Understanding Stocks

180 UNDERSTANDING STOCKS
itor the U.S. and international markets closely and make last-minute
decisions that could cost you a lot of money if you’re wrong.
How the Strategy Works
The strategy is simple: When the U.S. markets are up a lot (approximately
1 percent or more), you move your money from a mutual fund
money market account into an international fund. More often than not,
the foreign markets (primarily Europe and Asia) will follow the U.S.
markets. It is estimated that foreign markets follow the U.S. markets
about two-thirds of the time or more.
The strategy works because of the way mutual fund companies price
their funds. Instead of updating the net asset value (NAV) of a particular
fund the next day, mutual fund companies price their funds on the basis
of the previous day’s close, called “stale” pricing. The strategy works
because of the time difference between U.S. and foreign markets—what
some might call a loophole. The 6-hour difference between U.S. and
European markets allow you to arbitrage the funds (take advantage of
the inefficiencies in their prices). According to critic Jason Zweig of
Money magazine, “It’s like knowing tomorrow’s news today.”
The strategy is known by a variety of names, including time-zone
trading, market timing, and in-and-out trading. Gary Smith, author of
How I Trade for a Living (John Wiley & Sons, 1999), briefly wrote
about similar fund trading strategies. However, very few people are
aware that the strategy works most efficiently in a 401(k) or 403(b).
Although mutual fund companies have been aggressive about stopping
people from trading mutual funds in taxable accounts, many have
allowed 401(k) and 403(b) plan participants to continue to use this
strategy. To my knowledge, no one has ever revealed this secret.
The Rules
1. You begin with a company-sponsored 401(k) or 403(b) taxdeferred
savings plan. The beauty of using the strategy in such a
plan is that your gains are tax-free. (Although this strategy also
works using a regular taxable account, most mutual fund companies
penalize you for using market-timing tactics.)