Has the stock market rise disturbed your portfolio?
Consider this, suppose the prices of potato, ghee and sugar dropped to half, would you double your consumption and reduce that of the other food stuffs? Unlikely! You eat a balanced diet and a sudden price change does not make you change your diet drastically. Why then, should you behave differently with your money life and increase the proportion of an asset just because its price has taken its value higher? Rebalancing is a smart way to keep the portfolio suited to your risk and return needs.
Every portfolio has a mix of different instruments - debt, equity and cash. Debt, or interest-bearing instruments like bonds, income mutual funds and deposits, give low risk moderate returns, equity, or shares and stock market mutual funds, is risky and can give higher returns. Cash is the emergency and opportunity fund that gives very low returns, but is liquid and safe. Ideally, as a person ages, he should reduce the equity part of his portfolio and increase the lower risk debt since the risk-taking capacity goes down with age.
At each age and stage in life, each person will have his own unique asset allocation that works for his risk and return needs. For example, a 38 year old person may have an asset allocation of 60 per cent in equity and 40 per cent in debt and a 60 year old could have 20 per cent in equity and 80 per cent in debt. The idea is to stay at the chosen asset allocation at a particular age, even if the markets keep changing. Therefore the need for rebalancing.
Rebalancing the portfolio means coming back to the original asset allocation at least once a year, as markets take the value of the portfolio up or down. Consider this: in April 2003, a 38 year old with a 60:40 asset allocation in equity and debt has Rs 10 lakh in his portfolio. This means he has Rs 6 lakh worth of shares and equity mutual funds and Rs 4 lakh worth of debt paper like bank fixed deposits, debentures, bonds and funds. Now, almost a year later, the rising stock market has taken the collected value of his equity portfolio to Rs 12 lakh - his State Bank shares rose sharply, the index funds went up and so on, but his debt did not gain since interest rates did not fall and there was no capital gain on his bond funds. Now his asset allocation is Rs 12 lakh: Rs 4 lakh or 75:25 without him making any fresh investments or changing any older investments simply because the market took the equity value of his portfolio higher.
But this person had been comfortable with a 60:40 asset allocation, should he be at 75:25? No, he should go back to his original asset allocation, if he feels he cannot expose his portfolio to this higher level of risk. He can do two things:
Sell a part of his equity holdings to book profit and buy debt. It is difficult to sell the winner to buy the loser, specially when it looks as if the markets will keep rising. But remember, that if you don't rebalance, the market may do it for you and you will lose the profit you could have booked. Don't sell your entire holding of a favourite stock, sell a part of it and use the money to buy into debt instruments.
Make all fresh investments in debt. This may be difficult as such a large amount of money may not be available to bring the asset allocation back to the original level. It also prevents the person from booking profit, but it is an option for a person reluctant to sell in a rising market and yet needing to rebalance.
Booking profit to come back to your original equity-debt split is a smart strategy as it allows you to enjoy the gains and yet keep the desired proportion between assets intact. Remember to check on the tax angle before you sell. Sometimes it may be better wait a couple of months to become eligible for the lower long term capital gains tax. Sometimes it may be good to sell some stocks that have lost along with some winners to offset the losses to the gains.
How often should you rebalance?
Rebalance your portfolio once a year. Do it around tax investment time as your focus is already on money matters. Rebalance in the interim, if you feel that one asset class has suddenly shot up alarmingly. For example, the stock market vroom since April 2003 should be making you re-look at your portfolio now. But don't micromanage and churn for every percentage change in the asset allocation. A sustained 10 to 15 per cent change is the trigger to rebalance.
Is there some way to automatically rebalance?
If you find the job of managing your portfolio too heavy and rebalancing is a word you don't even want to hold, look at mutual funds. The newly launched fund of funds category is the most efficient way to follow the rebalancing strategy. A fund of fund invests in other mutual fund schemes. Fund houses like Birla Sun Life Mutual Fund and Prudential ICICI are offering different asset allocations to suit investment needs that will automatically rebalance according to the chosen asset allocation.
When should you not rebalance?
If you feel that your risk profile has changed and you can take higher risk, you can let your portfolio run on and not book profits. This is a high risk strategy, be aware of the risk and then do it, if it suits your profile.
http://www.indianexpress.com/oldStory/39393/
Wednesday, 2 September 2009
Some Investing Principles which cannot be disputed
While it may be true that in the online investing world there is no rule without an exception, there are some principles which cannot be disputed. These principles can help investors get a better grasp of how to approach online investments and nurture them to maturity.
Sell the losers and let the winners keep riding
For long term investing success it is important to ride a winner. Ever so often, investors make profits by selling their appreciated online stocks, but hold onto stocks that have declined in hopes of a rebound. If an investor doesn't know when it's time to let go of hopeless stocks, he or she can, in the worst-case scenario, see the stock sink to the point where it is almost worthless. Of course, the idea of holding onto high-quality investments while selling the poor ones is great in theory, but hard to put into practice.
