7 Deadly Investment Sins

Seven Deadly Investment Sins: How to Save Your Portfolio. Now.

Seven Deadly Investment Sins: How to Save Your Portfolio. Now. After nearly 30 years of providing world-class investment research, and nearly 15 years of portfolio management experience, Zacks has identified “7 Deadly Investment Sins” that have plagued so many investors. At some point everyone has been guilty of at least one of these “sins” and if allowed to continue, it can destroy your portfolio. The good news is that I have identified these “sins” for you in this special report. On the following pages I provide a detailed analysis of these “sins” and explain why they are so deadly to a portfolio. It is a great pleasure to share the results of my analysis with you in the hope you will be able to avoid these pitfalls in the future. I am confident that avoiding these “sins” will help you make your investment goals become realities. -Mitch Zacks

Contents: Seven Deadly Investment Sins ........................................................ 1 Sin #1: Market Timing ................................................................. 2 Sin #2: Investing On Emotions .................................................. 3 Sin #3: Lack of Diversification ................................................... 5 Sin #4: Not Knowing Your Time Frame ................................... 6 Sin #5: Not Understanding The Effect of Inflation on Cash Vehicles ........................................... 7 Sin #6: Chasing Returns ............................................................ 8 Sin #7: Procrastination ............................................................. 10 About Zacks ..................................................................................... 11

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Sin #1: Market Timing “I’m going to wait until market conditions improve before I invest…”

Market timing is a strategy where an investor attempts to predict the future direction of the market and then move in and out of the market accordingly. This is one of the most dangerous strategies ANY investor can employ. There are essentially two reasons why market timing is so dangerous: 1. Over the short term, the market does not always move logically or predictably. This makes it nearly impossible to time the market. Simply put, it can’t be done. 2. Even if you were able to beat the odds and create a system that accurately times the market, the payoff would not be worth taking that level of risk. Investors who attempt to time the market are at risk of missing periods of exceptional returns. This can have a large negative impact on an otherwise well planned investment strategy. Suppose for a moment your timing strategy was slightly off and you missed out on just 30 days of strong performance each year. The result would be disastrous to your overall return. The graph below illustrates the effect of missing the one best month in a calendar year for the period of 1995 - 2007.

Cumulative Returns January 1995 - December 2007 S&P 500 S&P 500 minus best month of each calendar year

300.58% 77.10

We should note that although we feel timing the market is an impossible strategy, we have proven that there are inefficiencies in the market that allows investors to accurately identify individual stocks that are poised to outperform (or underperform) the overall market. After years of quantitative research, Zacks has discovered that the most reliable and accurate predictor of future stock price movement are earnings estimate revisions.

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Sin #2: Investing On Emotions “The market is never going to survive this crisis, I’m going to cash…”

Whether it’s the morning newspaper, CNBC, the radio or the internet, at any given time you can find a pundit or “market expert” who is predicting major doom and gloom for the market. No matter the situation, at the time of their occurrence it inevitably seems like the entire U.S. economy is at risk. However, it is important to note that these “reporters” are dependent on attracting an audience, and they are much more likely to draw in a crowd by predicting the very best or worst scenario rather than telling you the truth… that whatever turbulent period we are in is par for the investing course. If you take a look at the past eight decades, every year is annotated with a reason to not invest in the equity market. Over that same time, we have witnessed the strongest economy in the history of the world that has provided investors like you with stronger returns than any other investment vehicle. Take a look at these world events: 1934: 1935: 1936: 1937: 1938: 1939: 1940: 1941: 1942: 1943: 1944: 1945: 1946: 1947: 1948: 1949: 1950: 1951: 1952: 1953: 1954: 1955: 1956: 1957: 1958: 1959: 1960:

THE GREAT DEPRESSION SPANISH CIVIL WAR ECONOMY STILL STRUGGLING RECESSION WAR IMMINENT WAR IN EUROPE FRANCE FALLS ATTACK ON PEARL HARBOR WARTIME PRICE CONTROLS INDUSTRY MOBILIZES CONSUMER GOODS SHORTAGES PRESIDENT ROOSEVELT DIES CHURCHILL'S "IRON CURTAIN" SPEECH BEGINNING OF THE COLD WAR BERLIN BLOCKADE RUSSIA EXPLODES A-BOMB KOREAN WAR EXCESS PROFITS TAX U.S. SEIZES STEEL MILLS RUSSIA EXPLODES H-BOMB DOW TOPS 300- MARKET "TOO HIGH" EISENHOWER FALLS ILL SUEZ CRISIS RUSSIA LAUNCHES SPUTNIK RECESSION CASTRO SEIZES POWER IN CUBA RUSSIANS DOWN U-2 PLANE

1961: 1962: 1963: 1964: 1965: 1966: 1967: 1968: 1969: 1970: 1971: 1972: 1973: 1974: 1975: 1976: 1977: 1978: 1979: 1980: 1981: 1982: 1983: 1984: 1985: 1986:

What has history taught us? No matter how grim or bearish individuals around you may feel, over time the U.S. equity market will produce the most consistent and strongest return for your investments. If you are appropriately diversified, you should not concern yourself with the market’s daily volatility.

BUILDING OF THE BERLIN WALL CUBAN MISSILE CRISIS KENNEDY ASSASSINATION GULF OF TONKIN CIVIL RIGHTS MARCHES ESCALATIONS OF THE VIETNAM WAR NEWARK RACE RIOTS USS PUEBLO SEIZED MONEY TIGHTENS; MARKET FALLS CAMBODIA INVADED; WAR SPREADS WAGE-PRICE FREEZE WATERGATE SCANDAL ENERGY CRISIS NIXON RESIGNS FALL OF VIETNAM ECONOMIC RECOVERY SLOWS MARKET SLUMPS RISE IN INTEREST RATES OIL PRICES SURGE TO NEW HEIGHTS INTEREST RATES AT ALL-TIME HIGHS BEGINNING OF A SHARPLY RISING RECESSION UNEMPLOYMENT REACHES THE DOUBLE DIGITS RECORD BUDGET DEFICIT TECHNOLOGY BUBBLE BURSTS EPA INITIATES BAN ON LEADED GAS LINE DOW AT 1800 - "TOO HIGH"

1987: 1988: 1989: 1990: 1991: 1992: 1993: 1994: 1995: 1996: 1997: 1998: 1999: 2000: 2001: 2002: 2003: 2004: 2005: 2006: 2007:

STOCK MARKET CRASH WORST DROUGHT IN 50 YEARS SAVINGS & LOAN SCANDAL IRAQ INVADES KUWAIT RECESSION RECORD BUDGET DEFICIT CONGRESS PASSED LARGEST TAX INCREASE IN HISTORY INTEREST RATES ON THE RISE DOLLAR AT HISTORIC LOWS GREENSPAN'S "IRRATIONAL EXUBERANCE" SPEECH COLLAPSE OF THE ASIAN MARKETS LONG TERM CAPITAL COLLAPSES Y2K PROBLEM DOT-COM STOCKS PLUMMET TERRORISTS ATTACK ON U.S. SOIL CORPORATE SCANDALS: U.S. INVASION OF IRAQ INFLATED OIL PRICES TRADE DEFICIT LEBANON CONFLICT CREDIT CRUNCH

1950

2,000

1,000

1960

1970

1980

1990

2000

Dow Jones Industrial Average Inedx is the property of Dow Jones & Company

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8,000

4,000

DOW JONES INDUSTRIAL AVERAGE INDEX 1934-2007

1940

14,164.53

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Sin #3: Lack of Diversification “I have 10 mutual funds, I am well diversified…”

