Your Money

The negative news about the economy continues and yet the stock market has kept going up.  This divergence reinforces one of the key lessons of active management, which is that the broader the financial instrument, the less predictable the movement of its price.  For example, let’s consider the shares of a single company, a very narrow financial instrument. Apple (AAPL) shares gained 90% in value from November 2011 to September 2012. From September 2012 until now, AAPL shares have fallen 40%.  An active manager has to effectively analyze an enormous number of factors affecting the perceived value of AAPL in order to benefit from some of the rise in the share price and avoid some of the fall in price.    If an active manager bought AAPL at a good time in the past 18 months, the value of the investment nearly doubled in less than a year.  If an active manager bought AAPL at a bad time in the past 18 months, the value of the investment was nearly cut in half in less than a year.  A concentrated, actively managed fund has 30 to 60 stocks in it, so in order to do well for investors, the manager needs to maximize good decisions and minimize bad ones.   While the best active managers make some mistakes every year, it’s important to limit those mistakes in both quantity and magnitude.  If the active manager’s expertise and skill are great enough, and their area of concentration is focused enough, they have the potential to add value to an investor’s portfolio.  Now imagine a broader instrument, such as the S&P 500 index.  The amount of factors affecting whether the value of the shares ofthese 500 stocks collectively moves up or down in any given period is unquantifiable.  Thus, consistently and repeatedly trying to figure out when it would be beneficial to own the S&P 500 index, and when it would not be, is probably an exercise in futility. However, we do know that, while this broad index is extremely volatile and experiences periodic temporary losses of 10%, 20%, 30% or more, on average over the past 90 years or so, the S&P 500 has gained over 9% per year.  Having an appropriate amount of exposure, commensurate with each individual investor’s life situation, goals and risk tolerance, to broad indexes such as the S&P 500 is best achieved through having a portion of one’s portfolio consistently invested in passive management or index funds.

Market Recap
(as of April 12th, 2013)

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