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Saturday, 16 February 2008
Managing A Portfolio in a Rational Fashion

As cross-posted on Trading Goddess

There has been a lot of discussion on this website about how to handle your investments in a difficult trading environment.

Should we identify stocks that are of good value, and then buy more when they decline making their value even more compelling? Should we chase price momentum, buying the hottest solar stock or Chinese 'stock du jour'? Should we set our horizons 10 to 15 years ahead and then 'batten the hatches' as the perfect storm sweeps over us? Or should we just try to time the market and bail when it appears the sky is falling?

As I write about frequently on my blog and occasionally on this website, I believe that we should probably think about our planned strategy for our portfolios before we ever buy any stocks or other investments.

I know that I have spent an awful lot of time thinking about my own responses to the market and what I should be doing in response to the widest range of events.

We can probably all agree that the long-term prospects of the stock market are excellent. We have all heard the statistics of the return for equities being somewhere between 6.5% and 11% long-term. And we all know what missing the 'best days' of the year does to the market timer. So how does the amateur individual investor respond to and plan to manage his or her investments long term?

I try to be able to maintain my investments long-term. And yet, I also want to be prepared for the outlier events. We all need to be capable of dealing with the compelling bull markets as well as the devastating bear disasters a la 1929.

It isn't adequate to say 'I am a long-term investor' and I don't need to pay attention to the impending financial turbulence.

But how do we deal with this? How do we respond to as well as anticipate market action? How do we preserve our capital during market corrections while being able to maximize our exposure to equities during market bull runs?

After many years of investing (I actually purchased my first stock as a 13 year old back in 1967), I have come to believe that a strategy is possible to accomplish this if you are willing to be disciplined and observant of your own stocks and of the market overall.

First of all, try to identify a universe of stocks that you believe are 'investable'. I have my own criteria of consistent revenue growth, earnings growth, free cash flow, stable shares, and a solid balance sheet. But my criteria may not be yours. You might develop a list of stocks that exhibit good value, that exercise responsible stewardship of the earth, or whatever your particular preference might be. It doesn't really matter. But stay consistent.

Next of all, decide what the size of portfolio would be ideal for you. I initially settled on 25 different stocks. Currently I have switched to a 20 position portfolio as a maximum number of stocks I wish to own. It doesn't matter what the size will be. But pick your maximum and stick to it.

Now bear with me as I go through this strategy. It makes sense to me and I think you will understand my thinking as we review this.

Let us assume that our investment posture will vary with our 'exposure' to stocks. That being fully invested is ideal in a strong market (20 positions). And being minimally invested is best in a weak investment environment (5 positions). And I vary my investment exposure based on the market's effects on my own holdings. That is when my own portfolio is acting 'healthy' I am moving from cash towards equities and when my own portfolio is acting 'ill' I shift from equities towards cash.

I do not guess anything. I simply 'listen' to my own holdings.

O.K. you are getting skeptical. Stocks don't 'talk' you are telling me. I have to smile. Of course they don't talk. But their actions speak volumes if you are prepared to observe the behavior of your own stocks.

How do I do that? I can almost hear you guys chuckling over your coffee today.

Here is the strategy. Sell your declining stocks aggressively to preserve your equity and sell your gaining stocks slowly and partially as they appreciate. After each sale at a gain, move up your stop under the advancing stock to work to preserve your gains. And use these sales, either on the upside or downside, as signals to tell you to move into or out of equities.

By this way, you are listening and hearing what your own stocks are telling you about the market.

At the extremes I ignore these signals. When I am at my minimum of 5 positions, I don't 'sit on my hands' on a sale of stock as I do otherwise, but instead look for a new position to keep me at at least 5 stocks. At 20 positions, after a sale at a gain, instead of looking for a new stock to buy, I plan on keeping the proceeds in the account and build cash.

There is no doubt that there are better methods of managing your portfolio.

But doesn't it just make sense to you? Regardless of how you decide to pick the stocks within your portfolio, managing them in some logical method seems to make intuitive sense.

It does to me.

Bob


Posted by bobsadviceforstocks at 8:03 AM CST | Post Comment | View Comments (3) | Permalink

Monday, 18 February 2008 - 1:37 PM CST

Name: "Tony Tovar"
Home Page: http://www.moolahblog.com

Bob, I completely agree with you. I know what you speak of because I have had the chance to buy a few stocks that I chose using my own criteria. I usually stick with the bunch that I have selected and in the sector that I am most comfortable with. Over time You start to see them "speaking" to you, by its ticks, rises and falls; After some time, I feel you can gage, even without news involved, who healthy or il particular stocks are doing within your own scope, in part due to your history of holding them and keeping an eye on them.

 

Tony Tovar 

Wednesday, 27 February 2008 - 6:24 PM CST

Name: "David"

Let me know if there is any stock going like vivo.

Wednesday, 27 February 2008 - 8:02 PM CST

Name: bobsadviceforstocks
Home Page: http://bobsadviceforstocks.tripod.com

Gang,

Thanks for the comments.  I never know when I will find another VIVO.  But many of the stocks I review have the same characteristics and I hope that some of them will perfomr the same way.

Good luck and I appreciate that you took the time to write.

Bob 

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