If you have a personal preference to sell after a stock has increased by a certain multiple - say three, for instance - you may never fully ride out a winner. No one in the history of investing with a "sell-after-I-have-tripled-my-money" mentality has ever succeeded.. Don't underestimate a stock that is performing well by sticking to some rigid personal rule - if you don't have a good understanding of the potential of your investments, your personal rules may end up being arbitrary and too limiting.
While riding a winner is important, you also should sell the losers. There is no guarantee that an online stock will bounce back after a long period of decline. While it is important not to underestimate good stocks, it is equally important to be realistic about investments that are performing badly. Recognizing your losers is hard because it's also an acknowledgment of your mistake. But it's important to be honest when you realize that a stock is not performing as well as you expected it to. Don't be afraid to swallow your pride and move on before your losses become even greater.
In both cases, the point is to judge companies on their merits according to your research. In each situation, you still have to decide whether a price justifies future potential. Just remember not to let your fears limit your returns or inflate your losses.
Learn to give a cold shoulder to hot tips
Whether the tip comes from your brother, cousin, neighbor or even online broker, no one can ever guarantee what online stocks will do. When you make an investment, it's important you know the reasons for doing so. Conduct your own research and analysis of any company before you even consider investing your hard earned money. Relying on a hot tip from someone else is not only an attempt at taking the easy way out, it is also a big gamble. Sure, with some luck, tips may sometimes pan out. But they will never make you an informed investor, which is what you need to be to be successful in the long run.
Don't panic when shares experience short-term movements
As a long term online investing strategy, you should not panic when your online investments experience short-term movements. When tracking the activities of your investments, you should look at the big picture. Remember to be confident in the quality of your investments rather than nervous about the inevitable volatility of the short term.
Day traders will use these day-to-day and even minute-to-minute fluctuations as a way to make gains. But the gains of a long-term investor come from a completely different market movement - the one that occurs over many years - so keep your focus on developing your overall investment philosophy by educating yourself.
Do not overemphasize the P/E ratio
Investors often place too much importance on the price-to-earning (P/E) ratio in their online investing strategy. It is one key tool among many. Using only this ratio to make buy or sell decisions is dangerous and ill-advised. The P/E ratio must be interpreted within a context, and it should be used in conjunction with other analytical processes. So, a low P/E ratio doesn't necessarily mean a security is undervalued, nor does a high P/E ratio necessarily mean a company is over valued.
Resist the temptation of penny stocks
A common misconception is that there is less to lose in buying a low-priced stock. But whether you buy a $5 stock that plunges to $0 or a $75 stock that does the same, either way you'd still have a 100% loss of your initial investment. A penny stock is probably riskier than a company with a higher share price, which would have more regulations placed on it.
Stick to your strategy
Online stock investors use different methods to pick stocks and fulfill investing goals. There are many ways to be successful and no one strategy is inherently better than any other. However, once you find your style, stick to it. An investor who switches between different stock-picking strategies will probably experience the worst, rather than the best, of each. Constantly switching strategies effectively makes you a market timer, and this is definitely territory most investors aiming at long term strategies should avoid.
While these suggestions cover some critical strategies for long-term online investments there is an exception to every rule. Depending on your circumstances, use these principles within the framework of your overall investment strategy, and reap the benefits of long term online investments.
http://www.1einvestonline.com/online-stock-investors.html
Sell the losers and let the winners keep riding
For long term investing success it is important to ride a winner. Ever so often, investors make profits by selling their appreciated online stocks, but hold onto stocks that have declined in hopes of a rebound. If an investor doesn't know when it's time to let go of hopeless stocks, he or she can, in the worst-case scenario, see the stock sink to the point where it is almost worthless. Of course, the idea of holding onto high-quality investments while selling the poor ones is great in theory, but hard to put into practice.
If you have a personal preference to sell after a stock has increased by a certain multiple - say three, for instance - you may never fully ride out a winner. No one in the history of investing with a "sell-after-I-have-tripled-my-money" mentality has ever succeeded.. Don't underestimate a stock that is performing well by sticking to some rigid personal rule - if you don't have a good understanding of the potential of your investments, your personal rules may end up being arbitrary and too limiting.
While riding a winner is important, you also should sell the losers. There is no guarantee that an online stock will bounce back after a long period of decline. While it is important not to underestimate good stocks, it is equally important to be realistic about investments that are performing badly. Recognizing your losers is hard because it's also an acknowledgment of your mistake. But it's important to be honest when you realize that a stock is not performing as well as you expected it to. Don't be afraid to swallow your pride and move on before your losses become even greater.
