Commentary: Stop the presses

Stop the presses! That's right, I said stop the presses! Have I got a scoop for you.Here we are in the 21st century and the mutual fund industry is just realizing what their role is in the financial lives of their shareholders.That's right. Here we are sending men to the moon and building computers that can just about think for man. Yet, the mutual fund universe has obviously been living in the dark ages.So you better fasten your seatbelt because what I am about to say may cause you to jump right out of your seat and hit your head on the ceiling if you aren't careful.Recently, the Wall Street Journal carried an article entitled Mutual Funds Try To Play Hedge Game By Offering Investors Absolute Gains.In other words, they now want to make their shareholders money regardless of the economy.Just remember you heard it here first. Why would anyone intentionally invest their hard-earned money and look at relative gains or losses instead of absolute results?I can tell you why. Wall Street has sold the American investor on the concept of relative rather than absolute returns.Why? It helps to protect the reputation of the mutual fund industry as well as the investment firms that sell their products.Now let me explain the difference between relative and absolute returns. Relative results depend on comparing one's returns against a benchmark such as the S&P 500 Index, while absolute returns are compared to a base of zero.For example, if a mutual fund's performance for a particular year is a negative 10 percent and the S&P 500 declined 15 percent, the mutual fund will claim success because they only lost 10 percent and not the 15 percent loss generated by the S&P 500. And the shareholder is supposed to take solace in this 5 percent spread?I can remember early in my career when a research analyst would get on the squawk box and tout a particular stock in the industry he followed. When the stock dropped 20 percent over the next year, the analyst would proudly claim that the corresponding industry as a whole fell 35 percent. The analyst felt he did a great job because it could have been worse. Yet the client still lost 20 percent of his principal.The problem is that analysts need to cover their industries in both good and bad markets. They analyze their stocks on a micro- instead of macro-investment basis.Analysts really don't consider the impact of wars, national deficits, inflation, interest rates, etc. when evaluating their industry selections. They decide if a stock is a buy, hold or sell based on stocks within the same industry.It was in those early years of my career that I first learned to measure my results on an absolute basis. I'd start each year by basing my portfolio on zero and look to earn a reasonable return on my monies based on the major economic factors that were in play at the time.For example, I have stayed away from long-term bonds since interest rates have been rising. I don't want to risk bond principal that would erode the total return yield on a bond when interest rates increase. I would rather buy short-term maturity bonds, TIPS or just a plain old money-market funds that now pay close to 3.5 percent than to subject myself to unnecessary risk by going long.I'd rather have a 3.5 percent return than perhaps a zero total return on a long bond because some of my principal was eroded due to rising rates. It is good to keep in mind you can only earn what the market will give. You can't make chicken salad out of chicken feathers.The same holds for investing in the stock market. There are times when you have to avoid certain sectors. For example, ever since the year 2000 the technology sector for the most part has had lousy performance, while REITs and utilities have had excellent results. Invest where you believe you will make a positive absolute return on your monies.So here it is, November 2005, and the mutual fund industry is just waking up to the fact that absolute results are important to investors and therefore they see a market for these types of funds.Personally, I always measure my investment success on an absolute basis. Even when I design an asset allocation plan for a client, I weigh the various sectors according to macroeconomics.For instance, this year I had strongly urged my 401(k) clients to favor their portfolios to the foreign sector and the large cap sector that stressed dividends.For the individuals who adhered to my advice, their portfolios have outperformed the Dow industrials, S&P 500, and the Nasdaq quite handsomely through the first three quarters of the year.Absolute investing is even more important during retirement years. Once you hit retirement, your focus should be on asset preservation and not accumulation. You need to develop a budget based on a desired percentage return on your nest egg. This has nothing to do with relative performance since you need to be in the plus column every year. Try telling your mortgage lender you can't pay them because you lost money in the market, but did better than the averages. Think the bank would say no problem?Once you begin to lose principal you are headed for planned bankruptcy. Strive to reach whatever percentage return you need to earn on your assets by utilizing all the various investment vehicles that are available to you and arrange them in an appropriate strategy based upon the macroeconomic environment that prevails.Bottomline: You might want to measure your mutual fund or investment advisor on a relative basis, but calculate your portfolio return on an absolute basis.David R. Clogg, an account executive at Chapin, Davis, writes this column, Educated Investor, every other week for The Daily Record. The recommended stocks may be owned by Clogg, his clients and his interview subjects. The opinions expressed are his own and not necessarily those of this newspaper. Clogg can be reached at 410- 435-3200.

Copyright 2005 Dolan Media Newswires
Provided by ProQuest Information and Learning Company. All rights Reserved.