The Rule of Five and The 5 Basic Steps of Portfolio Management

When do you sell and replace a stock?

(1)  Stocks with long term serious quality issues.  Sell Urgently.

Short term quality issues like slowing sales, pre-tax profit, or EPS growth rates or declining pre-tax profit margins should be investigated.
Stocks with long term serious quality issues should be sold outright and replaced.

Holding a stock with a serious quality problem will prevent you from being in a quality stock whose fundamentals and price are advancing thus costing you that stock's price appreciation.


(2)  Stocks that become too overvalued. 

When the stock becomes so overvalued that there is little five year price appreciation left you may wish to replace it with a stock of equal or greater value and greater potential return.

In essence this is similar to the reason you need to sell stocks with fundamental flaws in the previous quality sections.

There you missed price appreciation because the stock had failed to meet you expectations. You lost money because you were in a stock with little price appreciation when you could have been in another stock with good quality and price appreciation.

Here the price has gotten way ahead of the fundamentals and it will take time for the fundamentals to catch up. You could replace this stock, capture the excess profits, and invest in another stock of equal or greater value whose price is in line with or behind its fundamentals. You'd have lost money because you were in a stock whose price was too high and going nowhere when you could have locked in the excess profit and moved to another stock with price appreciation potential.



Portfolio Management - The 5 Basic Steps
Perhaps the best way to approach this would be to develop an outline for Portfolio Management. Anyone want to propose something?

Portfolio Design - Write out your philosopy, methods, & growth and diversification goals.

Planting - Researching, comparing, and purchasing stocks.

Weeding - Defense - Monitor the quality (growth + efficiency)

Feeding### - Adding to positions of stock with continued good quality whose anticipated return will add to the portfolio's desired rate of return.

Pruning - Offense - Monitor for grossly overvalued stocks that could be replaced with stock of equal or higher value and better return potential.

          

http://biwiki.editme.com/PM0


### Remember to continue feeding your portfolio

Uncle Chua's Buy and Hold Portfolio Performance Update

I have written about Uncle Chua's story and how he accumulated a great deal of wealth through his stock investment in Singapore.  The portfolio of stocks that he left in his will was mentioned in a book.

Here is Uncle Chua's portfolio & dividend income, reproduced here as accurately as was depicted in the book:
Uncle Chua's portfolio 2001
http://spreadsheets.google.com/pub?key=r5DhwS2nWTiIAK0pDCIPD-Q

All the shares he dealt in were ALL blue chip stocks.

I thought it would be interesting to see how his portfolio of stocks might have performed up to today, assuming the portfolio was left unmanaged, essentially a buy and hold strategy.

It was difficult to determine the initial prices of some of the stocks in the year 2001 and I have used the earliest available stock prices, from the Yahoo Finance website, to represent these initial prices of the stocks in 2001.  Some initial prices were left blank as I could not get any information on these.

Well, let's have a look at his updated portfolio.

Click here:
Uncle Chua's Updated portfolio 2012
https://docs.google.com/spreadsheet/ccc?key=0AuRRzs61sKqRdG43MlFBeWVDWVVpaDFBeHZxY181U1E

Uncle Chua's portfolio (Update)

Performance (not including dividends)
From 2001 to 2012
Period of 11 years		Gain %
		215.6%
		CAGR
		11.0%

What conclusions can we derive from Uncle Chua's updated portfolio?

The portfolio has done quite well, returning a CAGR in share appreciation of  11.0%.  With dividends added, its performance has certainly outperformed the general market.  Do you agree?

The buy and hold strategy for this portfolio can be adopted by the defensive investors in their investing.

There are great lessons one can derive from Uncle Chua's legacy even today.

Conclusion:   Buy and hold is a safe and rewarding strategy for highly selected stocks.  



Related:

Uncle Chua's Portfolio & Dividend Income

http://myinvestingnotes.blogspot.com/2009/05/uncle-chuas-portfolio-dividend-income.html

The story of Uncle Chua

http://myinvestingnotes.blogspot.com/2009/05/story-of-uncle-chua.html


Appendix:   Rule Of Five 

The Rule of Five is BetterInvesting's method of letting you know you're not perfect and neither are your stock selections.

It states "For every five stocks you select using BetterInvesting methods, one will do much better than you expected, three will do about as well as you expected, and one will do much worse than you expected." 



The Rule of Five forms the basis for the first step of portfolio management, defense.

Here are the three possible outcomes for a stock's fundamentals on the SSG.



Defensive portfolio management's ONLY concern is finding stocks whose FUNDAMENTALS of SALES, PRE-TAX PROFITS, EPS, & PRE-TAX PROFIT MARGIN are not meeting your projections for future quality.

Click here  for a more indepth discussion of defensive portfolio management or click here   to see how the PERT Report is used to implement defensive portfolio management.

Investment lifecycle in the Stock Market

Before choosing investments, think about the amount of time you can leave your money in the market.

Shares offer the greatest chance for growth in the long term, but if you only have a few months to invest, their volatility could leave you with losses. That is why you should always estimate when you might need your money again and invest accordingly.

Always remember that the value of investments can fall as well as rise and you may get back less than you initially invested even in the long term.

If you are unsure about investing you should seek independent advice.

Short-term approaches

If you only have a few years – or a few months – before you will need to pull your money out from the markets, you may want to look for low-risk, low-volatility investments.

A good short-term portfolio may include high exposure to bonds and gilts, as well as cash or cash-like investments. Some investors may also want to include some holdings in lower-risk shares from well-established companies.

Looking at the medium term

With 5 or more years, you can start looking at a more traditional portfolio, with a diverse mix of shares balanced with some holdings in bonds and cash. This is because in a typical economic cycle, 5 years is enough to recover from any significant downturns. Although this is not guaranteed.

Long-term investing

Younger investors saving up for retirement may find that that have 10 to 20 years or more before they will need to start drawing down money from their investments.

With the luxury of time, you may want to consider riskier and more volatile investments. While there are no guarantees, by taking on greater risk, you may earn a higher return. A downturn can hurt your portfolio, but you would be able to afford the wait for the eventual recovery. Then, as you approach retirement, you can slowly transition to safer investments in order to protect your gains.

Rule Of Five

The Rule of Five is BetterInvesting's method of letting you know you're not perfect and neither are your stock selections.

It states "For every five stocks you select using BetterInvesting methods, 

• one will do much better than you expected, 
• three will do about as well as you expected, and 
• one will do much worse than you expected."

The Rule of Five forms the basis for the first step of portfolio management, defense.

Here are the three possible outcomes for a stock's fundamentals on the SSG.

Defensive portfolio management's ONLY concern is finding stocks whose FUNDAMENTALS of SALES, PRE-TAX PROFITS, EPS, & PRE-TAX PROFIT MARGIN are not meeting your projections for future quality. Click here for a more indepth discussion of defensive portfolio management or click here to see how the PERT Report is used to implement defensive portfolio management.

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Last Modified 2005-05-13 


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