It’s perhaps the strangest opening of an academic paper on investing – a fall 2008 article cowritten by a Yale University finance professor and editor of the “Journal of Portfolio Management” that begins by recounting a scene from HBO mob drama, “The Sopranos.”
Tony Soprano, head of a New Jersey mob family, turns to his lieutenant Silvio Dante and says, “Sil, break it down for ‘em. What two businesses have traditionally been recession-proof since time immemorial?”
“Certain aspects of show business and Our Thing,” Sil replies.
As the authors of the paper, “Sin Stock Returns,” wrote: “Viewers of this HBO series knew what Sil meant. ‘Certain aspects of show business’ meant the adult entertainment that was often seen at Tony’s strip establishment, the Bada Bing Club, and ‘Our Thing’ meant organized crime, which involves many activities that exploit the vices of frail humanity.”
The researchers at Yale University and Stetson University put Tony Soprano's thesis to the test – not by examining organized crime, but by examining the historical returns of businesses that are considered morally suspect: alcohol, tobacco, defense, biotech, gaming and adult services. They examined 267 companies in 21 international markets from 1970 to 2007.
What did they find? The average annual return of the companies was about 19 percent, while the average stock market produced a return of just under 8 percent.
Gaming industries had the best return of 33.5 percent a year, followed closely by defense (33 percent), biotech and tobacco (both 22 percent), adult services (18 percent) and alcohol (about 13.5 percent).
No industry is full proof. For example, in the most recent downturn, the Vice Fund – a mutual fund which buys stocks in alcohol, tobacco, aerospace defense and gaming industries – fell 42 percent in 2008, mainly out of fears casinos were expanding too fast and taking on too much debt.
Still, if you have the moral stomach for this sort of investment, ‘This thing of ours’ might be the thing for you.
“Dollar cost averaging” is a fancy term for a simple concept. It’s the idea of investing a set amount of money at regular intervals, usually in individual stocks or a mutual fund, regardless of where the markets might be heading.
Many of us follow the strategy, particularly when we’re able to invest money from a regular paycheck using pre-tax dollars. I’ve done so for years.
However, each month when the statement comes, I tend to just look at how my overall investments have fared. Check the number, then toss the statement in a drawer. (From late-2008 through mid-2009, many statements weren’t even opened)
After more than a dozen years of following the concept of DCA, I finally decided to sit down with a calculator and crunch the numbers: Does it really work?
I picked a widely held mutual fund and tracked how it traded on the first trading day of the month. (For the record, it was hardly a scientific approach. I did not factor in possible dividends. And of course this was just one of countless mutual funds on the market today.)
I put in a hypothetical annual investment of $3000.
- To dollar-cost average, I invested $250 on the first trading day of each month. I tallied up the number of shares purchased.
Here’s how it fared after three years: Dollar-cost inched out a random approach by $35.
1. Dollar-Cost Averaging – 154.93 shares totaling $9,148
How about five years? Things changed. Looking back over historical figures since 2005, the lump sum strategy took the lead, albeit by about $45 over DCA.
1. Lump Sum Investing – 250.85 shares totaling $14,812
Now I was really curious. I took it back to 2003 (at this point my desk was littered with Excel spreadsheets and my calculator was asking for a break)
After seven years, the lump sum approach still held the lead, now by $463. Dollar-cost averaging was second. The random approach finished third.
1. Lump Sum Investing – 387.98 shares totaling $22,910
The findings turned my investing brain into mush.
Then I took a step back, and looked at the two years over the past decade where fear and volatility entered into the equation – points when an investor would be most inclined to hold off on investing, or to panic and simply hit the sell button.
As Puru Saxena, puts it “Markets have been run based on greed and fear for centuries, and they will continue to be run on greed and fear for centuries to come. If you want to keep your emotions out of the game, then investing in a disciplined manner on a monthly or quarterly basis is the best option for most people.”