In both cases, the point is to judge companies on their merits according to your research. In each situation, you still have to decide whether a price justifies future potential. Just remember not to let your fears limit your returns or inflate your losses.
Learn to give a cold shoulder to hot tips
Whether the tip comes from your brother, cousin, neighbor or even online broker, no one can ever guarantee what online stocks will do. When you make an investment, it's important you know the reasons for doing so. Conduct your own research and analysis of any company before you even consider investing your hard earned money. Relying on a hot tip from someone else is not only an attempt at taking the easy way out, it is also a big gamble. Sure, with some luck, tips may sometimes pan out. But they will never make you an informed investor, which is what you need to be to be successful in the long run.
Don't panic when shares experience short-term movements
As a long term online investing strategy, you should not panic when your online investments experience short-term movements. When tracking the activities of your investments, you should look at the big picture. Remember to be confident in the quality of your investments rather than nervous about the inevitable volatility of the short term.
Day traders will use these day-to-day and even minute-to-minute fluctuations as a way to make gains. But the gains of a long-term investor come from a completely different market movement - the one that occurs over many years - so keep your focus on developing your overall investment philosophy by educating yourself.
Do not overemphasize the P/E ratio
Investors often place too much importance on the price-to-earning (P/E) ratio in their online investing strategy. It is one key tool among many. Using only this ratio to make buy or sell decisions is dangerous and ill-advised. The P/E ratio must be interpreted within a context, and it should be used in conjunction with other analytical processes. So, a low P/E ratio doesn't necessarily mean a security is undervalued, nor does a high P/E ratio necessarily mean a company is over valued.
Resist the temptation of penny stocks
A common misconception is that there is less to lose in buying a low-priced stock. But whether you buy a $5 stock that plunges to $0 or a $75 stock that does the same, either way you'd still have a 100% loss of your initial investment. A penny stock is probably riskier than a company with a higher share price, which would have more regulations placed on it.
Stick to your strategy
Online stock investors use different methods to pick stocks and fulfill investing goals. There are many ways to be successful and no one strategy is inherently better than any other. However, once you find your style, stick to it. An investor who switches between different stock-picking strategies will probably experience the worst, rather than the best, of each. Constantly switching strategies effectively makes you a market timer, and this is definitely territory most investors aiming at long term strategies should avoid.
While these suggestions cover some critical strategies for long-term online investments there is an exception to every rule. Depending on your circumstances, use these principles within the framework of your overall investment strategy, and reap the benefits of long term online investments.
http://www.1einvestonline.com/online-stock-investors.html
When To Sell Your Stocks
When To Sell Your Stocks
David Serchuk 03.04.09, 6:00 PM ET
We sell our winners too early and ride the losers straight into the ground. This self-destructive pattern even has a name. It's called the "disposition effect."
Why do we do it? Ravi Dhar and Ning Zhu of the Yale School of Management believe that the disposition effect is real but that professional investors are less prone to it. One reason is because such investors are more able to confront bad news and admit error. But the madding crowd seems to lack this armor. Basically, we can't handle the truth.
To deal with such messy, emotional, but real issues we convened a special, more intimate meeting of the Forbes.com Investor Team. On one side of the table we have Michael Ervolini, the head of Cabot Research, which applies behavioral finance to its mostly institutional client base. Behavioral finance applies the lens of psychology to the seemingly cold, rational world of business and investing. On the other side of the discussion we have Marc Lowlicht, the head of the wealth management division of Further Lane Asset Management. Lowlicht is on the front lines, dealing with unhappy, stressed customers who feel panicked and powerless as their portfolios shrink.
What Ervolini has found is that many of our seemingly rational decisions--good or bad--are based on emotions hard-wired into us. Greed, embarrassment and shame are often in the driver's seat, no matter how much we would like to think otherwise.
In the case of stock sales, here's the problem: it's been documented that the pain of losing money is twice greater than the joy of making it. So if you buy a stock and it goes up $2, you're tempted to sell. Investors love to take small gains off the table. If it goes down $1, most investors will refuse to take the loss. They will hang onto the loser in the hopes of making that dollar back. That $1 loss has as strong an effect on the brain as a $2 gain.
"As long as the loss is hanging in the portfolio it has a chance of coming back," Ervolini says. "But once you sell a position, that position is a loser forever and a little bit of you is a loser forever."
Another problem Ervolini has found is that the same part of the brain that reacts with horror to death and disease is the one that's affected by financial losses. This stretches far back in our evolutionary history. In less civilized times, a financial loss, or the loss of a source of gathered or hoarded food, could lead quickly to death. We react the same way to the nest egg that's meant to see us through retirement.
There is very little research on the subject of stock sales. Ervolini found just one paper. But as shown by the recent market meltdown, selling is often the more critical skill.
