Tuesday, January 18, 2011

More of James Stewart's Questionable Investing Advice

I have had the occasion to answer some investing questions from friends as the new year begins. Having been professionally involved in equity and options investing for nearly 15 years, and in the financial sector for much longer, my advice is typically simple.

Avoid individual equities unless it's speculative money. If investing for a longish term, stick to dollar-averaging the S&P500 from a low-cost fund complex. Any other sector bets are best made via Vanguard or comparably-priced, passive index fund complexes.

The dirty little secret of investing is that non-professionals should steer clear of individual equity, bond or option trading and, for that matter, trying to chase the, on average, 25% of actively-managed publicly-available funds which manage to beat the S&P500 Index each year, because they are usually a different 25% the next year.

So I found a recent Wall Street Journal column by its official investing guru, James Stewart, particularly disheartening. Stewart spent most of the article's ink fretting about Apple's continued dominance and growth prospects. After much 'analysis,' Stewart confided that he'd sold some options on the firm's equity recently, content with the profits. His other recommendation involved Google and the new Motorola Mobility. About Apple, Stewart concluded,

"I see only one problem: I'm not sure what worlds are left for Apple to conquer."

Then, in classic fence-sitting fashion for a market pundit, he adds,

"I haven't given up on Apple. I still own shares and another set of call options that expire in January 2012. But the market recently hit one of my selling thresholds, and I feel comfortable taking some profits."

Clear on that now? Me neither.

But here's what really stuns me. Stewart holds options expiring a year from now. That means enduring a lot of potential price volatility. And he doesn't mention any sort of time-dimensioned discipline.

The problem with the price-targeting he uses is that it isn't referenced against a market index level. It's just free-floating, as if that's adequate.

My own equity approach holds portfolios for less than a year, but more than a few months. Shorter than that is to be nearly a market-timer, which doesn't work consistently over long time periods. Longer, and you are asking for trouble due to changing company situations. I don't mind holding the same equity for over a year, so long as the decision is made month by month to do so, for the entire planned duration.

With investing technology and institutional money management having evolved as they have in recent years, the notion that you can buy and hold technology issues for the long term is misleading. Even more so when the Journal recently published an article describing how concentrated many large hedge fund holdings are in just a few equities, often in the technology sector.

But I approach this from a professional perspective, and Stewart ostensibly writes market advice columns for a living. His readers, however, presumably have day jobs.

They have no business sinking substantial amounts into individual, volatile equities. Most of his readers are probably best off dollar-averaging their way into ever-increasing S&P500 Index positions, with some diversification into perhaps one or two passive sector funds and a corporate bond fund.

Many years ago, when I was just out of graduate school, I read the chilling, sad Wall Street Journal stories of how so many retail investors lost everything on WPPS bonds. The infamous Washington Public Power Supply debt wasn't actually federally guaranteed, but had been sold as such by unscrupulous brokers.

The moral of the story for me, however, was simply this. For many investors, just keeping their capital over their investing horizon probably puts them far higher in the distribution of retail investor returns than many would care to admit. Chasing tempting returns on individual technology equities merely adds to the risk.

Which is why I think Stewart's column is inappropriate for the Journal. But, as I wrote at the beginning of this post, that's the sector's dirty little secret. Most retail investors have no business even bothering over individual equities or debt issues.

That's what low-cost, passive index fund complexes, staffed by professionals, are for.

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