Saturday, August 22, 2009

My Mistake!

Everyone makes mistakes once in a while...I'm no exception. Before I started this blog, about 3 months ago, I decided to buy a leveraged index ETF (exchange traded fund). It was the Daily Large Cap Bull 3X Fund from Direxion, ticker BGU. Now, let me remind all of you who are beginner investors: be very wary when buying leveraged funds, because leveraged funds are meant to increase volatility, or risk, as defined by the investment industry (I disagree with this definition, but that will be the topic of another post).

Anyway, what was my motivation for buying this fund? Let me give you some background: I re-started my investing career some time in 2007. I had previously invested from 2000 - 2003 and you guessed it, I lost my shirt! So, after taking a fairly extended break (I was rediscovering the Lord, courting my then girlfriend, and preparing for my wedding), I decided that I should start investing again. This time, however, I'm actually going to learn about investing before doing it. So, I read a few books on technical analysis and then fundamental analysis. Thinking I was ready to take on the world, I put a majority of my retire funds into stocks. That was before the market meltdown in 2008. So, fast forward a year or so to June of 2009. The S&P 500 had shed about 60% from its peak just a few months prior, but the market seemed to have bottomed. I studied the Dow Jones Industrial Average and S&P 500 Index over and over again to see if I can discover any characteristics of bear markets. This was what I found:
  1. Almost all bear markets last less than 2 years (from previous peak to trough).
  2. If you had invested in an index fund when the market first dropped to the midpoint ([peak+trough]/2), you would be back to where you were in less than 2 years.
Below is a figure of the Dow Jones Industrial Average, showing the 2000-2002 bear market. (I actually prefer the S&P 500 Index, but that's ok...) The peak occurred in January 2000 at 11723 pts., and the trough occurred a little less than 3 years later in October of 2002 at 7286 pts. Yes, this was actually a very long bear market relatively speaking (more than 2 years). The market hit the mid point in March 2001 at 9500 pts. So, according to my finding #2 above, we should be back at 9500 pts. by March 2003. Well, I was wrong...but not by much. By October 2003, 7 months after that, the index was back at 9500 pts. So, my theory wasn't off by too much.

Figure 1: 2000-2002 Bear Market - Dow Jones Industrial Average

If we apply this theory to the bear market of 2007-2009, the midpoint occurred around 1100 pts. in the S&P 500 index (assuming March 2009 was the real trough) in the September 2008. We should see S&P 500 rise back to 1100 pts. before September 2010. We're already at 1026 pts today (August 21, 2009). So, I think my theory will work again this time around.

Whew! That was a long background to the story, and probably will be longer than than the story itself. Anyway, this little theory that I came up with led me to buy BGU. By March of this year, S&P 500 had already hit 680 pts and was on its way back up. I thought that 680 was probably going to be the bottom of the bear market. After all, the index did lose about 60%. How much lower could it go? Even if the index went down to 0 pts (hypothethically speaking, of course), the midpoint would be 790 pts ([1580 pts + 0 pts]/2), and the market had already dropped past that. So, I thought buying when S&P 500 was at 900 pts. would give me a gain of 22% (1100/900) in less than 2 years, except with BGU, it is 3X leveraged. So, the gain could be around 66% (probably less than that because it is 3X daily and not over the long term). Not too shabby!

As I watched the market rise from 900 pts to 1000 pts in a mere 3 months, I was so proud of myself for making this great call! After all, I did lose a good chunk of my portfolio just a year prior. Then I started this blog...and the more I wrote about ethical investing, the more I introspected. There I was, saying how investing in mutual funds could potentially be unethical because these funds could have invested in questionable companies, but I knew for a fact that within the Russell 1000 index, which the BGU was trying to mimic, there were companies like Merck (makes vaccines from aborted human fetus tissue), Philip Morris (makes cigarettes), and probably a whole bunch of companies that tinker with human embryonic stem cells, manufacture/sell artificial contraceptives, promote abortion, etc. etc.

I am kind of shocked at how heedlessly I had acted when I decided to buy BGU. The only thought in my mind at that time was "66% returns...66% returns..." So, yesterday, I decided to sell all of my shares. I did make a decent profit, but at the expense of investing in some companies that had questionable practices. Now I'm wondering if this calls for a visit to the confessional...LOL!

In conclusion, don't follow what I did! The rule of thumb should be not to invest in any funds at all without doing some extensive research. However, since most of us have lives to live, my suggestion is not to invest in funds at all. Pick good companies with good practices and you'll sleep better at night!