Another issue Lowlicht confronts is that his customers often don't understand that there can be no real growth without some risk. The problem, Ervolini counters, is that so few of us truly know how much loss we can bear. Often it is much less than we initially believe. "Know Thyself" might be a classic ideal but for many it remains just that.
Why We Can't Sell
Forbes: Mike, one thing you've mentioned is the anti-selling bias. You can be a good buyer of securities or a good seller, but usually people aren't both. Why is there this anti-selling bias?
Michael Ervolini: Well, I can relate it to [mutual fund] managers and then we can try to then relate it to individuals. From managers, there's a technical and an emotional explanation. The technical one is that for the past 30 years virtually every dollar invested in studying the strategic part of investing has been about buying. It's research for ranking stocks. It's portfolio risk management. It's optimizers. It's tools that do attribution analysis and on and on. It's all looking at what you own and what you're going to buy today. We did some extensive work on this and we found one academic article on selling.
Forbes: One? Was it a good article?
Ervolini: It was pretty good.
Marc Lowlicht: Compared to the others, it was great.
Ervolini: And there are no real heavy books on the subject. Everybody's oriented toward buying in terms of the profession. We talked to the people at Tower Research who do financial research. They agreed that 80% or more of the dollars that they see invested are on buying. In terms of research, capital, etc. So selling has just been under-served from the industry's perspective.
Our academic adviser, Terrance Odean [the Willis H. Booth Professor of Banking and Finance at the Haas School of Business at the University of California, Berkeley] has expressed a behavioral approach this way: When you buy something--and we're looking at long portfolios for a second--it's out of hope. What can this position do for me? It's a pretty nice place to be. When you sell, it's because of what the position did to you. And maybe there's just some natural inclination to want to spend more time thinking about buying because it's just a more pleasant thought process as opposed to selling. But, I can tell you we've looked at just scores and scores and scores of funds and we see it over and over again.
And when we talk to professional managers, it resonates. "Yeah, I have some concerns about my selling and I'm glad to be able to have a really thorough examination of just my selling. Because I know I can make it better." And it's they don't have in their organization feedback mechanisms to help them do it.
Lowlicht: Can I add something else in there that I've observed? Part of my business is to understand how people think because I have to guide them based on that. I think another reason people are better buyers than sellers is because when you buy, there's no tally to how you did. If you lose, it's a paper loss. "It's still a good company. It's going to come back." But when you finally sell something, if it goes higher, you sold too soon. If it goes lower, you made the right decision. If you outperformed, you did great. So, people like to be winners. People like to be right. That's why people argue. And when you buy, there is no weighing system as to whether you're right or wrong until the sale is made. So, it's much easier not to second guess a purchase.
And even if you bought Citigroup at $12, you can make a hundred excuses why you think it's going to $20. You still made the right decision. And right now, it's just a paper loss … But once you make a sale, your decision has been final and there's an accounting for the decision you made.
Ervolini: In behavioral finance, exactly what Marc's talking about is known as the disposition effect. And what we see repeatedly is that people love to take small gains off the table. We see it repeatedly, retail and institutional. People love to take gains for two reasons. Ten $1 gains make us feel better than one $10 gain. That's just the way our brains work. We like lots of small rewards as opposed to one big one. And once the gain starts to get up there, like $3-$4, we get fearful that the market will take it away. So, those two motivations cause us to take gains early.
And with losses it's what Marc was saying. As long as the loss is hanging in the portfolio, it has a chance of coming back. And we can postpone the self recrimination. But once you sell a position, that position is a loser forever and a little bit of you is a loser forever.
The other thing to keep in mind is that studies have shown that the emotional high we get from a dollar of win is only half the emotional low we get from losing a dollar. So a loss is twice as impactful as a win in money. We hate to lose and it's something primitive.
Forbes: Do investors really believe there is no reward without risk?
Ervolini: Oh, there's always a trade-off. When you allay someone's fears by changing their investment strategy, you're giving up return. And there's no way around that. The problem is the general investing public is misled into believing that return is magically created with no risk.
Lowlicht: And I think one of the problems is people want something for nothing almost. I don't know if that's the right terminology, but they have expectations of receiving, but don't consider what they give up. And they want to believe that there's a free lunch, that there's an easier way to do it. Or that somebody else has figured it out. Nobody else has figured it out. You've got a certain amount of return for the amount of risk you take. The more risk you take, the greater the return. The less risk you take, the less the return.
Ervolini: This is tough because one of the things we're not good at appreciating today is what a future outcome will feel like. And so, if Marc's interviewing me and he says to me, "Mike, can you handle a 5% draw down on your account?" I say, "Yeah, sure." And he says, "How about 10%?" I say, "Yeah, sure." And then he keeps going on and on. And he finally gets to a number where I say ouch. Let's say it's 40%. So now, based on his interview, Marc has a sense of one dimension of my risk tolerance. And then what happens is we're running down the road and my account gets drawn down 12% and I'm on the phone begging him to help me. Because I can't really appreciate what a 10% or 15% draw down feels like until I get there.
