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Home : 2011 Back Issues : Article

Perspective on Upgrading's Short- and
Long-Term Performance

By Mark Biller

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Most SMI readers are aware of the strong long-term track record generated by our Fund Upgrading strategy. Because we strive to keep readers focused on their long-term plan rather than the short-term fluctuations in their portfolio, we don't emphasize Upgrading's shorter-term results much (though they're published each month in the print version of the SMI newsletter).

While we believe this balance is appropriate and that the pros of keeping readers focused on the long-term far outweigh any cons, there is one subtle downside to not discussing short-term performance more often. It can lead to unrealistic expectations for Upgrading over shorter time periods.

Some readers naturally assume that Upgrading must consistently beat the market — even over the short-term — in order to generate such a significant long-term margin of victory over the market. The fact that Upgrading has beaten the market in 11 of the past 12 calendar years has only served to reinforce that perception. But the reality is somewhat more complex. Before we go any further, let's first quantify this long-term performance edge for Upgrading over the market.

Table 1 shows the results for Upgrading, as well as for the Wilshire 5000 (the broadest measure of the U.S. stock market), from January 2000-April 2011. Upgrading's total return of 138.2% dwarfs the market's gain of 24.7%. Upgrading earned 8% annualized during this 11+ year period; the market just 2% annualized. Obviously, the extra effort involved with Upgrading paid off in a big way during this long period.

You may not have thought of this, but Upgrading can outperform the market because the composition of our Upgrading portfolios is quite different than the composition of the overall market. If the Upgrading portfolios were much the same as the market, then the returns would be similar to those of the market. But they're not.

It is this difference, this lack of correlation, that makes such outperformance possible. Naturally we enjoy this when Upgrading is beating the market. But it's important to recognize this factor is also what causes Upgrading to lag the market at times. If we want the long-term performance edge Upgrading generates over the market, we need to understand it is this difference from the market that also leads to short-term underperformance at times.

In creating Table 2, we looked at all of the monthly rolling periods of varying lengths that are contained within the 12/31/1999–
4/30/2011 period. For example, the first 3-month rolling period we looked at was January-March 2000. Then we looked at February-April 2000, and so on.

The results show that, in fact, Upgrading did outperform the market the majority of the time in each time period. But I suspect many readers will be surprised to see how often Upgrading lags the market for these shorter time periods.

It's helpful to read both columns of the table — the percentage of the time Upgrading beat the market, as well as the percentage of the time the market beat Upgrading. Doing this reveals that the market actually had the upper hand in 40% of the one-month periods, 32% of the 3-month periods, 25% of the 6-month periods, and 17% of the 12-month periods. Yet we know this was a period (January 2000-April 2011) when Upgrading's overall performance beat the market by a wide margin.

The takeaway is clearly that lagging the market in the short-term doesn't hinder Upgrading's ability to produce superior long-term results.

As one would suspect, the data show that the longer the time period, the more common it was for Upgrading to outperform the market. This is why we encourage readers to develop the habit of not checking their returns daily, or even monthly. Those who watch their portfolios closely are more likely to suffer emotionally from the 40% of the time Upgrading lags the market during a given month.

If you can condition yourself not to focus on short-term results, you'll be both a happier investor and more likely to stick with your plan. And that's important to meeting your long-term investing goals.

Mark Biller is Sound Mind Investing's Executive Editor. His writings on a broad range of financial topics have been featured in a variety of national print and electronic media, and he has appeared as a financial commentator for various national and local radio programs. Mark is also the Senior Portfolio Manager of the SMI Funds.