By DAVID MOON, Moon Capital Management,
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
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
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
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?
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
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
In reality, your success
or failure is not about timing, but it is certainly about
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
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
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).