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To the Maxim

January 25, 2008

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CON The dour, perennial worrywarts at The Economist magazine—who fret over an awful lot of statistics we don't have room to list here—warned in December, 2005, that "the air is slowly leaking from the global housing bubble." One big red flag: The ratio of house prices to residential rents in several countries was much higher than usual. Australia's real estate market had already been hit hard in 2004, and the "hissing sound" from the U.S. got much louder last year. So far, Canada has been spared, but for how long? Even leaving aside potential gains or losses in price, buying a house, a condo or a piece of land is an illiquid investment for most individuals—if you need cash immediately, it's much easier to sell some stocks, bonds or mutual funds.

The upshot: Buying a home is a good thing, but try to make sure you won't have to unload it to alleviate a temporary financial crisis.

6. Don't sell stocks on Friday
PRO Stock traders—who often are not the same thing as stock investors—love spotting patterns in markets, and many of them factor those patterns into their trading strategies. Often there appear to be sound fundamental reasons for the patterns. The 2008 edition of Yale and Jeffrey Hirsch's Stock Trader's Almanac, a respected industry bible, notes that from 1989 to May, 2007, the Dow Jones Industrial Average posted a whopping cumulative gain of 9,338 points on Mondays and Tuesdays, and a cumulative loss of 1,367 points on Thursdays and Fridays. The reason? Short-term traders apparently don't like the uncertainty of keeping positions open over the weekend, so they tend to sell toward the end of the week, even if they take a small loss. The following Monday, they're often reluctant to jump back in too quickly, which means stocks rally over the next day or two.

CON Like many patterns, this one does not hold every week. Nor is there any fundamental reason why it should. Think about it: Would companies only release good financial news on Mondays and Tuesdays? Would positive economic developments happen only on those days of the week? Those things tend to help push up share prices, regardless of traders' emotions or their weekend plans. In fact, the Hirsches' own statistical summary shows that from 1953 to 1989, Monday was the most cumulatively negative day of the week for the Dow.

The upshot: Your first question about any apparent market pattern should be: coincidence or what? And do you want to make investment decisions based on happenstance?

7. You can't time the market
PRO There are reams of academic research showing that most investors—even professional money managers—don't beat the market indexes over the long term. One classic study that explains why is Princeton professor Burton Malkiel's book A Random Walk Down Wall Street, first published in 1973. Malkiel believes in the "efficient markets theory": All information about individual stocks is reflected in their prices, and pretty well all traders and investors know what those prices are, so it's unlikely anyone can consistently beat the market. Individual deviations from market averages are random.

CON This is a toughie, but let's start with two self-effacing gents with glasses: Berkshire Hathaway's Warren Buffett and Bill Miller, manager of the Legg Mason Value Trust. Although Berkshire Hathaway's A shares have sagged occasionally over the past four decades, the average annual total return since 1965 has been roughly double that of the Standard & Poor's 500 Index. As for Miller, as Globe Investor magazine noted last fall, he beat the S&P for 15 years straight, from 1991 to 2006. The odds of that are roughly one in 2.3 million. How do they do it? Classic, disciplined value investing, which can't be summed up in one or two simple rules. On the other hand, it may not be rocket science. In a lively 2003 book titled Yes, You Can Time the Market!, Ben Stein, a U.S. economist, lawyer, financial writer and game-show host, and Phil DeMuth, a psychologist and investment adviser, looked at stock market data going back to 1902 and determined that you could have beaten the market by using index funds and applying several classic value ratios, including the market's aggregate price-to-earnings ratio and the average dividend yield. You buy when the ratios indicate that the markets are undervalued and sell when they appear to be overvalued.

The upshot: If you stick to a sound discipline, you may not beat the market, but you probably won't do much worse.

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