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Those old investment proverbs
By Ceri Jones
Money and superstition have always gone hand-in-hand - from alchemy in the Middle Ages to lottery punters picking their 'lucky' numbers - generating a thousand proverbs. However, many popular investment adages contain more than a kernel of truth. Here's our selection of some of those that are worthy of note:
Sell in May and go away, come back again on St Leger Day
This is an ancient City saying. It recognises the fact that the London market winds down over the summer as many executives go on holiday or attend sporting events such as the Henley Regatta, Ascot, Wimbledon and Cowes, returning around the time the St Leger horse race is held at Doncaster, usually in mid-September. As a result, most gains are concentrated in the six months from November to April.
Research by Foreign & Colonial suggests that over the last two decades the stockmarket has delivered an annual average gain of 0.71 % per month, but if you consider only the months May to September this falls to just 0.2 %. Of course, it would be madness to incur trading costs by churning your portfolio for the summer months because, although they produce proportionally smaller returns, 65% of the time investors would in fact have made positive returns during May to September. Nevertheless, some stockbrokers still boost their clients' exposure to more defensive stocks like utilities as summer approaches.
The Father Christmas rally
The UK stockmarket usually rises in the second half of December, so of all the stockmarket sayings, this is the one that bears the most scrutiny. "History teaches that the stockmarket often disappoints investors at the beginning of December and then takes off like a rocket as mid-month approaches. Stockmarket prices rise from 11 December to 5 January some 80% of the time," according to stockmarket historian David Schwartz.
These profit odds have improved in recent years. The year-end bounce has occurred in 21 of the last 24 years. The average profit was over 2.7% a year. This translates to about 150 points on today's FTSE-100, claims Schwartz.
Run your profits and cut your losses: the trend is your friend
Although it's normally a good idea to ignore adages that rhyme - because they may be forced - this is the exception. Private investors are all too often reluctant to cut their losses if an investment goes sour and persist in the hope that the situation will rectify itself. Equally, they tend to take their profits too early, losing out on subsequent gains.
If a market or a share price is moving in a particular direction, it will generally continue to do so for longer than the private investor imagines. Such is the power of momentum that this happens even if a rising market is already overpriced, or if it still falls despite being cheap.
Buy companies with a moat
Warren Buffett, who turned $100 into a $42 billion fortune, has always looked for companies with a 'moat'. Such companies enjoy a uniquely well-defended position against the competition through factors such as geography, patent, brand name and entry costs. Good examples are companies whose products have almost totemic meaning, such as a bottle of Coca-Cola or a Gillette razor. "We like great companies with dominant positions, whose franchise is hard to duplicate and has staying power," the Sage of Omaha says.
Build on what you know; don't buy what you don't understand
This rock-solid advice has been put many ways. Buffett has always made it a policy to stand aside even from booming markets such as 1969 and the late 1990s if he feels he doesn't understand what is driving prices.
Peter Lynch, former manager of the massive US Fidelity Magellan fund, who averaged a staggering 29.2% annual return for more than two decades, advises: "Never invest in any idea you can't illustrate with a crayon." This addresses a common weakness in investors to be seduced by things futuristic and complicated, such as biotechnology companies, microchip developers and alternative energy. Because most of us cannot understand all these scientific developments, we tend to overestimate their prospects and pay through the nose for the shares. By contrast, boring but understandable businesses like utilities are typically undervalued.
Don't follow the herd: be fearful when others are greedy and greedy only when others are fearful
One of the silliest sayings in the English language is 'Great minds think alike'. The greatest of minds think independently or we would be simultaneously solving the mysteries of the universe. Still, investors tend to rush headlong into the same hot sector after it has already risen and long after the professional investor has already made a killing. The big examples of lemming-like behaviour are of course the dotcom crash and the Dutch tulip mania of 1633, where entire farmhouses changed hands for just three rare bulbs.
The financial services industry has a laughable record of launching specialist funds at the top of that particular asset's cycle. For instance, in 1998-99, over 20 technology funds were launched into a marketplace that had previously offered just four. More recently, property funds have been the in-thing, although commercial property has clearly peaked. Launches are bandwagon-driven because investment groups cannot launch a fund unless it can attract the critical mass to be profitable. The danger for the private investor is that a sector may not be appropriate for asset allocation and may create a completely unbalanced portfolio.
Beware the dead cat bounce
This gory phrase is used to depict a false rally, just as a dead cat might bounce if you tossed it from a building. It's a clear signal to sell. The classic example is the October 1987 crash, says Mark Dampier at Hargreaves Lansdown, when the market fell about 10% on the Monday and again on the Tuesday, but then rallied by around 6-7% on the Wednesday. "This was not the time to buy back in," he says. "The best time was four or five weeks later."
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