• Editor's Note
  • Editor's Note

    by Charles Rotblut, CFA

    Editor's Note Splash image

    John Bogle and Jack Schwager are two names not commonly mentioned in the same sentence. John Bogle started a mutual fund company to offer index funds in 1975 when nobody thought the idea would work. Today, Vanguard is one of the largest fund companies in the world. Jack Schwager interviewed several top traders and wrote about his conversations in 1989. His book, “Market Wizards,” became a bestseller and sits on my bookshelf at home. (Yes, I know John Bogle goes by “Jack,” but to avoid confusion here, I’ll use “John” to refer to him.)

    Though they have different backgrounds and different approaches—John advocates for buying and holding an index fund, whereas Jack’s experience is in trading—they express a common theme in the articles you will see in this month’s issue: Don’t invest based on past performance. Optimizing your portfolio based on what has happened in the past will often lead you to underperform in the future.

    John brings the subject up in terms of mutual fund performance (here). He says investors commonly look at which mutual funds have done well in the past and then buy them, thinking the good performance will continue into the future. Jack says traders err by optimizing an otherwise good system to mitigate past downward volatility (here). In both instances, investors look to the past with the assumption that it gives insight into what will happen in the future. Very often this practice leads to lousy returns.

    Neither argues that history is worthless; rather they are suggesting not to invest by looking in the rearview mirror. History does offer some guidance as to what has worked and what hasn’t. We know value has beaten growth, high costs have hurt returns, hot mutual funds have cooled and market meltdowns were caused by something other than what caused the previous meltdown. We also know behavioral errors and a lack of a systematic approach to portfolio management have hurt investors in the past and will hurt investors in the future. Most importantly, we know that the tendency of investors to buy into, rather than fear, speculative excesses will occur again in the future, given what history tells us.

    History’s best use is as a spotlight into what hasn’t worked and as a measure of long-term odds. It also useful for determining what has tripped you up in the past. Figuring out what your personal tendencies are and devising a system to work with them, as opposed to trying to follow a method that doesn’t match your personality or risk tolerances, can be very helpful.

    I want to quickly mention Jim Cloonan’s latest Model Shadow Stock Portfolio commentary, which starts here. In addition to making a change to the portfolio, he formalized a requirement that eliminates candidate stocks with negative earnings estimates for the current quarter or the current year. This latest tweak doesn’t alter the strategy underlying the portfolio, but it does evolve it to incorporate ongoing observations and practices. Being disciplined doesn’t mean being static; tweak your strategy when there is a clear and justifiable reason for doing so.

    One thing you won’t find in this month’s issue is the transcripts of my conversations with Jeremy Siegel and William “Bill” Sharpe that I referenced last month. We had a tighter-than-usual deadline for this month’s issue and couldn’t get the transcripts edited prior to the deadline. We’ll run the interviews in an upcoming issue.

    Finally, I want to make a correction to last month’s Editor’s Note. In the June 2014 AAII Journal, I said that investors holding shares of DirecTV (DTV) in a taxable account will owe capital gains taxes on the $28.50 cash payment they will receive if the AT&T (T) merger goes through. In writing this, I didn’t properly run the cost-basis numbers. As Claude Y. Paquin pointed out in an email to me, the cash payment will be taxable for those with an estimated basis of not over $66.50 in shares of DirecTV. Because the merger agreement allows for some flexibility in the acquisition price, the $66.50 figure is an estimate.

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    Wishing you prosperity,

    Charles Rotblut, CFA
    Editor, AAII Journal

    Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/CharlesRAAII.


    Claude Y. Paquin from GA posted over 2 years ago:

    For those who really, really care about the details of the proposed acquisition of DirectTV by AT&T, it might be pointed out that when the merger of DirectTV into AT&T is completed (if it is) AT&T will exchange a number of its shares for each DirectTV share as well as pay $28.50 per DirectTV share. The number of AT&T shares will be determined by a formula which will track the average price of AT&T shares over 30 consecutive trading days before the effective date of the merger. If that average price is between $34.903 and $38.577, the number of AT&T shares will be determined by dividing $66.50 by this average price. Otherwise, the minimum number of AT&T shares will be 1.724 and the maximum 1.905. We’re likely to find out the actual number only at the time the merger is completed, whenever that is.

    Then it will be time for each DirectTV stockholder to calculate the fair market value of what he received from AT&T by adding to his $28.50 cash payment (per DirectTV share) the value of the AT&T shares received as computed in one of the four manners described in my article. The excess of this value over his basis for the DirectTV stock is his gain. If that gain is $28.50 or more, a gain of $28.50 will have to be reported for income tax purposes, the rest of the gain will be untaxed (for now), and the basis of the DirectTV stock will become the basis of the AT&T stock. If that gain is less than $28.50, that gain will have to be reported, and the difference between $28.50 and that gain will need to be subtracted from the basis of the DirectTV shares to determine the basis of the newly acquired AT&T shares.

    Hey, you can’t explain that in 50 words or less! But here is a pop quiz for my better students. What will be the acquisition date of the AT&T stock received in the merger?

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