You may be committing one of the worst investment “sins” and not even know it. Many investors mistakenly believe that because they have several stocks or mutual funds that they are well diversified. However, to ensure true diversification you have to look deeper into your investing strategy. Let’s suppose that you had the noble intentions of creating a diversified portfolio and went out to the market and purchased several mutual funds each with a different investment style. You may not realize it, but mutual fund holdings, often have a great deal of overlap. Take Microsoft for example. You may own a balanced fund, a growth fund, a technology fund and a global fund and each of these may have a position in Microsoft. What exacerbates the situation is the fact that mutual funds do not publish their holdings on a regular basis. Even mutual fund research firms, such as Morningstar, typically only receive the underlying holdings once a quarter. This makes it nearly impossible for you to have a full understanding of the true sector and position weightings of any mutual fund. In a different scenario let’s say you hold individual stocks. No overlap is possible here, but you still may not be as diversified as you think even if you own 10, 20 or even 50 stocks. You need to dig deeper to see your diversification across market cap size, sector and style. At Zacks, we divide the equity universe into 16 different sectors. If you are managing a portfolio of individual stocks, it is important for you to understand your sector weightings in order to ensure proper diversification. Even if you are convinced a particular sector is going to outperform all others, you never want to have all of your proverbial eggs in one basket.

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Sin #4: Not Knowing Your Time Frame “I’m in (or close to) retirement, I just need fixed income investments at this time…”

If you are in or are approaching your retirement age, you should have a portion of your allocation in fixed income investments. However, it is just as important for you to maintain some exposure to equities. The average life expectancy for Americans continues to rise. It is more important than ever for you to consistently earn returns in retirement so you do not outlive your money. With advances in medical technology, the average life expectancy has increased from 69.7 in 1960, to 77.8 in 2004 (see below). Couple this with the rising costs of health care and inflation and this creates a scenario where, for most individuals, fixed income investments are not enough.

CDC’s National Center of Health Statistics Life expectancy at birth

Life expectancy at birth United States, selected years 1900-2004 (Data are based on death certificates) Birth Year 1900 1950 1960 1970 1980 1990 2000 2004

Expected Age 47.3 68.2 69.7 70.8 73.7 75.4 77.0 77.8

The truth is there is not a one size fits all solution. Only through a comprehensive evaluation of your goals, risk tolerance and time horizon can an appropriate allocation between equity, fixed income, cash and alternative investments be established.

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Sin #5: Not Understanding The Effect of Inflation on Cash Vehicles “I want my money in cash. It is safe then…”

You may feel that an investment in cash is “safe” and it will not decrease in value. Although it is true that a cash investment is dramatically less risky than an investment in the stock market, inflation will erode at the real value of your portfolio over time. What is even more staggering is that once you take into the effect of taxes and inflation, a cash investment will likely have a negative return.

3.7%

0.7% -0.7%

T-Bill Return

After Inflation*

After Inflation* & Taxes**

For this reason you never want to hold too much money in cash at ANY time. * Assumes a 3% annual rate of inflation

We should note that you should always maintain approximately six months of living expenses in **Assumes a 37% tax rate cash for your emergency fund. However, outside of that, your portfolio should not be over allocated to cash. Don’t let yourself fall into the false assumption that cash is safe.

* Assumes a 3% annual rate of inflation **Assumes a 37% tax rate

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Sin #6: Chasing Returns “My friend made a fortune in Energy stocks; I want to switch my investments to this asset class now…”

One of the deadliest actions you can take as an investor is to chase returns. Whether it is purchasing a new mutual fund, changing investment advisors, switching newsletters, or selecting a new stock, it is a common pitfall for investors to follow the hottest trend. If you follow this instinct then essentially you are managing your portfolio by looking in the rear view mirror and letting your desire for huge returns interfere with rational thinking. An investment philosophy like this will cause you to feel as if you are “always late to the party” and your portfolio will suffer greatly. To gain a better understanding of how detrimental chasing returns can be to your portfolio, let’s imagine it is January 1, 2000. As you analyze the returns from 1999, you see that the biggest winners were investments in Japan and in the Technology Sector. You decide that this is where you need to invest and who would blame you; all of your friends and colleagues are bragging to you about how great their portfolio has been doing, and there are still plenty of “analysts” out there telling you the party is not over.

