Risk Management Investing
When it comes to investing in the stock market, you have to be humble. Nobody is bigger than the market. You can never predict a top and never predict a bottom. Nobody’s that good. If you’ve done your research and found the stock that you predict will give you a 20% return, there are still certain rules you need to stick to, in order to manage your portfolio correctly. The following are five rules that I abide by. If you apply these strategies, your margin of safety and return on your money will be that much greater.
Rule #1: Invest in Market Leaders
If at all possible, try to invest in best of breed companies. Figure out who has the biggest market share in the sector, or compare each companies financials and you will know who’s the better company. In the long run, market leaders outperform the sector and command a higher P/E premium.
Rule #2: Buy in Wide Scale Stages
Never buy all at once. Like I said before, nobody is that good in predicating a top or a bottom. You need to buy in stages. With discount brokerages like TD Ameritrade and Etrade, commissions have come down so low, it shouldn’t be a costly issue.
Example: ABC stock at $20 and you plan to buy 100 shares.
Buy 25 shares at $20 and hope it goes down some more. Wait for it to go down 10-20%. Don't keep buying every time it drops 1%. Buy in wide scales and only add to your position if you believe it’s still undervalued (future prospects still look bright). Buy at $17, $14.50, and $12. Arrogance is a sin and if were to buy $20 all at once and the stock is at $12, that’s a 66% loss. By staging your buys in wide scales, you lower that % loss.
If the stock goes higher, please don’t chase. It only lowers your return and the stock might come right back down. Keep your money in cash and wait for a pullback and if it doesn’t, look for other stocks to invest elsewhere.
The stock market is like baseball. Each ball coming over the plate is the price of a stock. You don’t have to swing at every pitch that goes over the plate. Just swing at good pitches that are in the strike zone (bargain prices of good companies) and go for singles rather than home runs (buying in wide scale stages). You’ll strike out less and have a better batting average. That’s the disciplined investor.
Rule #3: Diversify or Die
You’ve probably heard the old adage “Don’t put all your eggs in one basket”. This is true when it comes to investing. Whether you have $100,000 to invest or $2000 to invest, diversification is important to protect yourself from downside risk.
Example
All in one basket portfolio
| Stock | Bought | Shares | Sold | Return |
| ABC | $20 | 100 | $18 | -10% |
Diversified portfolio
| Stock | Bought | Shares | Sold | Return |
| ABC | $20 | 25 | $18 | +50% |
| DEF | $20 | 25 | $25 | +25% |
| HIJ | $20 | 25 | $40 | +100% |
| KLO | $20 | 25 | $30 | -10% |
| | | | | |
| Total | | 100 | | 41.25% |
The “all in one basket” portfolio example is much like gambling. It’s either lose big or win big. If the stock is down, you’re stuck in the mud waiting for it to go up. By diversifying, it allows you to stay in the game and trade the ones that are up. You can still get a stellar return with a diversified portfolio and lower the volatility. I advocate no more than 10% of your portfolio in one stock.
If you don’t have a lot of money to begin with, don’t be ashamed to buy 10 shares or even 1 share of a company. So long as you calculated a good return on investment factoring in commissions, 10 different stocks getting 20% is the same as 2 stocks getting 20% return. But you have reduced your risk.
Diversification also entails diversifying in different sectors. Usually if one sector is out of favor, another will pick up. That’s called “sector rotation”. If you were to buy all retail stocks for example, and the sector is in a slump, you’re stuck waiting for a rebound while others are handsomely profiting because their sector is moving up. Stocks tend to move in groups and if you get the sector right, normally you get the stock right too. This is why you need to invest in different industries to keep you in the game.
Rule #4: Buy, Sell a little, and Hold strategy
A big question always is when to sell. As a rule of thumb, if your stock goes up 15-20%, it’s time to ring the register and sell a little and let the rest of your position in the stock ride. You haven’t really made a profit until you sell. If it were to go back down, you missed that potential profit. But if you sold some, and it were to go down, you can buy back what you’ve sold. That’s called “trading around your core position.”
By not selling all of your position prevents you from kicking yourself if the stock doubles or triples in value. So I am not advocating a “Buy and Hold” strategy, but a more prudent approach of “Buy, Sell a little, and Hold strategy.”
Rule #5: Sell on strength, Buy on weakness
“Be fearful when others are greedy, and be greedy when others are fearful” – Warren Buffet
Most traders like to buy in a bull market (market rallying higher) and sell in a bear market (market correction). But as a contrarian value investor, I do the exact opposite. However, it’s easier said then done because it takes a lot of discipline. Nobody wants to miss a huge run up and greed sets in. But believe me, when the market keeps going up, you need to build your cash reserves because at any time, the market can change in a heartbeat. When the market is up and rallying in a bull market, sell a little into the strength. When the market is irrational and feels invisible in a bull market, cash is king!
