One of the great things about being a professional investor is the opportunity one has to apply his or her long-term experience to the investment environment that is unfolding (or coming unglued) in the present. If nothing else, most successful investors develop a consistent strategy that allows them to take advantage of short-term changes and the opportunities that they create in a somewhat unemotional manner. You can always tell a “newbie” by a “let’s see how you do for a year” comment, or a “what’s hot” question.
Wall Street would like us to ignore the fact that the stock market is a cyclical beast that changes direction periodically, and almost never at the turn of a calendar quarter or year— cycles vary in length, breadth, and direction. Inevitably, less experienced investors get caught with their portfolio egos unprepared for market realities.
Similarly, Wall Street would like investors to look at income securities (bonds, CEFs, preferred stocks, etc.) with the same analytical eye that they use for equities. They too are expected to grow in market value forever, even though it’s the income that the investor is after. High total returns mean missed profit taking opportunities more often than they signal increased income.
So as much as the wizards would like us to believe (a) that up arrows are always good and down arrows always bad, and (b) that they can get you safely hedged (protected) against the bad stuff with all forms of creative portfolio care products; its just never going to work that way.
Cycles are a good thing. They cleanse the markets of both fear and greed residue, and (all appendages crossed please) this time, perhaps, they’ll point out that both multi-level derivatives and congressional tinkering don’t ever produce the intended results.
Unfortunately, investors in general are a lot like teenagers. They know everything immediately; expect instant gratification; take unnecessary risks; fall in love too easily; ignore all voices of experience; prefer the easy approach; and feel that the lessons of the past just can’t possibly apply to what’s going on now. Duh, dude!
That said, what can Joe the plumber do to protect his 401(k), IRA, or personal investment portfolio from the Bernies, Nancys, and Harrys that are waiting in ambush? How does he protect himself from unregulated scams, and Wall Street toxins now, and into the future?
Well, it requires a slightly more mature mindset than the new media allows most investors the patience to develop, and an appreciation of the miracle drugs that have saved the lives of comatose portfolios victimized by the correction viruses of the past.
What if: (1) In the 30’s, you had purchased shares in from 20 to 40 prominent, dividend paying, NYSE companies, or even in October ’87, or ’97. Now, if you had sold all those issues that gained 10%, and reinvested 70% of the profits keeping a diversified portfolio of similar stocks, hitting “replay” religiously, how much more market value would you have today?
What if: (2) At the same start date, 30% of your portfolio was placed in high quality income securities, and 30% of the income produced (and the remainder of that produced by equity profits) was reinvested similarly, how much more income would you have today than you do now?
If you combined the two analyses, how much more working capital would be in your wallet? You would be amazed at the results of this research; it would lead you to these portfolio life saving, and KISS-principle preserving, conclusions:
One: Every market up cycle produces profit-taking opportunities, and all reasonable profits should be realized— in spite of the taxes. Two: Every market down cycle produces buying opportunities, and buying activities of three kinds must be continued throughout the downturn.
Three: Compound income growth is a wonderful thing, so find investment vehicles that can be added to routinely and, if spend you must, always spend less than you make. Four: Unhappily, nearly all of your past decision-making has been back—wards.
Just as the process described above is significantly more difficult to implement with mutual funds and other products, so too is the three-pronged strategy for dealing with market opportunities.
Reinvest portfolio generated income in three ways, and leisurely according to your planned, working-capital-calculated, asset allocation. Good judgment and an awareness of overall industry conditions are always required:
One: Add new equity positions, in new industries if possible, and keep initial positions smaller than usual. Never buy a stock that does not meet all Working Capital Model (WCM) selection criteria, and never stray more than 5% from your overall portfolio asset allocation guidelines.
These acquisitions should be monitored closely for quick turnover, at net/net profits of from seven to ten percent, depending on the amount of smart cash (WCM again) in your portfolio.
Two: Add new income positions when yields are unusually or artificially high, and watch for quick profits in this area as well. When yields are normal or lower than normal, diversify into new areas. For better results, do more “ones” than “twos” if possible.
Three: Add to positions in stocks that have maintained their quality rating and dividend while falling 30% or more from your cost basis. If the addition doesn’t produce a significant change in cost per share, return to “one” or “two”.