My investing strategy part 1

I wanted to start this blog to remind myself of my original goals and as a quick way to track my progress. As I’ve mentioned before, I studied finance and spend a good amount of time tracking the markets and doing security analysis. It’s a hobby of mine and something that I like to share with others and this seems like the perfect avenue to foster discussion regarding my ideas and strategies. I think investing is one of those interesting realms of study where divergent opinions exist and are often given equal weight depending on what you happen to believe.

It is hard to make sense of that sometimes because you’ll look at the financials of a stock or even the market as a whole and think it is quite attractively priced. You’ll do some additional research and find a dozen financial analysts saying the same thing but also a dozen other guys saying the direct opposite. It’s odd and concerning when you see something like that considering this is your money and your future that we’re talking about here. I guess what I’m trying to see here is that the valuation of a specific company or even the market as a whole is relatively subjective and not always guided known information. There is an element of randomness that makes objective analysis of a stock quite difficult. This randomness can be anything from current events affecting the value of companies, or information that is not known by anyone including you at the time of your analysis. Take a look at a company like Valeant which recently has dropped nearly 70% in the last three months after some information that questioned the validity of Valeant’s accounting came out. This is a stock that was a hedge fund darling and even they didn’t see that coming simply because the information they looked at when they did their due diligence didn’t tell the whole story. The stock ran up from the low 140s to a peak of 262 before falling off a cliff into the low 100s after that information was revealed. Despite the backing of Bill Ackman, a prominent hedge fund manager and activist, the stock has continued to drop into the 70s

Now were there people that made a lot of money off of VRX(stock ticker for Valeant)? Yes, I’m sure there were – there are people who bought well below the $260 high and sold off somewhere around there but are those people just amazing traders or were they just lucky to get out before the dagger fell? Just like there were people who likely saw the meteoric rise from the 140s into the 200s and bought somewhere around the high and then were left stranded as the stock saw a free fall into the 70s.

Now it’s true that the stock may be priced attractively now if we look back at this five years from now and those who bought near the highs may get their money back but it’s also possible that the stock will continue falling. If you read the news today, you’ll see stories about how some hedge funds are seeing this as an opportunity and buying more while others are selling even though it might mean a paper loss for them. Two conflicting strategies from companies that manage more money than I will likely see in my lifetime. What’s the deal? I’ve done some research on Valeant myself and I can’t see any reason to get into it with what we know right now – the information provided by the company didn’t really answer all the questions and their business model doesn’t appeal to me anyway as they’re a predatory RX firm that buys up drugs and often spikes prices – a business model that may see additional scrutiny from our government in the future. That doesn’t seem like a recipe for success to me but some hedge fund managers disagree and are eager to pour more money into it. They must think that the sinking ship has enough people bailing buckets of water out of it and that now is the prime time to buy. Maybe they’re right, maybe they’re not but it seems to me like there’s no clear answer here so I’m staying out of it all together.

On top of that, Valeant shows the fickleness of the marketplace and the emotional response that the market can generate when a stock moves one way or the other. If you watched or read anything about the stock market in the past few weeks, you’ve probably heard about Valeant. Some people saw this 70% crash as a fantastic buying opportunity while others spoke about how the company was doomed and headed to 0 because of accounting fraud; think Enron 2.0 if you will. Now I can’t speak for other individual investors but I know that if I bought in at $250 and saw my investment shrink down $100 in a matter of weeks, I’d be pretty worried. If I continued to see it shrink day by day into the 70s, I’d likely consider getting out because $70 is still better than $50 and even better than $0 if it goes that way. Such big losses are difficult to stomach when they come in such a short term and human emotion often triumphs over reason when we’re dealing with such wide swings. It’s quite likely that if I saw my investment plummet by half, I’d want to get out fearing additional loses. Now what if VRX rises again in the future to a high of $350? I’d have missed out all that gain and feel like a fool but what if it plummets all the way down to $20, I’d have made the smart decision to sell. What would you do in this situation?

There is a reason that most individual investors under perform the S&P 500 when you look at long term returns and I believe a good part of that reason is situations like these. Most people, myself included, simply don’t have the emotional fortitude to stomach short term fluctuations in individual securities and will often made poor decisions during periods of growth and recession respectively. If stocks are falling, they’re often selling because they don’t want to lose money and if they’re rising then they’re often buying because they don’t want to miss out on the gains. This seems like a good idea on paper but if you’re selling when stocks are falling, you’re selling well below the market top because it takes some time for an actual trend to be established. The same applies the other way around, if you’re buying when the market is rising, you’re often buying well above the market bottom. That’s why according to a 2014 study by Dalbar, a financial research firm in Boston, individual investors have under-performed the S&P 500 by 7.4% annually. That’s a 3.7% return for the average investor versus in the past 30 years versus an 11.1% return if you just put your money in the S&P 500 30 years ago. Now this study is not a 100% perfect comparison as the investor return doesn’t assume a straight line 30 year investment period but accounts for investments and withdrawals during that period but it does show a trend that presents itself in other studies. As I talked about in my last post, most investment professionals don’t even beat the market with up to 85% of people who do this for a living failing to beat their benchmark.

And that my friends sums up my main strategy when it comes to investing.

Time in the market beats timing the market. You can read more about what that means in my last post but this is something I truly believe and something that makes up the backbone of my investing strategy when it comes to stocks.

In simple terms for those who want an easier approach to investing, it means putting your money in the market now and not just into any individual stock but a low cost fund that tracks the whole stock market and you’re most likely to do better than 90% of the people out there. There’s a bit more to it than that including using any tax advantaged accounts you have access to and developing an asset allocation between stocks, bonds and other investments that suit your risk profile and retirement timeline but we can talk about that in future posts.

For others who find it fun to dabble in the world of investing research and are willing to take on a bit more risk, there’s more aggressive asset allocations, individual stock investing and tilting towards riskier small or mid-cap stocks over the large-cap centric total market portfolio.

I fall into that second category and my next post will lay out my long-term investment plan and what strategies I utilize to maximize my returns while limiting my risk as much as possible. Hopefully, I’ll have that up in a day or two and can do my first portfolio analysis this weekend.

Like I said in my first post, I’ve gotten lazy recently and it’s not only when it comes to how much I’ve been saving but how well I’ve tracked my portfolio. It’s been a while since I’ve taken a deep dive into my portfolio and I’m excited to see if I’m still within my asset allocation parameters or if I need to change anything up.

Talk to you all soon.

Please check out the next post in the series right here!