Benchmarks: You use the Vanguard Index 500 fund, which
closely tracks the S&P 500 index with dividends reinvested,
as a basis of comparison when presenting performance data. Why
this fund? Would a more aggressive index fund be better? How about
the average performance of all the Select funds?
The S&P 500 is probably the second most mentioned index, after
the Dow Jones Industrial Average, as a measure of how the "market"
is doing. The Dow had the advantage of getting established and
publicized earlier. It celebrated its 100th birthday in May. However,
30 stocks is too few to really measure the market. The S&P
500 index is based on 500 stocks (surprise!) that total about
80% of the market value of all New York exchange stocks, so it
is considered a broad measure of the listed market. (The newer
New York Stock Exchange Index includes all the stocks on that
exchange.) I like to use the Vanguard Index 500 fund as a benchmark
since the S&P is often considered as a good measure of the
market and because an individual can actually buy it. There is
not a feasible way for individuals to buy most indices. Vanguard
has several index funds now, but only one of them, the Small Cap,
has been in existence for the entire period covered by my Selects
research data, from 1987 to date. This fund mimics the Russell
2000 small stock index. (Vanguard is my favorite provider of index
funds since they have extremely low expenses, so the funds' performances
are usually just slightly below the corresponding index, which
does not have any transaction and management costs.) The Selects
are mostly aggressive growth funds like the Small Cap Index fund,
but they are not limited to small cap stocks, and some own foreign
stocks. Since the Index 500 fund is usually considered to be a
growth and income fund, it will have different performance characteristics
than most of the Select funds.
The average performance of all the Select funds is a valid basis
of comparison for the results of the Select Switching System,
but it is not really practical. One could buy an equal dollar
amount of each Select fund at the beginning of the year, hold
on for a year, and then re-balance at the beginning of the next
year. Given the transaction costs and the tax consequences, an
index fund would probably be a better choice. Due to particular
Select funds, the group probably has a heavier weighting to technology
and other in vogue sectors (health, finance, energy) than the
broad market. There is also the question of whether or not American
Gold and Precious Metals should be included since I don't use
them as part of my system as I explained in the last newsletter.
In the table that follows, the average Select performance is shown
with and without these two funds.
Now we will look at how the Index 500, Small Cap Index, and the
average of the Select funds have done annually for 1987-95 so
we can see how they compare to each other. All the returns shown
assume that dividends and distributions are reinvested.
ANNUAL RETURNS OF "BENCHMARKS"
Average Select Fund Vanguard Index
Year All No Golds 500 Small Cap
1987 -3.0% -6.2% 4.7% -6.9%
1988 14.2 16.1 16.2 24.6
1989 26.6 26.6 31.3 10.4
1990 -5.6 -4.7 -3.3 -18.1
1991 40.1 42.7 30.1 45.2
1992 13.3 14.9 7.4 18.2
1993 26.8 22.7 9.8 18.7
1994 0.6 1.1 1.1 0.5
1995 32.6 34.3 37.4 28.7
There does not seem to be any pattern to the comparisons. For example, the average Select excluding the two gold funds did better than the Index 500 in the bull years of 1991 and 1993 and 1992 to some extent, but does worse in 1989 and 1995, which were also bull years. Because most investors have heard of the S&P 500 index and have an idea what it measures, I will continue to use the Vanguard Index 500 fund as the benchmark.
Minimum Holding Period: Your system calls for holding
the funds you buy at least five weeks in order to avoid the 0.75%
penalty for selling within 30 days. What if there were no penalty;
would you trade more frequently? The answer may well be no.
I have not researched this question extensively since I don't
think Fidelity is going to eliminate the short-term selling charge
they instituted in 1989 to discourage such activity. The Selects,
the oldest of which date back to 1981, originally did not have
that penalty, and some traders figured out how
to profit through short holding periods. Most fund managers can't
handle a large amount of very short-term trading.
I have looked at the performance of the top-ranked fund in my
system over various periods. That fund, on the average, performs
better than the other Selects over the following five weeks. However,
that is not the case for shorter periods. Over the next week,
the average gain of the fund I would buy is in the middle of the
Selects and is not close to the best performance. Over longer
periods, its relative performance improves. One reason for this
may be that my best ranked fund has moved up recently, and some
profit taking or consolidation may be expected. Of course, there
is a considerable amount of variability. For example, several
times a year, a fund will be top-ranked for three or four weeks
in a row.
Without changing the other parameters in my system, I eliminated the short-term selling penalty and tested to see what would happen if I reduced the minimum holding period. For minimums of one week (which is the shortest possible the way I test), two, three, or four weeks, the long-term hypothetical returns are worse than when I impose a five week minimum holding period. The returns improve as the length of the minimum holding period grows. I also tested minimum holding periods of six weeks or greater. The overall returns were inferior to those achieved with a five week minimum. That does not mean that the system could not be improved if there were no penalty for short-term selling. It may be possible to change one or more of the other parameters to take advantage being able to sell quickly without penalty. However, I see no point in developing such parameters as long as Fidelity continues to impose the penalty. If they do remove it in the future, which I do not think is likely, then I will research the parameters and my system thoroughly to see if a significant improvement is then possible.