200 Month Moving Average-an opportunity to test the system

A friend recently sent me an article which highlighted the significance of the 200 month moving average (mma). The article asserted that if the S&P 500 were to drop another 20% it would hit the 200 mma, an event which has happened only a few times in the past century. Each time, it marked a massive bear market.

My friend went on to remark that this was a scary thought, being only 20% away from such a marker. Ok, that seemed like a reasonable, if dour, sentiment. At the same time, the market didn’t seem that bad to me.

He then went on to say that this would mean that if you bought the market using dollar cost averaging over the past 16.6 years (200 months), it would mean you would have received zero return over this period. Not quite… perhaps he meant to say that if you had bought the S&P 500 at the average price for the 16.6 years you would have no return. The two statements may sound pretty similar, but there is a world of difference. Dollar cost averaging implies that you buy more when the market is down and less when it is up. The result is decreased risk, as well as profit from taking advantage of volatility.

To get a quick check on the logic, I checked my 401-k, where I use an advanced form of dollar cost averaging. I reduced the balance by 20% and checked the return over the last 16.6 years. The result surprised even me, resulting in about a 9% annual return over the period. I expected a positive result, but that seemed too good to be true.

That had me doing a bit more checking. I downloaded the monthly closing prices of the S&P 500 for the past 16.6 years, adjusted for dividends and splits. Sure enough, it seemed to confirm the assertion of the article…the 200 mma for the S&P 500, according to my calculations, was about 24% below the current average. But it also revealed a few other things. The 200 mma was about 140% above the level of 16.6 years ago. In other words the 200 mma was so high because the market rose significantly in the ‘90s and has been relatively flat to downward since. It also meant that any balance in the S&P 500 16.6 years ago would have increased about 5.4% per year if it had just been left alone to grow.

Time to check what ordinary dollar cost averaging would have done to an equal investment each month in the period. When I ran those numbers, it turned out that dollar cost averaging would have also resulted in an annual return of about 5.4% on the dollars invested in the period.

All pretty positive when compared to the thinking that hitting the 200 mma meant effectively a no return market for 16.6 years, but still significantly lower than my returns. So, it was back to the drawing board to explain the outperformance of my portfolio.

I use dollar cost averaging on steroids… investing in several markets and using long term projected returns to buy when the market is below the projection and sell when it is above. Many of the markets I trade would be difficult to trace back 16.6 years, but I downloaded the S&P Midcap and Smallcap history. Sure enough, these indexes had significantly outperformed the S&P 500 ( I had to use the midcap as a proxy for smallcap for a few months, since that index doesn’t go all the way back that far). I calculated that they had returned 6.6 and 5.8% respectively in the past 16.6 years. Although significantly better returns than for the S&P 500, it still didn’t come close to explaining my returns of about 9%. So, I set up a simulation of my “dollar cost averaging on steroids” system, in which I started with 210 units about 16.6 years ago, with about 60 invested in each index and 30 in cash. Then, I simulated investing 1 unit each month for the period, using my system(buying when each market was below trend and selling when above). This resulted in a current balance of 1270, for an annualized return on investment of 8.4%, reasonably close to my actual results, considering I invest in several other indexes as well as those simulated, mainly using the same system.

Despite the fact that I’ve been preaching the merits of this system to all who would listen for several years, I’m impressed with the results. This kind of returns, in what by some measures, might be considered a poor market, is pretty amazing. Of course, investing in indexes which are doing better than the S&P 500 is part of the explanation, but that is part of the system…spreading the risk with broad diversification. The fact that this result is obtained using an easy, mechanical process and basic index investing with minimal effort makes it even more remarkable. When you consider that you get decreased risk and volatility in the bargain, it is pretty hard to beat. And, it justifies my claims that it is easy, in fact almost automatic, to beat the market using this system.

Of course, if you could guess the right market to be in and effectively jump onto the best market trends, you'd do even better. But few can do that consistently. This system helps you do something close, with ease. And it allows you to sleep at night.

