The first decade of this century has not been kind to buy and hold investors. 2008 in particular was a devastating year for buy and hold investors. The S&P 500 Index declined 36.77%. The normal benefits of diversification disappeared as many non-correlated asset classes experienced large declines at the same time. Commodities, REITs, and foreign stocks all suffered losses of over 35%. So much for asset allocation and buy-and-hold.

However, there is a very simple system that the average investor can use with no-load mutual funds or ETFs (exchange traded funds) that significantly outperforms buy-and-hold a risk-adjusted basis. Thank Professor Jeremy Siegel and his book, Stocks for the Long Run, for the ability to keep your sanity in a very volatile economy.

In his book, Professor Siegel tested a system from 1886 to 2006 that bought the Dow Jones Industrial Average (DJIA) when it closed at least 1% above the 200-day moving average. He sold the DJIA when it closed at least 1% below the 200-day moving average. When not invested, he was safely in Treasury Bills.

The Result: He concludes that market timing improves the absolute and risk-adjusted returns over buying and holding the DJIA. When transaction costs are included (taxes, bid-ask spreads, and commissions), the risk-adjusted returns are still higher when employing market timing. Our research shows it is effective with all asset classes and funds in reducing risk

When applied to the Nasdaq Composite Index since 1972, the market timing system thoroughly outperforms buy-and hold, both on an absolute and risk-adjusted basis. Siegel finds that the timing model outperforms buy and hold by over 4% per year from 1972-2006 even when accounting for all costs, and with 25% less volatility. Unfortunately, Siegel does not report drawdown figures, which would have further demonstrated the superiority of the timing model.

So if you’re near retirement and unsure if you should be in the market (or asset class), this simple model can be used by nearly everyone (including in your 401k) to reduce risk. Remember, it’s not how much you make, but how much you keep. Yahoo! Finance has free tools that allows charting of funds and asset classes. Best of all you don’t need a stockbroker for this. Just slap a 200-day moving average on that investment.

This entry was posted on Wednesday, October 27th, 2010 at 11:26 am and is filed under 401(k)s, Financial Planning, Investment Management. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.