Don’t Get Shorty
Short-selling has its place, but it’s best to stay out of it.

Mr. Glassman is editor of TechCentralStation.com.
March 26, 2002 8300 a.m.

ver the long run, there is no investing goal more difficult to achieve than losing money.

Just take a look at mutual funds that sell stocks short — that is, their managers try to make money for investors by making bets that particular stocks (or the market as a whole) will decline. Rydex Ursa (as in bear), based in Rockville, Md., is a good example. If you had put $10,000 into this short-selling fund five years ago, your holdings last week would have been just $7,811. Meanwhile, $10,000 invested in the Vanguard 500 Index fund, which invests in the stocks of the benchmark Standard & Poor's 500-stock index, would have grown to $15,930. One of the great clichés is that the stock market is a casino. In fact, it is the opposite of a casino. At the roulette table, for example, the house has an advantage of about 5%. Sit there long enough and you'll probably lose your entire stake. But in the stock market, you are the house, and your advantage — if history is a guide — is better than 10%. Invest long enough and your stake will mount impressively.

I was reminded of the power of positive investing with the arrival last week of the latest edition of one of my favorite books, Stocks, Bonds, Bills and Inflation, fondly known as SBBI. It's published every year by Ibbotson Associates, the Chicago-based research firm chaired by Roger Ibbotson, the Yale finance professor who developed a famous series — of historical record — of stock and bond performance going back to Jan. 1, 1926. SBBI (available at www.ibbotson.com) is not cheap; it's $110, but well worth the price for serious investors.

Here are some highlights from the new SBBI:

o Since 1926, the annual average return of large-company stocks, as represented by the S&P 500, has been 10.7%. An investment of $10,000 in such stocks in 1926 would be worth $22,791,300 today.

o Stocks have returned an average of 7.6% annually (adjusted for inflation) over this period. That compares with only 2.2% for long-term U.S. Treasury bonds and 2.7% for long-term corporate bonds. At that rate, an investment in a stock mutual fund that looks like the S&P index would, even after expenses, double in purchasing power in 10 years, quadruple in 20, and rise by a factor of eight in 30. A bond investment over 30 years, with the interest reinvested, wouldn't even double.

o With the bear market of 2000-01, stocks have now lost money in 22 of the 76 calendar years covered by SBBI. That's an average of one loss every three or four years.

o But hold on to a portfolio of stocks for a longer period, and it is unlikely to lose money at all. Look at all 67 of the overlapping 10-year periods since 1926 (i.e., 1926-35, 1927-36, etc.) and the Ibbotson data show that large-company stocks have lost money only twice — both times back during the Great Depression of the 1930s. The period 1992-2001 was the worst 10-year stretch of the past quarter-century. During that decade, a $10,000 investment in the S&P grew to $33,646. Not too shabby.

o Stocks have never lost money over any 15-year period since 1926. And, during the worst 20-year period since 1931 a $10,000 investment still rose to $35,236. During the worst 20 years since 1970, $10,000 rose to $88,206.

Examining these facts, how could any investor shun stocks for the long run? More incredible, how could he bet on stocks to go down? Don't get me wrong. I like having short-sellers around. They add stability to markets by punishing miscreants. After all, it was James Chanos, who runs a hedge fund that's famous for uncovering weak companies and betting their prices will drop, who exposed the accounting shenanigans at Enron Corp. But short-selling is a short-term game, and it is for experts. Amateurs can do extremely well by simply finding good companies and becoming partners in their success for the long term — or by partaking in the prosperity of the economy in general through owning index funds or managed mutual funds. Even if you get the urge to sell short for just a few days, resist. Understand that the price of a stock today is determined by the buying and selling of thousands of investors, many of them much better informed about the company than you are. Short-selling is an act of incredible hubris, and hubris isn't a quality that's rewarded in the stock market.

Shorting international stocks is as unproductive as shorting U.S. stocks. Over the past 15 years, the MSCI EAFE index, a popular global measurement, has returned an annual average of 9%, with only three negative years, and the average international mutual fund, according to Morningstar, has returned 10.7%.

The short-selling process is a mystery to most investors. Here's how it works: Instead of buying 100 shares of Coca-Cola Co. outright at, for example, $50 a share (going long), you borrow 100 shares from someone who already owns Coke and then sell those shares immediately for $5,000. You still have to return the borrowed shares sometime in the future (that is, you are "short" the 100 shares and need to make them up), but your hope is that Coke's price will drop from $50 to, say, $40 in the meantime. If that happens, you go into the market and buy 100 shares of Coke for $4,000, return the borrowed shares and pocket the $1,000 profit (minus interest on your loan).

But these details aren't important. Just tell your broker you want to sell a stock short, and the result will be that you'll make a profit if the price falls and suffer a loss if it rises. You can also short the broad market by selling S&P futures contracts and through other esoteric means. But, more easily, you can purchase one of the half-dozen or so mutual funds that specialize in trying to make money off declines in the market.

Only don't do it. These funds have horrible track records. It's not their fault. They're providing a service desired by pessimists who think they can outsmart the market. It's a nice niche. Consider a fund based in Bethesda called ProFunds UltraBear. According to its website, the fund "seeks daily investment results that are twice the inverse, before fees and expenses, of the performance of the S&P 500 Index." In other words, not satisfied with losing the historic average of 10.7% a year, this fund — thanks to the use of leverage — is headed for a loss of 21.4% a year, minus expenses (another 1.48%).

Between its inception, on Dec. 22, 1997, and the end of 2001, the fund, according to the ProFunds site, lost 33.5% of its value — compared with an increase of 20.4% for the S&P. That's a difference of more than $5,000 on a $10,000 investment. Still, that's a terrific showing compared with another ProFunds offering, UltraShort OTC, whose bearish target is the tech-heavy Nasdaq 100 index. From inception on June 2, 1998, through 2001, the fund fell 93%. That's almost as bad as Enron, and so far there's been no congressional investigation.

What about buying a fund run by an actual human being, who tries to pick companies that are about to go into the tank? Unfortunately, the most prominent of these funds, Prudent Bear, has done even worse than the short-selling index funds over the past five years. Rydex Ursa is down an annual average of 4.8%, compared with a loss of 6.7% for Prudent Bear. (The difference is mainly in fees.) Prudent Bear is run by David Tice of Dallas, who devotes most of his waking hours to searching for companies that are overpriced. He's the fellow who blew the whistle on supposedly questionable accounting practices at Tyco International Ltd., the Bermuda-based conglomerate, in 1999. Tice also holds a few long positions, mainly mining stocks, and he thinks the economy and the market are headed downhill fast. His website, www.prudentbear.com, is filled with reprints of gloomy articles, such as "Wall Street's Fake Rally," from Fortune, and "College Funds Hit by Losses," from the Arizona Republic. Fake rally or not, the Prudent Bear was itself hit by losses — of 22.1% in the fourth quarter of 2001. The fund has come back a little in 2002, but it was trailing the S&P by 4 percentage points for the 12 months that ended March 20, 2002.

Still, I have sympathy for Tice. He's chosen one of the toughest professions known to humankind — trying to profit from the losses of a stock market that has a powerful history of gains.

Maybe he should try shorting the roulette players in Las Vegas. Now, there's a sure thing.

— Mr. Glassman's new book is The Secret Code of the Superior Investor. This column originally appeared in the Washington Post.