See More Intelligent Investing Features.
http://www.forbes.com/2009/03/04/psychology-selling-stocks-intelligent-investing_psychology.html
David Serchuk 03.04.09, 6:00 PM ET
We sell our winners too early and ride the losers straight into the ground. This self-destructive pattern even has a name. It's called the "disposition effect."
Why do we do it? Ravi Dhar and Ning Zhu of the Yale School of Management believe that the disposition effect is real but that professional investors are less prone to it. One reason is because such investors are more able to confront bad news and admit error. But the madding crowd seems to lack this armor. Basically, we can't handle the truth.
To deal with such messy, emotional, but real issues we convened a special, more intimate meeting of the Forbes.com Investor Team. On one side of the table we have Michael Ervolini, the head of Cabot Research, which applies behavioral finance to its mostly institutional client base. Behavioral finance applies the lens of psychology to the seemingly cold, rational world of business and investing. On the other side of the discussion we have Marc Lowlicht, the head of the wealth management division of Further Lane Asset Management. Lowlicht is on the front lines, dealing with unhappy, stressed customers who feel panicked and powerless as their portfolios shrink.
What Ervolini has found is that many of our seemingly rational decisions--good or bad--are based on emotions hard-wired into us. Greed, embarrassment and shame are often in the driver's seat, no matter how much we would like to think otherwise.
In the case of stock sales, here's the problem: it's been documented that the pain of losing money is twice greater than the joy of making it. So if you buy a stock and it goes up $2, you're tempted to sell. Investors love to take small gains off the table. If it goes down $1, most investors will refuse to take the loss. They will hang onto the loser in the hopes of making that dollar back. That $1 loss has as strong an effect on the brain as a $2 gain.
"As long as the loss is hanging in the portfolio it has a chance of coming back," Ervolini says. "But once you sell a position, that position is a loser forever and a little bit of you is a loser forever."
Another problem Ervolini has found is that the same part of the brain that reacts with horror to death and disease is the one that's affected by financial losses. This stretches far back in our evolutionary history. In less civilized times, a financial loss, or the loss of a source of gathered or hoarded food, could lead quickly to death. We react the same way to the nest egg that's meant to see us through retirement.
There is very little research on the subject of stock sales. Ervolini found just one paper. But as shown by the recent market meltdown, selling is often the more critical skill.
Another issue Lowlicht confronts is that his customers often don't understand that there can be no real growth without some risk. The problem, Ervolini counters, is that so few of us truly know how much loss we can bear. Often it is much less than we initially believe. "Know Thyself" might be a classic ideal but for many it remains just that.
Why We Can't Sell
Forbes: Mike, one thing you've mentioned is the anti-selling bias. You can be a good buyer of securities or a good seller, but usually people aren't both. Why is there this anti-selling bias?
Michael Ervolini: Well, I can relate it to [mutual fund] managers and then we can try to then relate it to individuals. From managers, there's a technical and an emotional explanation. The technical one is that for the past 30 years virtually every dollar invested in studying the strategic part of investing has been about buying. It's research for ranking stocks. It's portfolio risk management. It's optimizers. It's tools that do attribution analysis and on and on. It's all looking at what you own and what you're going to buy today. We did some extensive work on this and we found one academic article on selling.
Forbes: One? Was it a good article?
Ervolini: It was pretty good.
Marc Lowlicht: Compared to the others, it was great.
Ervolini: And there are no real heavy books on the subject. Everybody's oriented toward buying in terms of the profession. We talked to the people at Tower Research who do financial research. They agreed that 80% or more of the dollars that they see invested are on buying. In terms of research, capital, etc. So selling has just been under-served from the industry's perspective.
Our academic adviser, Terrance Odean [the Willis H. Booth Professor of Banking and Finance at the Haas School of Business at the University of California, Berkeley] has expressed a behavioral approach this way: When you buy something--and we're looking at long portfolios for a second--it's out of hope. What can this position do for me? It's a pretty nice place to be. When you sell, it's because of what the position did to you. And maybe there's just some natural inclination to want to spend more time thinking about buying because it's just a more pleasant thought process as opposed to selling. But, I can tell you we've looked at just scores and scores and scores of funds and we see it over and over again.
And when we talk to professional managers, it resonates. "Yeah, I have some concerns about my selling and I'm glad to be able to have a really thorough examination of just my selling. Because I know I can make it better." And it's they don't have in their organization feedback mechanisms to help them do it.
