I read your column on mutual funds, and your penchant for the Vanguard Index 500. I agree, that is the only one I would recommend myself.
However, you also mentioned that it is very difficult to beat the market. On that note, a method was developed by Michael O’Higgins and refined by the people at AOL’s Motley Fool that seems to do just that. It involves investing in the five lowest priced stocks of the 10 highest yielding DOW 30 industrials (well, actually the second thru fifth lowest priced, the lowest is omitted). The portfolio is reallocated once a year.
That’s it. I just described the entire process. This process has produced returns at a compound rate of 17% since 1961. I believe the market has been about 10% during that time period. [Actually, according to the kind folks at Ibbotson, it was a just over 11%.]
I’m a little familiar with this system. The problem with this sort of thing is that they didn’t develop it in 1961 and predict what would happen, they looked back to 1961, ran a lot of computer analyses, and found what would have worked had you started in 1961.
Whether it will work as well for the next 35 years is doubtful, for two reasons.
First, it may be that there is no great underlying logic to why it worked in the past, any more than there is great underlying logic to why one guy out of 256 might have flipped heads eight times in a row. (The odds are one guy would — but not because his coin-flipping method is better.)
(I guess the logic would be that these stocks are out of favor, yet have high yields to boost your return and cushion any further falls. It’s certainly not the most dangerous system you could play, that’s for sure. But it also entails lots of taxable dividends and taxable gains if you readjust your portfolio each year rather than buy and hold. If you did it, you might want to do it within the shelter of your Keogh Plan or something.)
Second, as this becomes more and more popular, with the Fool already suggesting you consider doing it in December, to beat the January crowd, the people who do it in January will find their performance a little worse (because prices were bid up in December) — and so forth.
Not to say you might not do reasonably well with this system. But it’s not quite the miracle it appears. Looking back, there will always be strategies you can identify that would have worked. Looking forward, it’s harder.
All comments welcome.