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Why you need ‘Alpha’ if you’re going to win…

Courtesy of Dr. Paul Price, Beating Buffett

Why you need ‘Alpha’ if you’re going to win…

‘Alpha’ represent excess returns- the amount you (hopefully) make through active management versus passive indexing. Friday’s Wall Street Journal showed this nice rundown of the past four years’ returns for the S&P 500…

S&P   4 years of results.JPG

At first glance things look pretty good. Three out of the four years showed gains of + 4%, + 24% and + 13% [through Dec. 29th] against the one bad year in 2008 when shares dropped by 36%. The problem is the actual math.

Starting Balance

$1,000,000

Cumulative Return

End of 2007

$1,040,000

+ 4%

End of 2008

$665,000

(33.5%)

End of 2009

$825,344

(17.47%)

Dec. 29, 2010

$932,639

(6.74%)

 

Because the bigger gains came after the large decline, indexed investors are still underwater since the end of 2006. Those who navigated the treacherous times with skill have done much better. In fact, it’s typically during the worst markets that the most money is made.

We all tend to tally up our gains and losses when we finally close out a position but in reality you make or lose money when you first take a position. If you bought grossly overpriced shares like the internet companies in 1999 you’d already lost your money- you just didn’t know it yet. Conversely, if you committed to almost anything in early 2009 that survived the credit crisis you were already sitting on big gains even though it would take a year or more to prove out.

Dr. Paul Price  www.BeatingBuffett.com www.OptionsProfits.com 


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