Lowlicht: Can I add something else in there that I've observed? Part of my business is to understand how people think because I have to guide them based on that. I think another reason people are better buyers than sellers is because when you buy, there's no tally to how you did. If you lose, it's a paper loss. "It's still a good company. It's going to come back." But when you finally sell something, if it goes higher, you sold too soon. If it goes lower, you made the right decision. If you outperformed, you did great. So, people like to be winners. People like to be right. That's why people argue. And when you buy, there is no weighing system as to whether you're right or wrong until the sale is made. So, it's much easier not to second guess a purchase.
And even if you bought Citigroup at $12, you can make a hundred excuses why you think it's going to $20. You still made the right decision. And right now, it's just a paper loss … But once you make a sale, your decision has been final and there's an accounting for the decision you made.
Ervolini: In behavioral finance, exactly what Marc's talking about is known as the disposition effect. And what we see repeatedly is that people love to take small gains off the table. We see it repeatedly, retail and institutional. People love to take gains for two reasons. Ten $1 gains make us feel better than one $10 gain. That's just the way our brains work. We like lots of small rewards as opposed to one big one. And once the gain starts to get up there, like $3-$4, we get fearful that the market will take it away. So, those two motivations cause us to take gains early.
And with losses it's what Marc was saying. As long as the loss is hanging in the portfolio, it has a chance of coming back. And we can postpone the self recrimination. But once you sell a position, that position is a loser forever and a little bit of you is a loser forever.
The other thing to keep in mind is that studies have shown that the emotional high we get from a dollar of win is only half the emotional low we get from losing a dollar. So a loss is twice as impactful as a win in money. We hate to lose and it's something primitive.
Forbes: Do investors really believe there is no reward without risk?
Ervolini: Oh, there's always a trade-off. When you allay someone's fears by changing their investment strategy, you're giving up return. And there's no way around that. The problem is the general investing public is misled into believing that return is magically created with no risk.
Lowlicht: And I think one of the problems is people want something for nothing almost. I don't know if that's the right terminology, but they have expectations of receiving, but don't consider what they give up. And they want to believe that there's a free lunch, that there's an easier way to do it. Or that somebody else has figured it out. Nobody else has figured it out. You've got a certain amount of return for the amount of risk you take. The more risk you take, the greater the return. The less risk you take, the less the return.
Ervolini: This is tough because one of the things we're not good at appreciating today is what a future outcome will feel like. And so, if Marc's interviewing me and he says to me, "Mike, can you handle a 5% draw down on your account?" I say, "Yeah, sure." And he says, "How about 10%?" I say, "Yeah, sure." And then he keeps going on and on. And he finally gets to a number where I say ouch. Let's say it's 40%. So now, based on his interview, Marc has a sense of one dimension of my risk tolerance. And then what happens is we're running down the road and my account gets drawn down 12% and I'm on the phone begging him to help me. Because I can't really appreciate what a 10% or 15% draw down feels like until I get there.
See More Intelligent Investing Features.
http://www.forbes.com/2009/03/04/psychology-selling-stocks-intelligent-investing_psychology.html
Warren Buffett On Sex
Published in Investing on 22 July 2009
Buffett's analogies frequently involve sex. Here are our favourite Buffett thoughts and quotes on sex.
Besides being the world's greatest investor, Warren Buffett is a Michelangelo when it comes to drawing analogies.
He is a master at distilling complex concepts into humorous one-liners that we can understand. And we tend to trust him because he only invests and speaks about what he knows.
He develops decades-long relationships with portfolio holdings including Coca-Cola, Wells Fargo and American Express and while he's been known to sneak a peek at companies outside his circle of competence, you'll never see him stray to Google or even Microsoft.
What does all this have to do with sex, you ask? Well, we already know that Buffett tends to stick to stuff he understands in and out. We also know that his analogies frequently involve sex. Ahem. You can connect the dots yourself. To help you, here are our favourite Warren Buffett thoughts on sex!
Buffett's advice seems to be to start early ... and we ain't talkin' retirement planning:
On being active: "It's nice to have a lot of money, but you know, you don't want to keep it around forever. I prefer buying things. Otherwise, it's a little like saving sex for your old age."
On career advice: "A few months ago I was talking to another MBA student, a very talented man, about 30 years old from a great school with a great resume. I asked him what he wanted to do for his career, and he replied that he wanted to go into a particular field, but thought he should work for McKinsey for a few years first to add to his resume. To me that's like saving sex for your old age. It makes no sense."
On loving your job: "You want to have a passion for what you are doing. You don't want to wait until 80 to have sex."
All this bedroom talk may have you wondering if Buffett is straying too far outside his primary circle of competence. Not to worry:
On ninja-like focus: "You know, if I'm playing bridge and a naked woman walks by, I don't ever see her."
