Inspired by Kevin Kingsbury's piece at MarketBeat, we decided to take a look at the flow of capital in and out of asset classes over time to see how good investors are at predicting market movements. In his piece, Kingsbury notes a spike in outflows from long-term mutual funds just before a late November market rally, citing ICI for his data on money flow. When we saw they had a downloadable spreadsheet with historical data going back to January 2007, we decided to take a closer look at the ability of investors to time the market.

How did they do? In the following scatterplot, each dot represents a month and an asset class. On the x-axis we show the flow of capital into an asset class, on the y-axis we show the corresponding percent change in that asset class[1].

If investors as a whole are good at timing the market, then we should see a positive correlation (visually, a trend line with a positive slope). Instead, we see a noisy plot consistent with a hypothesis of no correlation. So, at best, investors do not consistently predict market movements and allocate assets accordingly. At worst, they're more likely than not to sell out of a market before gains are realized. The average trend-chaser never catches up.

The difficulty of achieving above-average returns via market timing is well-documented. Here's Jack Bogle (as quoted in Malkiel's A random walk down Wall Street):

In 30 years in this business, I do not know anybody who has done it successfully and consistently. Indeed, my impression is that trying to do market timing is likely, not only not to add value to your investment program, but to be counterproductive.

As a recent example, here's Larry Swedroe writing for CBS MoneyWatch. He warns against the impulse to pull out of the stock market during these uncertain times:

While it's difficult to stay in the market when risks are high, that's when expected returns are high. It's easy to stay in the market when risks seem low, but that means you buy when expected returns are low and sell when expected returns are high, which doesn't make sense.

The market is a poor advisor: don't let it make your allocation decisions for you. Determine an acceptable level of risk, allocate your investments accordingly, rebalance, and reap rewards in the long run.

Note: 

1. We used index funds VTI, VEA, and VBMFX as proxies for the domestic equity, foreign equity, and total bond markets.

Edit: We clarified the conclusion we're willing to draw from this data set.

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Josh Tokle is a member of the finance team at FutureAdvisor.

At Morningstar.com, Christine Benz asked message board users to rate their 401(k) plans. Fees and sector coverage are foremost on people's minds, with employer matching and other perks (like good user interface) further down the list. Here's the full article.

Over in Time.com's financial section, Stephen Gandel talks about new research from the Center for Retirement Research. As you would expect, a company that offers more in contributions to a 401(k) will pay lower salaries. The surprising part of the article is that the tradeoff between wage and 401(k) contributions is much more favorable for those making low incomes than for higher income earners. Mr. Gandel focuses on the negative impact: employer 401(k) contributions drive wages down and poorer Americans who can't afford to save see no benefit.

That's a valid point, but here's a more positive (if somewhat speculative) take on the research: if you make less than the 60th percentile income (around $57,000 per year) and you're taking full advantage of employer contributions to your 401(k), then your total compensation is higher than what it would be if you were being paid a salary only. That is, employer contributions increase total compensation (for those who can afford to save).

Stay tuned for a more detailed write-up of these findings.

It's the end of the year: last chance to take stock of your 2011 tax obligations. As an investor, you should make particular note of any realized capital gains. Maybe you sold out of a top-performing asset class to keep your portfolio in balance. Maybe you liquidated some of your holdings to finance a new project or a new expense. In any case, if you sold shares at a profit then the IRS will be asking for their cut.

The good news is that some of your investments may have lost value. While not generally the sort of thing people celebrate, a capital loss provides you the opportunity to defer taxes by a method referred to as tax loss harvesting. In short, losses from one asset sale can be used to cancel gains elsewhere.

Read the rest of this post by Josh Tokle in the FutureAdvisor Research Notebook.

Not yet a FutureAdvisor user? Find out if your workplace retirement plan is supported and request an invite at https://www.futureadvisor.com/signup.

Your questions, comments, and suggestions are always welcome at advisors@futureadvisor.com.

Today we're announcing that the FutureAdvisor algorithms now include better diversification through application of the well known Fama-French Three Factor Model. Use of this model allows us to fine tune your risk vs. reward tradeoff by including an appropriate amount of lean towards small cap and value equities in an effort to maximize long term returns.

Highlights from the FutureAdvisor Research Notebook:

Check out recent posts from Josh Tokle of our Finance Team that explain the Fama-French Model and our lean towards small cap and value equities for long term investing.