Sun Emerges from Gloom and Doom

A recent article in the Wall Street Journal made much of the fact that the S&P 500 Index is only slightly higher than 10 years ago. I didn't see the article, but I've seen comments about it in several places, and I even had a comment from a friend in Indonesia. The general tone of most articles and comments I've seen are despair that the "US Markets" have had such a meager return.

All the noise put me in the mood to develop my own perspective and to look at my own returns during this "disturbing" period in the market. After all, I depend heavily on use of index funds, of which the S&P 500 is the biggest. The results brought the sun out of gloom and doom for me and confirmed the power of the investing system I use.

First, it is interesting that this one index and single period is highlighted, with a reference to the fact that the Nasdaq did even worse. A 5 or 15 year period would have painted an entirely different picture, as would a look for the 10 year period for, say, the MidCap Index.

I use a system of dollar cost averaging, agressive rebalancing and broad diversification across several indexes (You can see the details in my article of March, 2007) in my 401-K. And, so, my results beg comparison to the performance of the S&P 500 Index. After a quick look back at my performance, I came back with a smile... and a return of about 11% per year over the past 10 years! How is this possible in such a flat market, particularly by a passive system that focuses on index funds, rather than brilliant stock picking? The results are a testament to the power of a disciplined, mechanical system that uses simple, basic, money management techniques like diversification, dollar cost averaging and rebalancing to beat the markets, while reducing risk.

Spring is here, and the sun is out. The gloom and doom is pushed back, for at least another day.

Cash Comforts, but the Fed has set off a scramble to find profitable yields.

I'm certainly not advocating a run for cash. If that is your thinking, read my previous couple of articles. But, I do advocate everyone having an emergency fund, and for us retirees, the fund needs to be considerably bigger to avoid the necessity of selling low to raise living expenses. And, while the recent market action has made the cash feel a lot more comfortable than before, the Fed's response has made it much more difficult to find a decent profit on the cash part of our portfolio.

On the off chance that others are struggling with this issue, I'm documenting what I'm doing and looking for suggestions from those who may have found a better solution.

Over the past couple of years, I've been relatively happy with CDs and money market funds that paid 5-6%, or 2-3% over inflation. Suddenly though, I'm faced with money market funds, and renewing CDs at a 2% lower rate.

Three to four years ago, when interest rates were also very low, I bought I-Savings Bonds. These generally guarantee 1-2% over inflation, and driven largely by energy inflation the 5-6% yield looked relatively attractive. The inflation guarantee and the tax deferral feature also suited my needs. I still hold those bonds, although over the past several months the 4.5-5% yield made me question the decision. Now, that looks relatively attractive again. These are easy to set up and fund on-line with Treasury Direct, but be aware they do have some holding limits and penalties for premature withdrawal. Annual purchases are also limited.

Outside of that, the best thing I've found is the Washington Mutual Savings for Success program. It guarantees 6.5% for accounts which are funded by regular withdrawals from your checking account and held for a year. It is essentially an inclining balance, 1 year CD. Unfortunately the structure of the program makes it difficult to invest significant sums and I'm sure they'll try to hang on to the deposits at a lower rate after the one year guarantee. Even so, it seems worthwhile for those who keep close tabs on how hard their money is working and are looking to place even modest amounts.

Another option I've been moving toward, although certainly not cash accounts, is high dividend blue chips. It is relatively easy these days to get 4-5% dividends on solid stocks like Dow or GE that also have some growth potential.

Once you get beyond these relatively modest proposals, ideas get pretty uninspiring. Stick with the money market and hope rates head upward soon? Invest in CDs, with the anticipation that even today's low rates may look good tomorrow? Maybe the best chance to do better is to look for short term, local, promotional deals, but read the fine print carefully.

Ok, here's the best part...where you, the reader, get to enlighten us with your research and ideas. Come on guys, here's your chance to publish. Just hit "comments" and let us know what you have.