Know When To Hold Em......

Hello everyone. Hope you all had a great week. The S&P index closed down 4% this Friday from the April 30 monthly close. As you know this correction falls into the "normal" category so the green arrow remains in effect. However, as I mentioned a couple of weeks ago I see some early warning signs of a potential end to this bull market. If any significant developments take place on a Friday close before the next month end update (May 29) I'll be sure to let you know.

FOR YOUR EDUCATION...Today I thought it would be a good idea to recap the most important principles necessary to maximizing returns in your 401-k:

1) Do not make investment decisions based on fear, emotion or gut feel. This is a sure path to substandard results and possible financial ruin.

2) Do not simply put all of your money into mutual funds and forget about it. This also is a sure path to substandard results and possible financial ruin. Hopefully I've demonstrated that to your satisfaction in the April 23 article. If you haven't read that yet PLEASE do so now.

3) The most sensible thing you can do is find a market timing method which has been successful in accomplishing three things: A) Has all of your money in well performing mutual funds when the probabilities favor that over the long term prices will rise. B) Keeps all of your money in mutual funds through the "normal" corrections. C) Has all of your money in safe money market funds when the probabilities favor that over the long term prices will fall.

Let me demonstrate the importance of following these principles. Please click on the following image. Take some time to examine this chart. As you can see the chart shows the important long term buy and sell arrows. A buy in April 2003, a sell in November 2007 and a buy in March 2009. Next I've noted the magnitude of all the "normal" declines in each bull market.












OK, now let's assume three investors:

Investor A tends to be influenced by his emotions. Although he puts all of his money into mutual funds when the green arrows appear he gets scared and looks to exit when the market declines significantly on a daily or weekly basis after negative news.

Investor B has ultimate faith in the market. He leaves all of his money in mutual funds all of the time assuming the market will always bounce back.

Investor C follows my market timing model. He puts all of his money into mutual funds when the green arrow appears and leaves the money in through all the normal corrections. When the red arrow appears he puts all of his money into money market funds. When the next green arrow appears he again moves all of his money into mutual funds.

Let's assume that all three investors start with $10,000 all in mutual funds in April, 2003. How would each have performed from April 2003 to May 14, 2010? Let's take a look:

Investor A puts all of his money into safe money market funds in April 2005 when the market declines 5%. He then shifts back into all mutual funds in March 2009. He then shifts all the money back into money market funds in January 2010. His account balance is now $17,000 which which represents a 70% return on his original $10,000 investment. His average annual return was 10%. Not too bad.

Investor B has had all his money in mutual funds ever since April 2003, enduring even the brutal bear market decline from November 2007 until February 2009. His account balance is now $12,400 which represents a 24% return on his original $10,000 investment. His average annual return was only 2.4%. Obviously not that good.

Investor C keeps all of his money in mutual funds through the normal corrections. He shifts all of his money into safe money market funds in November 2007. He then shifts back all of his money in mutual funds in March 2009. His account balance is now $23,000 which represents a 130% return on his original $10,000 investment. His average annual return was 19%.

Have a great weekend everyone!