On due diligence: "Other guys read Playboy, I read annual reports."
On over-diversification: "If you have a harem of 40 women, you never get to know any of them very well."
Of course, maybe we're underestimating how large his circle is:
On internal yardsticks: "Would you prefer to be the greatest lover in the world and known as the worst, or would you prefer to be the worst lover and known as the greatest?"
Sometimes opportunity knocks -- gather ye rosebuds while ye may:
On investing in 1973: "I feel like an oversexed guy on a desert island. I can't find anything to buy."
On investing in 1974: "I feel like an oversexed man in a harem. This is the time to start investing."
An Indecent Proposal:
On selling your business to Berkshire Hathaway vs. private equity: "You can sell it to Berkshire, and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever. Or you can sell it to some porn shop operator, and he'll take the painting and he'll make the boobs a little bigger and he'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it.''
On becoming a true investor: "We believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a 'romantic.'"
Some insights into the current economic situation that make us wonder which of these he's tried:
On the first stimulus package: "[It was like] half a tablet of Viagra and then having also a bunch of candy mixed in -- it doesn't have really quite the wallop."
Solicited to buy Bear Stearns, and asked if he wanted more information (from the book Street Fighters): "It was sort of like having a woman standing in front of you who had taken half her clothes off and then asked whether she should continue, [Buffett] thought. Just as he'd want the woman to finish the job, he was certainly curious to hear what was happening that weekend with the embattled Bear."
On the speed of economic recovery: "You can't produce a baby in one month by getting nine women pregnant. It just doesn't work that way."
Buffett knew a girl who knew a guy who knew a credit default swap:
On financially transmitted diseases: "Derivatives are like sex. It's not who we're sleeping with, it's who they're sleeping with that's the problem."
> A version of this article was originally published on Fool.com. It has been updated by Bruce Jackson, who has an interest in Berkshire Hathaway.
http://www.fool.co.uk/news/investing/2009/07/22/warren-buffett-on-sex.aspx
Buffett's analogies frequently involve sex. Here are our favourite Buffett thoughts and quotes on sex.
Besides being the world's greatest investor, Warren Buffett is a Michelangelo when it comes to drawing analogies.
He is a master at distilling complex concepts into humorous one-liners that we can understand. And we tend to trust him because he only invests and speaks about what he knows.
He develops decades-long relationships with portfolio holdings including Coca-Cola, Wells Fargo and American Express and while he's been known to sneak a peek at companies outside his circle of competence, you'll never see him stray to Google or even Microsoft.
What does all this have to do with sex, you ask? Well, we already know that Buffett tends to stick to stuff he understands in and out. We also know that his analogies frequently involve sex. Ahem. You can connect the dots yourself. To help you, here are our favourite Warren Buffett thoughts on sex!
Buffett's advice seems to be to start early ... and we ain't talkin' retirement planning:
On being active: "It's nice to have a lot of money, but you know, you don't want to keep it around forever. I prefer buying things. Otherwise, it's a little like saving sex for your old age."
On career advice: "A few months ago I was talking to another MBA student, a very talented man, about 30 years old from a great school with a great resume. I asked him what he wanted to do for his career, and he replied that he wanted to go into a particular field, but thought he should work for McKinsey for a few years first to add to his resume. To me that's like saving sex for your old age. It makes no sense."
On loving your job: "You want to have a passion for what you are doing. You don't want to wait until 80 to have sex."
All this bedroom talk may have you wondering if Buffett is straying too far outside his primary circle of competence. Not to worry:
On ninja-like focus: "You know, if I'm playing bridge and a naked woman walks by, I don't ever see her."
On due diligence: "Other guys read Playboy, I read annual reports."
On over-diversification: "If you have a harem of 40 women, you never get to know any of them very well."
Of course, maybe we're underestimating how large his circle is:
On internal yardsticks: "Would you prefer to be the greatest lover in the world and known as the worst, or would you prefer to be the worst lover and known as the greatest?"
Sometimes opportunity knocks -- gather ye rosebuds while ye may:
On investing in 1973: "I feel like an oversexed guy on a desert island. I can't find anything to buy."
On investing in 1974: "I feel like an oversexed man in a harem. This is the time to start investing."
An Indecent Proposal:
On selling your business to Berkshire Hathaway vs. private equity: "You can sell it to Berkshire, and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever. Or you can sell it to some porn shop operator, and he'll take the painting and he'll make the boobs a little bigger and he'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it.''
On becoming a true investor: "We believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a 'romantic.'"
Some insights into the current economic situation that make us wonder which of these he's tried:
On the first stimulus package: "[It was like] half a tablet of Viagra and then having also a bunch of candy mixed in -- it doesn't have really quite the wallop."