In 2001 and 2008, dollar-cost averaging outperformed the lump sum approach, and it wasn’t close. (In 2001, the dollar-cost approach saw declines of 17 percent while the lump sum strategy fell 20 percent. In 2008, it was 23 percent versus 36 percent.)
And that’s why many advisors point to the dollar-cost approach in the long run. It takes fear and greed out of the equation. It can help prevent investors from making the all too common mistake of buying high, and selling low.
Brazil, Russia, India and China – the so-called BRIC countries – cover about 25% of the world's land area, and are home to about 40% of the world's population. Over the past year, their stock markets have also been outperforming those in developed nations. So where might investors want to place their bets in the year ahead?
On this week's Biz Clinic Andrew Stevens gets advice from a man who's had his eye on emerging markets for more than 40 years - Mark Mobius.
For an entertaining, thought-provoking and sometimes infuriating read, Marc Faber’s aptly titled “The Gloom, Boom & Doom Report” fits the bill. Among the wide swath of topics he tackles in his New Year’s Day edition this year, this section on the potential for cyber attacks jumped out at me:
“I, for one, am convinced that sometime in this next decade we shall experience successful cyber attacks, which may result in electricity blackouts, airport control tower failures, traffic jams, train and underground collisions, erroneous missile launches, a breakdown of the Internet, and so on.
“And whereas I perfectly understand their entire investment strategy around such highly disruptive events, they should at least prepare themselves for the day, week, month or even year when they may not be able to access or use their credit cards, bank and brokerage accounts, the Internet, and their mobile phones, and when they may have to live without oil and electricity amidst acute food shortages and poisoned water…
“It’s all wonderfully depressing, and some readers will consider me to be an alarmist. But the fact is that the likelihood of one or other of these conditions occurring sometime in the future is actually rather high. Therefore, I advise my readers to take out some insurance (but not with … any insurance company) in term for being prepared for an emergency situation.
“I suppose most people keep a small toolbox in their cars for emergencies, a fifth wheel in case of a flat tire (the Fed chairman doesn’t need a spare wheel because he wouldn’t know how to replace one in the first place), and a small home pharmacy for treating minor injuries. So, being prepared in the event of a major disruption in our lives might be considered prudent (especially if other people, such as small children) and not just an unnecessary warning by an insane alarmist. Hoping that all will go well is just not an option at this stage.”
Yikes! Sounds like science fiction. But as he quotes Arthur C. Clarke, famed writer of “2001: A Space Odyssey”: “If we have learned one thing from the history of invention and discovery, it is that, in the long run – and often in the short one – the most daring prophecies seem laughably conservative.”
Financial experts give their resolutions for investing in the new year in this Web exclusive extended Biz Clinic.
The end of a year (or the start of a new one) is a time of reflection, a time to reassess life and your financial portfolio. Last year was tough for the global economy but a lucrative one for investors in stocks or gold.
So what about 2010? These are some of the trends to consider when investing.
1) Interest rates are bound to stay low. With governments trying to encourage economic growth, financial experts expect central banks to keep money cheap. What does that mean? "People are getting no return on their cash, no return on their bank accounts," Keith Wade, economist at Schroders, told me. "They will continue to look for yield."
2) Emerging markets will be in focus. With fund managers concerned about sluggish growth in the U.S. and Europe, many say they will hunt for higher returns in places like Asia. Asia has been recovering faster than the West. Stocks and property have run up in the past several months and brokerages like UBS believe the trend will only continue all year. Some governments have taken measures to rein in speculators, but in places like Hong Kong, their hands are tied. This city's monetary policy tracks the U.S. because its dollar is pegged to the greenback.
3) The U.S. dollar will likely stay weak but be prepared for a few surprises. Richard Duncan, author of "The Dollar Crisis," argues the U.S. economy is structurally flawed and too burdened with debt, which hurts the prospects for the dollar. He says with the U.S. government borrowing so much to finance its massive spending programs plus two wars, the outlook for the dollar will only worsen. However, with so many financial experts down on the dollar, some are starting to wonder if the greenback might swing in the other direction at least for a short while in 2010. One theory is that the dollar makes a comeback as investors flee to dollars to shelter themselves from market volatility.
