putting my money with a hot fund…¨ think again. Just ask the legendary and much-respected investor and inventor of the index fund, John Bogle, about the how this approach has performed over time. In his 2007 work, “The Little Book of Common Sense Investing¨ he calculates that only 2% of all equity mutual portfolios will outperform the stock market over 50 years. So, good luck finding the 2%!.

So much for reflection on past performance and the year that was. Turning now to what matters, (i.e. that which we can do something about) finds me taking the opposing view to Mr. Bogle and confirming my thoughts as expressed in June of last year.

The primary reason for my stubborn, (some might say obsessive) defence of an active investing approach for the year 2011 and for that matter for ANY year, is that the facts warrant it. Were it not the case I would be first in line to adhere to the wise words of one JM Keynes who stated:

“When the facts change, I change my mind. What do you do, sir,?”

The facts I am referring too are the lacklustre performance of market averages over more significant periods of time. 3, 5 and 10-year returns for the S&P 500 have been -3,1%, 2,1% and 0,3% respectively. In similar fashion geographic diversification yielded little safety as the MSCI All-World Ex-US delivered a paltry -5,66% for the last 3 years and 1,87% annually since 2006.

Although fund-chasing is statistically a loser’s game, individual stock picking need not be so. For one, individuals have but themselves to answer too and have no incentive to subtly trace an index. Substantiating my optimistic outlook for the private investor in 2011 is the fascinating account of 10 completely unknown (until now anyway) individual investors portrayed in the recent “The Warren Buffetts Next Door: The World's Greatest Investors You've Never Heard Of and What You Can Learn From Them”.

Here, laid bare in the simple yet effective style of journalist Matthew Schifrin, are the ongoing success stories of a set of unrelated individual investors who chose to take an active role in managing their money. A number of them have been beating, or should I say trouncing, market averages by over 10% annually over 5 and 10-year periods. The common trait shared by these folks is not accepting the market’s irrational whims but rather making it work for them.

Mr Benjamin Graham, the father of value investing, would be pleased with these efforts as they represent the spirit of his conceptual role for the “market”, relegated to the role of “servant” as opposed to leader ofintelligent investors.

As 2011 unfolds, this is the side I want to be on.