Saturday, September 10, 2011

Loose Ends

Rob Carrick, personal finance columnist at the Globe and Mail interviewed David Chilton, author of the Wealthy Barber and recently of "The Wealthy Barber Returns". Rob states that for him, the Wealthy Barber is one of the most influential personal finance books in Canada. I tend to agree and just spend some hard earned money on the Return. If you want to learn more about this author, visit the Globe and Mail website:

Emotion driven investment transactions typically result in underperformance. And… it is so easy to do. I see it in myself. I know that in today's choppy scary market stocks are cheap and that this is the time to use your cash. Yet, I tend to buy on up days; the down days are too scary. I should do the opposite but in spite of all my investment experience, I still tend to run somewhat with the stampeding herds. At least, I refrain from selling. Again, don't sell in these depressed markets; once things pick up and your portfolio is recovering you're likely to make a less emotional 'sell' decision.

What to sell?

That is not easy. Once markets have fallen, risk of falling further is typically less. Risk of a falling market is highest at the peak, when most investors are euphorically buying. Over the long term, real estate and stock markets provide the best investment returns. Certainly when compared to 'safe' investments such as GICs and money market funds. So, especially during down turns and recoveries, the last thing you'd want to sell is a stock portfolio which is likely to provide you superior returns during the rest of the business cycle.

The best way to look at your portfolio is not by looking back and mourning how much you lost! That is useless and often damaging to your portfolio performance. Instead you look at how to get the best return on your current portfolio! The first thing you do is looking at your asset allocation. Recent winners or market out-performers tend to form an increasingly larger portion of your portfolio, while the proportion of losers declines. What proportions or 'weightings' you assign to your investments depends on your personal investment strategy, personality and situation in life. Typically, a stock should not make up more than 5% of your portfolio. Thus, if you own more than a 5% weighting of a particular stock in your portfolio then it is time to sell some of it and use it to buy something else – start by considering adding to the underweighted positions already in your portfolio.

Every time that you review your portfolio, ask yourself whether your current stock holdings give you the best performance. For example, Yellow Media may have fallen from $2.40 to $0.70. Don't look at the past losses! Instead ask yourself: if you sell Yellow Media today would you be able to invest that money in a more promising investment? What will give you the best potential rate of return at an acceptable risk level? If your evaluation shows that you can make a better return elsewhere, then sell Yellow Media and buy the other investment opportunity. Otherwise, hang on. Make sure that your decision is not based on stubborn emotion but that it is based strictly on the numbers. Leave emotion out of it!

In my last post, I suggested another emotion free strategy for investing. Buy a fixed dollar amount of investments, typically an index ETF, every month and once per year make with the rest of your cash savings a 'one-time' investment. This may be sounding contradictory to my earlier advice of buying an investment in steps (How to take advantage of the U.S. debt circus - II ). This doesn't have to be. Your one-time-annual investment does not have to be one 'single' transaction. You can buy in steps, and I would advise you to do so especially when you're dealing with larger amounts. As in said posting, you may decide to buy $5000 worth of DIA Spiders and buy them in smaller portions at different, preselected time points.

The same would be true for any buying in a down market. Nobody times the market perfectly, and certainly not market bottoms. So do not burn all your powder in one single purchase. Buy at regular intervals along a market bottom. For example, in the post: Bull and Bear Market Analysis we learned that the time from bottom to peak averages 2.3 years. I estimate that the bottoming process of a downturn lasts typically 1 year. Now decide to start buying from the time you reached the average decline of a bear market (24%) or from the point that you reach bear market territory (after a20% market decline) and plan over the next year to spend your available investment cash once per month, or once every two months, i.e. invest amounts of 8% or 16% of your cash respectively. That should keep the emotions away.

Corrections last shorter. Summer corrections are not uncommon and last typically one to 3 months, followed by a recovery starting in late September until January of the next year. So decide to buy your 'once-a-year' investments in three equal tranches in early October, early November and early December.

I hope these tidbits help you to tie together the loose ends of my summer postings.


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