And given the lingering fears of another Dubai debt crisis or a double dip recession, there will be no shortage of market jitters.
You have to admit gold has kind of stolen the show in the metals sector this year. The traditional safe haven investment raced to settle at a record price of $1,218.30 an ounce in early December. Now prices have fallen off somewhat since then, but the gold bulls and the gold bears are still arguing it out over when we might see $1500.
In all this gold rush though, you may have overlooked the significant gains in other metals. Here are a few to watch in 2010.
Platinum: Platinum prices have made solid gains this year, but some analysts say the precious metal could have more room to grow. Used both for jewelry and industrial purposes, constrained supply is an issue.
Copper: Prices for this industrial metal more than doubled in 2009 after a difficult 2008. Copper watchers expect demand for the metal will continue rising as global economies pick up in 2010. Copper is a key component for building projects, autos and electrical wiring, so it is an essential resource for quickly growing countries like China.
Steel: More, more and more seems to be China's attitude towards steel at the moment. Still the outlook for this essential building material is far from certain. Fitch Ratings predicts in a recent report that demand will recover at a "modest pace" over the 12-18 months, but says high stocks and excess capacity should limit price increases. Morgan Stanley believes such overproduction should recede though and higher prices are on the horizon, driven by rising raw materials costs and China's booming property sector.
How have the housing markets held up in three major cities at the end of a tumultuous year?
My wife invested a tidy sum more than a decade ago in five Chinese companies – and then forgot about it. When going through some paperwork, she rediscovered her investments and learned they had grown five-fold in value by November, 2007.
Our awareness of the investment, however, weighed on us during the calamitous events of 2008 as we watched, month-after-month, the value of the stock slide until we couldn’t take it anymore – in January this year, with the value just 20 percent up from her original investment, we cashed out.
From my previous reporting on behavioral finance, I knew that in the long run the smarter move would be to keep the cash in the market. But an surprise pregnancy and the unplanned expenses (to counter the unplanned joy) made it a straightforward decision for us. At least, we were getting out while we were ahead.
And then I’ve watched the Chinese stock market roar back to life, with year-to-date gains on the Shanghai index alone reaching 90 percent in August.
What can I say – we’re human. And as humans we have a nagging propensity to sell low and buy high.
According to behavioral economist, our natural “fight or flight” impulses that kept us alive in the jungle often make our investment portfolios dead meat.
A buy and sell of a stock on a single day is a virtual coin toss: investors have a 50.2 percent chance of making money, investment counselor Philippa Huckle once told me. The longer investors hold, however, the chances of profit expand exponentially: there is a 70 percent likelihood of earning a profit holding for 18 months. Hold for five years, odds increase to a 95 percent probability of positive return, she said.
Yet despite this knowledge, our patience for investment is slipping: from 1984 to 2000 the average stock buy was held for two years and seven months; by 2004, the average slid to two years and two months.
According to Dalbar Inc., a financial research company, a $10,000 mutual fund investment in 1985 left to sit without withdrawal would be worth $95,000 in 20 years, despite losses suffered during the 1987 market crash, the 1997-98 Asian currency crisis and the technology implosion of 2000.
One interesting fact from behavioral finance research helps explain why we dropped that forgotten Chinese stock once we became aware of it – loss aversion. Research shows that investors “feel” the loss twice as much as a similar gain: In other words, the experience to lose $1 ,000 twice as intense as the pleasure of a $1000 gain.
Watching the stock drop month-after-month became too much to take, and we – like a lot of other investors – wanted that pain to go away. And it cost us.
Now I’m trying to forget that, too.
About Business 360
CNN International's business anchors and correspondents get to grips with the issues affecting world business, and they want your questions and feedback.