Motley Fool are masters of the sensational headline; case in point: their blog shouts Avoid the Mistake That Cost Buffett 8 Years of Better Returns, which turns out to be a reasonable discussion of technical analysis v fundamental investing a la Warren Buffett:

Technical analysis is the practice of predicting where stocks will trade based on charts of historical pricing and volume information. There’s a certain logic to it. Stocks trade based on supply and demand, which is greatly influenced by investors’ attitudes about the stocks. The charts should reflect those attitudes and might predict where the individual stocks will go.

But Buffett discovered one small problem. Technical analysis didn’t work. He explained, “I realized that technical analysis didn’t work when I turned the chart upside down and didn’t get a different answer.” After eight years of trying, he concluded that it was the wrong way to invest.

So, what does Warren say is the right way to invest?

Well it would be unfair of me to steal Motley Fool’s Thunder [ AJC: see I, too, can write clever headlines 😛 ] …

… instead, I want to point you to an even better strategy for small-time investors who can hop in/out of positions far more nimbly than Warren Buffett:

Combining value investing with basic technical analysis as touted by Phil Town of Rule # 1 Investing ‘fame’. Phil reportedly turned $1,000 into $1,000,000 over 5 years using these strategies, so maybe you can, too?

I didn’t have this same kind of success (with stocks!), but I did only start to use these strategies as the market crashed 50+%, yet my loss (including doubling my risk by using margin lending) was a 15% loss in the US (on approx. $1,000,000 invested) v a 60% loss in Australia (on approx. $750,000 invested) and a 80% loss in the UK (on approx. $3,000,000 invested) where these techniques were NOT used.

Before you say “what a dope”, my UK ‘investment’ was actually part of my buyout, so I had no choice … but, Australia and US were my [stupid!] decisions to invest at the peak 🙂

So, a 15% US loss should actually be read as a 35% ‘gain’ over the market, thanks to these tools …

Here’s what Phil Town has to say about sticking to his technical analysis-based buy/sell signals:

For all you arrows users (Investools or Success): I buy with three greens and it’s amazing how many times I regret it when i jump the gun and buy with two.  So three green.

And I get out when the stock stops going up and I get two reds down below.

And, here’s how to combine the two:

– Select a stock based upon sound fundamentals: i.e. is it trading below its long term value?

– Buy when the ‘technicals’ tell you that the major fund are beginning to buy in and sell when they are beginning to sell out.

IF this works for you (and, it has worked pretty well for me), it allows you to rid the short-term ‘waves’ in a stock’s price …

… but, you sell out for good, once your ‘value analysis’ tells you that the stock is no longer cheap.

In choppy and down markets it’s natural to be nervous … so, it’s no wonder that investors start to look at funds that purport to ‘guarantee’ your initial capital, your return, or some combination of both.

I have a close friend who is a financial adviser, who works strictly on a fee basis, yet his practice is associated with the products of one major insurance and fund management company.

He was telling me of the rise of these Absolute Return funds that work on the basis of not only guaranteeing the original amount that you invested, but also lock in your returns to date …

– in other words, if you invest $1,000 this year and the market falls, the fund guarantees to pay you back at least $1,000

– then next year is a good year for the market and your fund increases by 10%; now the fund guarantees to pay you back at least $1,100

– but, next year there’s another market crash and the market drops by 15%; but, the fund STILL guarantees to pay you back at least $1,100

– if you remain with the fund and the market eventually totally recovers, as soon as the fund value rises above your new $1,100 ‘guarantee’ then so does your return.

There have been plenty of systems that have produced similar results … they usually do this by some combination of insurance and/or derivatives (e.g. stock options). In fact, you could replicate some of these results for yourself simply by buying the right type and duration of stock option along with the underlying stock (or index).

The problem is that all of these end up costing you money: the insurance premium and/or options are bought out of your initial (or ongoing) investments. The ‘cost’ of these ‘guarantees’ comes as some combination of increased fees or reduced returns when compared to a similar fund that does not offer the ‘guarantee’ …. it’s that simple.

You can provide yourself a similar – or better – result at far less cost: buy a low-cost Index Fund and wait 30 years to cash it out; I can virtually ‘guarantee‘ an 8.5% minimum return 🙂