Saturday, February 19, 2011

“Sell Everything Right Now!” is NOT in my investment vocabulary

Portfolio management is not about emotional sells and buys. That may be fine for the casino, lotto players and day traders but it does not belong in the tool kid of an investor. Portfolio management is like gardening, weeding out the bad and keeping the good. Sometimes a plant can go bad and so do individual investments.

If you have followed the postings on this blog, you have by now set your investment goals, you have learned how to set up your portfolio's asset allocation, and you know how to invest for the long term. The longer you hold your stock portfolio and individual stocks the less likely it is that you lose money. The longer you hold a diversified stock portfolio and re-invest the dividends the more likely it is that you will achieve the long term overall stock market returns as described by authors such as Jeremy Siegel. You may also notice that I am a proponent of buying instantaneous diversification by using stock market index based ETF's. For Canadian Investors I highly recommend the iShares S&P/TSX ETF (symbol XIU), but there are several other similar products available in the market.

You may by now also realize that diversification does not only restrict us to investing in stocks and bonds. It also involves other investment classes, in particular, owning real estate. In future postings I may become more specific on what types of real estate investments may help your pocket book most. I have made by now enough mistakes to know so.

Also discussed is the need to open your eyes to the 'breaks' in life: company savings plans, employee stock options, owning a business (not a holding company) and owning your own real estate business. I can think of numerous other 'breaks' and they happen to each to us. It is just a matter of recognizing your breaks and taking advantage of them. We all show often admirable strength when confronted with life's adversities but recognizing and taking advantage of opportunities (breaks) seems more difficult. Oh, and remember, I am not talking about inheritances or lottery wins which often seem to bring out the worst in us.

Diversification is often frustrating, because when one investment class is doing well, the other seems to be going no-where. Right now it is not a lot of fun to own Calgary or Edmonton rental properties with vacancies and falling rents. But during the crash of 2008-2009 it protected my portfolio nicely, not to speak about 2004 – 2007 when the real estate portfolio value exploded. Seems right now it is the turn of stocks. BTW I just 'lost' money on call options because the value of one call option shot up dramatically along with the stock market. I had the choice of buying the options back at a significant loss but regain the opportunity to un-cap my upside on the underlying stock investment or… to sell the underlying stock at a tiny profit and be happy with the sales proceeds of the options. I was not really willing to let the shares (Bank of Montreal) go, so I bought back the call options. I digress…

It takes a long time to build a well-diversified portfolio, just like creating a beautiful garden. So portfolio management is more about 'tweaking' your portfolio rather than 'Sell everything right now – the world is about to end'. We prefer to buy more good company stock during downturns and take some profits during the subsequent bull market. We are now in the second leg of a pretty strong bull market which started (hind-sight is 20/20) in February 2009. Earlier I predicted based on past bear-bull market performance that the TSX would likely become ripe for the next crash 3 to 5 years later (2012-2014) when it reaches 18,000. Don't sell your entire portfolio when it does reach this level which is only 22% above today's index number. The 18,000 is just intended as a danger signal, indicating that valuations are likely too rich and that the stock market's chance to crash is quite high.

Many investors feel confident in bull markets and morose in bear markets. You should realize that the successful investor has the opposite view. Near the heights of a stock market risks are high as well, while near the nadir (bottom) of a bear market the risk that stocks will lose even more value is small.

Don Campbell of the Real Estate Investor Network came up with the 'Five traffic light analogy' (posted November 6, 2010). Right now, I estimate that the fourth light has turned green. So we should enjoy the ride for now. But rather than looking for the 'green sprouts' in the waste land of economic debacle, we should be more cautious – keep our feet on the ground – and start looking for danger signals. Once the last light jumps to green and nearly everyone is euphoric we should take profits and build up our cash position to get ready to buy again in the next down turn. Because from then on, lights can only turn red again!

Up to now, I quoted often from Jeremy Siegel's book: "The future for Investors". I promoted the Index ETFs as a way to start an instantaneous diversified stock portfolio. Now it is time to turn to more specific stock selection techniques. You will hear me quote from David Dreman: "Contrarian Investment Strategies: The Next Generation", published in 1998 by Simon & Schuster. You will also read more about the techniques of the Canadian Shareowner Association and its valuable "Stock Study Guide and Data".

If time permits, I will edit the previous posts and convert it into an e-book. This is my intend, but I may be restricted by the realities' of available time.

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