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Give Me the Investors Edge!!

           “WHAT MAKES AN INVESTOR SUCCESSFUL?”

 

   December 1998     

 

                      Know thyself.

 

                      As Socrates noted, "The unexamined life is not worth living." Sun-Tzu wrote, almost as succinctly, "Know yourself and know your enemy and win 100 battles."

 

           I'd like to invite you to join me on a journey in which you can win 100 battles.    The research I've done over the past few years leads me to the inescapable conclusion that timing and asset allocation decisions are even more important than stock selection.

      Too many investors don't know themselves. As a result, lots of people who don't know livestock from lively stocks or convertible cars from

convertible bonds make good money in a bull market. But a la the Noble Fir Tree graphic I put in Investor's Edge a while back, they gain in a good market and give back in a bad market. Over a particular time span they may be up 100%, down 40%, up 80%, down 41%, up 120%, down 50%. Do this just three times in one life and you'd think you'd be pretty far ahead, right? Wrong. If this typical investor starts with a $50,000 inheritance and gains 100%, they have $100,000. Down 40% leaves them with $60,000. Up 80% takes them back to $108,000. Down 41% leaves them with $63,720. Up 120% means they now have $140,184. But down 50% leaves a net of just $70,092. Say it takes 20 years for these 3 full market cycles to take place. That means our typical investor just took 20 years to make $20,000 on a $50,000 stake -- considerably worse than they could have done, with no risk, no time invested and no stress in a bank savings account, a CD or a money market fund.  I'm convinced that there must be 3 components to any successful investing strategy:

           *  A timing component. This can be as occasional as "when the various assets reach this percentage imbalance, I'll re-allocate and re-balance", whether that occurs in a month or a year. Or it can be as aggressive as "every single month I'll faithfully re-allocate". The point of introducing a timing component into your investing is that it forces you to review your portfolio with some regularity.  Most importantly, it forces you to buy low, even if your mind and the media tells you this is not the time to buy; and it forces you to sell high, even if your mind and the financial press tell you this is not the time to sell.

      * An asset allocation component. This is the part of your strategy which forces you to give greater weight to one or another asset category. No timing system is perfect by itself. No stock selection strategy can be 100% perfect all the time. Your asset allocation component keeps you from going overboard in any one direction for any length of time. This keeps you from hitting home runs, but also keeps you from striking out. You just keep advancing runners around the bases and winning "the battle for investment survival".

           Others will brag of their occasional home run, but that's because their days of glory are few and far between. They'll strike out 3 out of 4 at-bats.

      *  A stock selection component. For years, this has been my forte. But if we select our timing and asset allocation components wisely, stock selection becomes less critical. Of course, even if you're in the market at the right time (about 3/8 of market success) and you're in the best asset classes to be in at the time (another 3/8 to 1/2 of the battle), it's still nice to add that extra 1/8 or 1/4 as icing on the cake.  But there's still more. The strategies you select must also take into account these 4 factors:

      * Your age. The usual patter you'll receive from financial types is, "The younger you are, the more risk you should assume." I say, "Not necessarily." What I will tell you is that the younger you are, the more you can allocate to the long term. Why? Because you have a lot more "long term" left than the rest of us. When you're older, you can't simply "sit tight" during every market "correction" as the Pious and Platitudinous Planners intone that you must. That advice is a crock for older folks. When you're 65, you might need to tap your capital for medical bills and other emergencies no longer covered by a salary. Long term might be next week. It is no comfort to you, as you watch your nest egg dwindle by half, that "stocks always come back in the long run". As John Maynard Keynes noted, "In the long run we are all dead."     

           * Your income. This one is pretty bloody obvious. Pious advice regarding how you "must" save 10% (or 20% or whatever) of your salary makes sense if you make $50,000 a year. But the same advice is dumb for someone making $20,000, who cannot part with the same percentage - or for someone making $250,000, who doesn't need but half of that to live on. Your income will determine, as well, how much risk you can reasonably assume. If you have little, the temptation is to bet it all on one spin of the roulette wheel - but that way lies catastrophe. In fact, the less you have, the more carefully you must grow it.    

           * The time you have to devote to investing. I refer here to the amount of time you choose to devote to investing. Which strategies you select will be hugely influenced by this factor.
           * Your temperament. You can't control your age. In many cases you have only limited control over your income. And while you might be master of how much time you devote to investing, it's darn tough to change your temperament. I suggest you come to grips with the approaches with which you are most comfortable in your investing. If you find that buying Internet stocks makes your pulse race as they go up but makes you nauseous as they decline, that too much action keeps you awake worrying at night, then here's a thought: don't buy them!

           As I've maintained throughout the past few years of publishing Investor's Edge, there is (considerably!) more than one way to skin a cat. If one approach bores you or terrifies you or puts you to sleep or keeps you awake, don't take that approach! I promise to give you plenty to choose from.     

           I will provide you the approaches -- and the stock ideas to hang upon the framework each approach suggests. Not one investor in 50 thinks through timing, asset allocation and stock selection in relation to his or her own age, income, time and temperament. Are you that 1 in 50? If so, on the pages that follow is the game plan...     < >

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