Gurus debate which system is best

November 03, 1991|By Thomas Watterson | Thomas Watterson,Boston Globe

When the stock market is going up, everyone enjoys the ride. And when the market's going down, people get out and wait for the rebound.

But when the market is meandering sideways, which appears to be the current state of affairs, professional investors look for other diversions.

Lately, a popular form of entertainment seems to be taking potshots at other professionals who claim to have a sure-fire "system" for investing in the market, whether directly in stocks or in mutual funds.

Don Phillips, editor of Morningstar Mutual Funds, a Chicago newsletter, started the latest skirmish a couple of months ago, when he slammed market timing. Market timers look for signals telling them when the market is rising, or signs that can lead

them out of the market when -- preferably before -- it falls.

Fundamental investing, on the other hand, keeps all or most of a mutual fund's money in the stock market but looks for promising industries and companies. It includes research into each company's future prospects and expected earnings.

In his newsletter, Mr. Phillips noted what he called "the utter failure of market-timing practitioners to establish a winning record in the mutual-fund arena." His jabs at Paul Merriman, manager of the Merriman group of funds, were particularly sharp.

Comparing market timers to astrologers, Mr. Phillips concluded, "the difference, however, is that horoscopes just waste your time; market timing can waste your money."

Shortly after, Mr. Merriman devoted most of his newsletter to a defense. Calling the horoscope analogy "a cheap shot," Mr. Merriman said, "Phillips appears to have woefully inadequate knowledge about what market timers actually do."

Mr. Merriman tried to show the superiority of market timing by comparing the six- and 12-month records for performance and volatility of his funds with the Twentieth Century family, which includes the Ultra fund, one of this year's best performers. Mr. Merriman's funds beat all the Twentieth Century funds, except for Ultra. But he missed an important point: While most of the Twentieth Century funds have impressive records over five, 10- and 15-year periods, they are very volatile in the short run. So if you invest in one of these funds and pull out just a few months later, you're likely to lose money.

The debate over timing got a bit louder more recently, when two professors analyzed market timing and found it wanting. In an article in AAII Journal, published by the American Association of Individual Investors in Chicago, the professors, P. R. Chandy of the University of North Texas and William Reichenstein of Baylor University, concluded that there's a big penalty for being out of the market at the wrong time.

The professors looked at the distribution of monthly stock returns of the Standard & Poor's 500 index for the 744 months from 1926 through 1987. They found that if an investor was out of the market for just 50 of the best months -- or 6.7 percent of the time -- all of the S&P's return for those 62 years vanished.

Who's right? Based on the evidence, the fundamental, buy-and-hold strategy seems to have the edge.

For people with the time or temperament to follow the stock and bond markets closely and decide when to jump in our out, timing the market with part of their money might be fun and perhaps profitable.

For the rest of us, however, the best course seems to be to pick a fund with a good long-term track record under the same manager, then add the same amount of money every month or three months, no matter what the market is doing. This practice, known as dollar-cost averaging, buys more cheap shares when the market is down and lets them grow when the market is climbing.

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