From First To Worst

Next you go out and purchase two low cost mutual funds that track the following indexes: ■■ MSCI Japan: Up 61.77% in 1999

1999 100% 80%

■■ S&P North American Technology Sector Index: Up 88.87% in 1999

60%

■■ These indexes both dramatically outperformed the S&P 500 index which returned 21.04% in 1999.

0%

40% 20%

MSCI Japan 61.77%

Move ahead to January 1, 2001. You take a look at your investments, and this is what you see: ■■ MSCI Japan: Down 28.07% in 2000 ■■ S&P North American Technology Sector Index: Down 37.84% in 2000 ■■ This compares to just a 9.11% loss for the S&P 500 in 2000. This is a common error that millions of investors make every year. It is very common for funds to move from “first to worst.” In fact, typically the greatest inflow

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S&P Technology Sector 88.87%

S&P 500 21.04%

2000 0% -5% -10% -15% -20% -25% -30% -35% -40%

MSCI Japan S&P -28.07% Technology Sector -37.84%

S&P 500 -9.11%

into a given mutual fund is immediately after it has generated above average performance and immediately before it begins a period of underperformance. Today the potentially same costly mistake is being made by thousands of investors as they flock to energy stocks and investments in China. Investing is a process that takes time and patience. The real way to benefit from an asset class is to be involved before it becomes hot and knowing when to pull profits off the table. It is critical to look at forward looking indicators to identify stocks and sectors to invest in before the profits are made.

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Sin #7: Procrastination “I need to take some time and think everything through before I make any changes...”

With all of the various choices in the investment world, it is easy to understand how you can feel overwhelmed and put off making any changes to your portfolio. But perhaps the worst decision you can make is no decision at all. A portfolio that is constructed with a variety of mutual funds and/or stocks that does not have an overall strategy is doomed for failure. You will constantly be in a state of uncertainty and never know when to buy or sell your stocks and mutual funds. This will lead to poor and irrational decisions. We are not recommending you invest with a manager or follow a newsletter without fully understanding the philosophy, but put yourself on a strict timeline to make a decision. Evaluate the process and examine it to make sure it avoids all of the previous “sins” we have discussed. Make no mistake, there are many newsletter writers, brokers, investment managers and “gurus” who are just as guilty of committing these “sins” as individual investors. That is why it is no surprise that so many mutual fund managers underperform the market as well.

Disclaimer: This article is provided for informational purposes only and does not constitute legal or tax advice. Zacks Investment Management, Inc. is not engaged in rendering legal, tax, accounting or other professional services. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel.

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About Zacks Mitch Zacks Mitch serves as Director of Quantitative Modeling and Senior Portfolio Manager of Zacks Investment Management. Mitch is integrally involved in Zacks’ research efforts and has portfolio responsibility for several of the strategies. Mitch has been featured in various business media including the Chicago Tribune and CNBC. He wrote a weekly column for the Chicago Sun-Times and published the acclaimed book about quantitative investment strategies, Ahead of the Market. Mitch has over 10 years of investment experience. He has a B.A in Economics from Yale University and an M.B.A in Analytic Finance from the University of Chicago.

Zacks Investment Management Zacks Investment Management, a wealth management boutique, is the world’s leading expert on earnings and using earnings estimates in the investment process. We are a wholly owned subsidiary of our parent company, Zacks Investment Research. Through our rigorous investment process we provide individual and institutional clients with a level of customization and personalization unavailable at most investment firms. Client portfolios are managed using a unique combination of Zacks independent research and Zacks quantitative models that have proven year after year to deliver superior results. Call 800-245-2934 today to learn more about our powerful program or to request a free consultation.

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