Ask Colin

I have read that if you are out of the market on the best 10 or 20 days, it seriously reduces your return? What do you think?

This is, in my opinion, self-serving propaganda from the managed funds industry. This is why:

1. Of course it is true. Why would it not be? It is simple common sense. If you are out of the market when it goes up, of course your return will be less. This is used to try to persuade you to leave your money in a managed fund no matter what, because you might miss some of those good days. It is usually associated with statements that you cannot time the market.

2. Common sense also says that if you are out of the market on the 10 or 20 worst days, it will increase your return. They don't mention that. I have only seen one writer actually acknowledge it (there will have been others, but I have not seen them). So, the trick is to be in the market on the best days and out on the worst. Kindergarten students can grasp that idea. It is simply nonsense, except if you believe that it is impossible to time the market.

3. In one sense, I think what they are saying makes sense - for them, but not for the private investor. If the Dow went from about 1,000 points in 1982 to over 10,000 points in 2000, AND YOU RUN A LARGE DIVERSIFIED PORTFOLIO, then your portfolio probably performs somewhere near the index and you would have been silly not to be fully invested.

4. But wait a minute. The NASDAQ fell like a stone after 2000. A Technology fund would have performed far better if it had been in cash, even though some large up days occurred in that period. If you believe as I do that it is possible to pick the big bull and bear markets before they have gone too far from the turn, then it is possible to time the market. Then again if you are a big fund, you could not go hugely into cash in a bear market, for many reasons. However, a private investor can go into cash easily.

5. The other big problem with the argument is that, while it can be true in a bull market for a big fund, it may not be true for the small portfolio of a private investor. If a small investor is going to beat the index, the portfolio must be more tightly focussed. This also means it has higher risk, which is an important aspect. However, in terms of what we are talking about here, the performance of a private investor can be totally different to a large fund, which is always struggling to beat the index. At the ATAA conference in September 2003, I showed some charts that demonstrated two things. Firstly, that I was for me to be able to pick some stocks in 2002/3 that went up strongly in a down year and my portfolio had a return of plus 19.7% while the market was minus 2.8%. Second, I showed that individual stocks move far more in percentage terms than the index. That is why a focussed portfolio can beat the index and even if it was out of the market on some of the best days. Of course, if your portfolio is in the wrong stocks, it goes down much more than the index.

6. I must warn you that I am only talking about the question you raised. There is far more to risk management than that. I discuss all of these other things in the videotape of my investment plan. The book I am going to start publishing on my subscription web site from December 2003 will also deal with these issues.