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posted by RetireRichBlog at 6:41 PM
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Value Stock Investing - The November Syndrome On Drugs
Every fall, especially in opportunity rich markets like this, I encourage investors to think about some year-end strategies that make the final calendar quarter a special time in all markets. Several forces are at work, all of which have links to conventional Wall Street wisdom; none of which promote good long-term investment decision-making.
This year, we have the added excitement of anticipating a new, perhaps economically too liberal, administration taking over with an already implanted, and demonstatably inept, congress. The markets are in a truly unprecedented state of "uncertainty overload". What's an investor to do--- or not to do?
Typically, the November syndrome has features that impact in both directions. It causes weak prices to fall even further and strong prices to climb higher. This year, the strong category requires a microscope for candidate viewing, while the weak seem to have inherited the listings. Money Market funds and Treasury securities are the low yielding, lower-risk, depositories of choice.
At the individual investor level, the mad dash to lose money on equity securities has begun. The idea that this is somehow a good thing is an anomaly created by a counter productive tax code and an industry that has a vested interest in perpetuating the absurdities it (the IRC) creates.
Assuming that we are dealing with investment grade securities, lower prices should most logically be seen as an opportunity to add to positions cheaply--- not as an opportunity to reduce one's tax liability on investment earnings. There is, and never will be, a good loss or a bad ---.
Naturally, both you and your CPA feel better with lower tax bills, but why sell a perfectly good security at a loss to produce pennies on the dollar in tax relief? Speculations, sure, valueless securities, why not? But when nearly all IGVSI stocks are at their lowest levels in decades, selling for losses should be the last thing on your mind.
Most IGVS companies remain profitable. Less profitable, for sure, but few have cut dividends and nearly all will survive and prosper when the economy recovers. Would your CPA accept just half his fee to save on his own taxes? Would you barge into your boss' office and demand a pay cut?
In the old days, when markets moved slowly and buy-and-hold was the investment strategy of choice, the 30-day, buy-it-back, tactic was an effective way of having your tax break cake and maintaining your portfolio as well. But with 1,000-point weekly swings, there are no guarantees that the markets will tread water for your personal tax convenience.
In fact, more often than not, major corrections such as this one produce either a Santa Clause rally or "January Affect" that is far more profitable for November-low buyers than for tax-motivated sellers.
Similarly, "letting your profits run" to push the dreaded taxes into next year is foolishness. Talk to the geniuses that didn't take profits in 1999, or in the '87 or '07 summers. The objective of the equity investing exercise is to take profits--- the more quickly and more frequently, the better. This year's volatility has produced hundreds of profit taking opportunities.
Another popular year-end shell game is the "bond swap", which preys on the fear most income investors experience when their somewhat guaranteed, income securities, fall in market value. This is the same absurdity that allowed "mark-to-market" accounting rules to crack the foundations of financial institutions around the world.
A contract (from a quality borrower) to pay a fixed rate of interest, and full principal at maturity will vary in price throughout its existence. It's nothing to be particularly anxious about. Junk bonds are for speculators, not for those of us with gray-templed children.
Bond swaps allow an advisor to pick your pocket by exchanging them at a "nice tax loss" for another bond with "about the same yield". He gets a double dip (invisible) commission and you get a bond of longer duration or lower quality.
On the same page, the idea of exchanging a steady, much-higher-than-normal-yield, closed-end-fund (CEF) cash flow for an overpriced T-Bill yielding less than 1% is above Emperor's New Clothes absurdity levels.
But there are even more year-end games going on to take advantage of your confusion. Wall Street gangs up on you with a self-serving strategy blithely referred to by the media as "Institutional Year End Window Dressing"--- a euphemism for consumer fraud.
In this annual ritual, mutual fund and other institutional money managers unload stocks (and CEFs) that have been weak and (usually) load up on those that are at their highest prices of the year. This year, they'll be holding cash and Treasuries.
Always keep in mind that (a) Wall Street has no respect for your intelligence and (b) the media "talking heads" are entertainers, not investors. Institutions must paint a picture of brilliance in their annual glossies. This year, a panic-stricken Main Street is helping them with their annual "sell low" hypocrisy.
It would be an understatement to say that these year-end tax and face saving activities are misguided and unnecessary. But this year's "November Syndrome" is an unprecedented investment opportunity that most people are too confused to appreciate.
Simply put, get out there and buy the (high quality) November lows, both equity and fixed income. Establish new positions for diversity, and add to old ones without surpassing "working capital model" diversification limits. Keep appendages crossed for a therapeutic dose of "January Affect" elixir, as you reaffirm your understanding of long-term investment strategy.
The media will talk about this New Year phenomenon with wide-eyed amazement. Most of those terrible losers (you just sold?) begin to rise from the ashes, as the professional window dressers repurchase the solid companies they just sold for losses--- interesting place Wall Street.
One last thought; if you have taxable profits that you can't bear the thought of holding on to, just send the profit portion to me. I'll pay the terrible taxes.
Steve Selengut
http://www.sancoservices.com/
http://www.kiawahgolfinvestmentseminars.com
Professional Investment Management from 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"
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