If you're not going to be good, you better be lucky

By DAVID MOON, Moon Capital Management, LLC
May 27, 2007

If you have cable television and more than a passing interest in money, it was hard to miss the news that the S&P 500 flirted with all-time highs again this week. For brief periods on Monday and Wednesday, the index actually broke into record territory but settled back into more familiar terrain before the market close.

The Dow Jones Industrial Average, after a series of new records, continued its assault on the 14,000 level.

The S&P 500 has now increased 90 percent in almost the last 4' years.

If it keeps up, this stock market thing might just catch on.

* * *

A lady came into our office this week wanting a little help. She had received an inheritance several years ago and left the money at the bank where the wills and trusts had been established.

She admitted that she wasn't terribly sophisticated about investment matters, but she apparently does have cable television, because she'd been hearing that the stock market seemed to be doing quite well. Yet her trust account was within one percent of where it had started in early 2000. In a little over 7 years, she'd made zero.

She didn't really expect to make 90 percent over that time frame, she explained, but wasn't zero a bit less than what she should have expected?

That depends on whom you ask.

Her assets were invested in eight different mutual funds, representing, in total, thousands of different stocks. It was diversified, if nothing else.

In fact, it was a de facto index fund masquerading as an actively managed account. She owned the entire stock market.

So how did her homemade index fund so badly trail the real index?

Timing.

Since October 2002, the S&P 500 has increased 90 percent. (This rudimentary example ignores dividends, but it also ignores taxes and inflation.) Had you purchased the S&P 500 on that date, you'd be a pretty happy camper today.

But if your investment date was only 25 months earlier, prior to the collapse of 2000, your experience would look like that of the lady who found her way into our office last week. Since then, the S&P 500 has managed to go from about 1,500 to 1,500: a whopping increase of zero.

The folks who were managing the account for the lady explained that her performance was satisfactory, since it was in line with the market averages. She was just unfortunate enough to have received the money at a terribly inopportune time.

In reality, your success or failure is not about timing, but it is certainly about price.

Many investors smugly reassure themselves that overdiversifying protects them from horrible outcomes. The odds of owning a bunch of different things and having them all blow up at once is low.

But if your underlying premise in selecting that collection of investments is benchmarking or mimicking an arbitrary index, that becomes the most important factor ' not price.

And it doesn't matter how many indexes you mimic if they're all overpriced. Overpriced trumps diversified every time.

With a collection of investments purchased without concern for price, but only for the perceived safety of diversification, a few weeks or months can make all the difference in the world ' or at least all the difference in your portfolio.

It's enough to make a lady ' or a gent ' cry.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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