By Richard Schmitt
NEW YORK (
) -- After four solid years of holding stocks, passive investors caught in the market updraft may have lost sight of downside risk. Then the market's stumble in June again reminded these investors of the inherent risks, as well as rewards, of investing in stocks.
Not only did June bring losses to the major U.S. stock indices, but volatility ruled the month. While the
Dow Jones Industrial Average
declined by 1.4%, both the
Standard & Poor's 500
index and the
composite index dropped by 1.5% for the month. Meanwhile, June was marked by the type of volatility that brought the daily change in the Dow Jones Industrial Average to exceed 100 points on 16 of 20 trading days.
The market conditions in June presented another example in life where good things happen to people who pay attention. In this case, these more fortunate people employed an active portfolio rebalancing strategy that involved noticing market changes and executing trades based on the market changes.
In the case of investing retirement savings split evenly between inexpensive stock index and cash funds, an investor may make a daily fund exchange between the stock index and cash funds based on the daily change in the market index just before the market close.
When the market is about to close higher, the fund exchange involved in so-called "401(k) day trading" amounts to selling some stock to lock in a gain.
Similarly, when the market is about to close lower, the fund exchange results in buying some stock to set up a future gain. These fund exchanges done the right way within retirement savings accounts do not trigger immediate income taxes or direct trading costs.
Whereas a passive investor lost 1.5% holding the S&P 500 index during June, a 401(k) daytrader using daily rebalancing could have wrought a gain of 0.7% (both excluding dividends) for this one-month period. Thus, 401(k) daytrading brought an added return of 2.2 percentage points over holding the S&P 500 index during June.
Yet this approach works best over the long term. From Jan. 1, 2000 through June 30, 2013, holding the S&P 500 index would have returned 9.3%, whereas 401(k) daytrading would have returned 34.8%, both excluding dividends. This time, paying attention in the form of 401(k) daytrading generated an extra 25.5% return over the period.