Fama, French, and beyond: greater diversification means lower risk for your expected return

You're young: seek out higher returns by investing in small cap and value stocks

A graph from the above post demonstrates how small cap and value equities have outperformed large cap and growth equities over the last 80 years.

Within our app you will see two visible changes:

First, we show the position of the equities in your recommended portfolio compared to your current portfolio on the familiar size vs. style matrix.

Not yet a FutureAdvisor user? Find out if your workplace retirement plan is supported and request an invite at https://www.futureadvisor.com/signup.

Your questions, comments, and suggestions are always welcome at advisors@futureadvisor.com.

At the core of the FutureAdvisor service are tools to help you optimize your portfolio-wide diversification, minimize fees, utilize tax advantaged accounts, and rebalance regularly. Equally important is saving enough in order to reach your retirement goal as quickly as possible. Here's a look at how we help you evaluate your savings to date:

See if you're ahead or behind for your retirement goal; we show how your current assets compare to the target for your age:

Find out how much you need to save per year to meet your retirement goal:

Get best, worst, and average performance projections for your retirement goal:

Work at Microsoft or Google? You're in luck as FutureAdvisor already supports your 401(k). Email us at advisors@futureadvisor.com as we'd love to send you a beta invite code.

Work somewhere else? Let us know at https://www.futureadvisor.com/signup and be among the first of your coworkers to experience FutureAdvisor.

The latest from Josh Tokle of the FutureAdvisor Finance Team:

"With active management you're placing a bet that your fund manager can beat the market after taxes and fees. Like all bets, the odds favor the house, in this case passively managed index funds."

Read the rest of this post on the FutureAdvisor Research Notebook.

At FutureAdvisor our passion is in bringing unbiased and academically-backed investing advice to individual investors via algorithms and a user friendly web interface.

While we've designed our web application to be as self-service as possible, we realize that folks occasionally have a question about a unique financial consideration or maybe just need a little additional clarification. To help in these situations we’re happy to announce our “Ask an Advisor” feature which can be found on the left sidebar once inside the application.

Questions are answered by one of our investment advisors in no more than one business day, although usually much sooner. This service is included with all FutureAdvisor subscriptions.

Do you have a suggestion for how FutureAdvisor can better help you optimize your portfolio? We’d love to hear from you at advisors@futureadvisor.com.

While FutureAdvisor recommends building long-term retirement portfolios with low-fee mutual funds and ETFs, we recognize that some of our users may want to hold individual stocks for a variety of reasons.

We are happy to announce that we now recognize stock holdings and fetch the most recent closing price for almost all stocks listed in major US exchanges. This includes not only stocks of companies domiciled in the US, but also American Depository Receipts of foreign stocks. For our users with stock holdings this update will improve the accuracy of our asset allocation analyses and the resulting rebalancing recommendations.

In the below screenshot, we have assigned Vodafone (UK), BP (UK), Nokia (Finland), and Toyota (Japan) to the Foreign Stock asset class, in addition to a holding of ETF shares of the Vanguard Tax-Managed International Fund, a fund we frequently recommend as a low-fee way to gain broadly diversified exposure to foreign stocks.

Do you have suggestions for how we can make FutureAdvisor more useful? We would love to hear from you. Just email us at advisors@futureadvisor.com.

One of the most frequently requested features over the last few months has been the ability to manually enter existing investments into the FutureAdvisor application, as an alternative to the direct connection option we currently offer at several dozen of the largest US financial institutions. As our current users may have already noticed, we quietly launched the first version of this feature several weeks ago. Today we are pleased to announce this feature publically, now that we have added the functionality to automatically fetch the last closing price for most mutual funds, ETFs and stocks in US markets.

As can be seen in the above screenshot, all we need to know is the symbol of the security and the number of shares you own. With that information, FutureAdvisor will fetch the full name of the security, its latest closing price[1], and calculate the current value of your holding. At that point we treat it just like a holding that came in via the direct connection method. In other words, we analyze each security and assign its constituent pieces to the proper asset classes before assessing whether or not your portfolio needs adjustments to ensure you on are track for your retirement savings goal.

Your questions, comments, and suggestions are always welcome at advisors@futureadvisor.com.

[1] Data provided by Lipper and Xignite.