Fool's Eye View

[ March 7, 2000 ]

Daily Dabblings

By Stuart Watson (TMFTiger)

You do get some daft stories in the press sometimes. Recently, we have had numerous wafflings concerning how the days of index trackers are numbered now that Vodafone AirTouch (LSE: VOD) accounts for more than 10% of the UK stock market. This has even led to the launch of capped indices that will restrict the weighting of any one particular company to 10%.

Now we also have some pointless research showing how dramatically market returns are affected if a few key trading days are excluded. A recent report stated that index trackers had returned 14.9% a year since 1987. But if the ten best days on the stock market were taken away the overall return falls to 11.9%. Take away the 40 best days and overall returns fall to a measly 4.8%.

This brings to mind one of the few reasonable accounting jokes I have ever heard. A balloonist gets blown off course due to some unexpected gales. He lands in a field next to a country lane. Luckily he sees a man strolling the road. "Excuse me," he says, "but could you tell me where I am?"

"Certainly" replies the helpful stranger. "You are fifty feet from this hedge, two hundred feet from that ditch and about quarter of a mile from the top of that hill."

The balloonist replies, "Are you an accountant by any chance?"

The stranger is taken aback. "As a matter of fact I am," he says. "How did you know?"

"It's quite simple really. The information you gave me was perfectly accurate but completely and utterly useless."

That brings us back rather neatly to the findings of this report. It is not surprising that market returns are affected by taking out the best days. It is not that unusual to see the stock market gain or lose 3% in a day. If you exclude three such up days each year, your overall returns are naturally going to suffer, especially if you are looking at returns in the region of 15% per year. Remove 9% of these gains and naturally your annual return will plummet like a lead balloon, and probably land in the aforementioned ditch as well.

But what is the point of this report? Excluding days where the stock market moved significantly makes no sense whatsoever. It is bit like saying to Tiger Woods "Nice round you shot there, 7 under par. However I'm afraid we are going to have to exclude those two eagles you scored on those easy par fives. Sorry mate but you only really shot three under."

Quite how investors would miss just these days in isolation is somewhat of mystery. Would you ring up your index tracking fund and say "I don't want to be in the market today, but put me back in again from tomorrow"? I think we can rule that one out. Maybe we have some private investors who try and maximise their returns by selling one day and buying back later in the week? Again that seems rather unlikely, especially given that even the biggest one-day gains would decimated by charges. Even if this was the case, the chances of missing just the 40 best days out of over 3,000 since 1987 are absolutely miniscule. You probably have a better chance of winning the National Lottery. Perhaps some mathematically-minded Fools could tell us the actual odds.

At least the article in question did partly redeem itself by going on to say that you should not try and time the market to catch the best days and the sensible approach was to invest over the long term in order to iron out the fluctuations. Even so, I don't think we should let them off. These alarmist sorts of articles do the great investing public a great disservice. How many people have been put off or delayed investing in the stock market due to stock market scare stories in the press and stuck to their "safe" building society account where the vast majority of their returns are gobbled away by inflation? How many millions have investors lost as a result? Now if someone were to commission a report about this, I certainly would be interested.

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