Solicited to buy Bear Stearns, and asked if he wanted more information (from the book Street Fighters): "It was sort of like having a woman standing in front of you who had taken half her clothes off and then asked whether she should continue, [Buffett] thought. Just as he'd want the woman to finish the job, he was certainly curious to hear what was happening that weekend with the embattled Bear."
On the speed of economic recovery: "You can't produce a baby in one month by getting nine women pregnant. It just doesn't work that way."
Buffett knew a girl who knew a guy who knew a credit default swap:
On financially transmitted diseases: "Derivatives are like sex. It's not who we're sleeping with, it's who they're sleeping with that's the problem."
> A version of this article was originally published on Fool.com. It has been updated by Bruce Jackson, who has an interest in Berkshire Hathaway.
http://www.fool.co.uk/news/investing/2009/07/22/warren-buffett-on-sex.aspx
3 Really Bad Reasons Not To Sell
3 Really Bad Reasons Not To Sell
By Bruce JacksonPublished in Investing Strategy on 24 July 2009
Selling shares really is much easier than you think. You should do more of it.
Investors often find it difficult to sell their shares. If I had a pound for every time someone said to me "selling is the hardest investing decision", I'd be a rich person.
What hogwash. Selling is easy. Just click the sell button. Poof. Shares out, cash in.
It can't get much easier than that. And with trading commissions so low, there really is no reason not to sell.
Yet people still struggle to sell. Why?
Bad Reason #1 -- Laziness
The easy option is to do nothing. The same goes in business. Most businesses simply keep doing things the way they've always done them, "because we've always done it that way."
Why change? I'll tell you why. There is always a better way of doing things. You need to constantly challenge yourself, and challenge the status quo.
When it comes to investing, people don't challenge their investments. They don't look at them and say "this one is overvalued now" or "that one is struggling to grow its market share" or "I think there's trouble ahead for this sector".
Unfortunately, there are precious few "buy and hold forever" companies. Just ask the people who thought Royal Bank of Scotland (LSE: RBS) and Lloyds Banking Group (LSE: LLOY) were large, stable, high yielding and cheap companies.
Bad Reason #2 -- Boring
Buying is far more exciting. It's always fun looking for the "next big winner", the share that is going to make your investing fortune. People spend most of their time looking for this illusive company, the next Tullow Oil (LSE: TLW) or the next GlaxoSmithKline (LSE: GSK).
Whilst there is nothing wrong with looking for tomorrow's big winners, I'd suggest investors should spend much more time monitoring their existing portfolio stocks.
Things they need to keep an eye on include…
■The competitive environment. If you own shares in J Sainsbury (LSE: SBRY), you might want to think about whether the resurgence of Wm. Morrison (LSE: MRW) might impact on their future sales growth.
■The economy. In the past 12 months, as we all found out to our cost, ignoring the economy can be wealth destroying. If you think the economy is in for a rough time over the next few years, you might want to think about selling your shares in companies selling discretionary goods, like DSG International (LSE: DSGI) and Carpetright (LSE: CPR).
■Valuation. When a company reaches your estimate of fair value, you should start selling. It's as simple as that. So why don't people sell on valuation grounds? Read on…
Bad Reason #3 - Fear
People fail to sell because they fear of missing out on a huge winner. Fear and greed are the two most powerful emotions investors have to deal with, almost on a daily basis. Fear can come in many guises, but is most powerful when people fear losing money. How else do you explain the massive and indiscriminate selling spree witnessed in March this year? It was based on fear alone.
But there's another thing investors fear almost as much. They fear of selling too early. The stock market is littered with tales of people who bought Tesco (LSE: TSCO) shares in the early days and hung on all the way through to now, or Domino's Pizza (LSE: DOM), one of the best performing shares of the last decade.
The stories usually recount how these great performers were, at various times over the years, over-valued. Yet the companies kept growing, kept beating market expectations, and the share price ended up providing these canny investors with returns in the thousands of percentage points.
This is very much the exception rather than the rule. The intensely competitive environment usually puts a cap on the long-term growth prospects of most companies. For example, although Domino's Pizza dominates the takeaway pizza environment today, it wasn't too many years ago when many thought PizzaExpress would open hundreds of takeaway outlets and rule the world of ham, cheese, tomato, pineapple and anchovies.
Fear not. If a company in your portfolio is highly valued, just click and sell. You'll most likely get the chance to buy it back at a cheaper price anyway.
The Best Parts About Selling
If this choppy market has taught us anything, it should be that you need to sell at the right time. It's not that difficult. And you know the best parts about selling? 1) It's cheap and easy, and 2) you can't lose cash!
http://www.fool.co.uk/news/investing/investing-strategy/2009/07/24/3-really-bad-reasons-not-to-sell.aspx
By Bruce JacksonPublished in Investing Strategy on 24 July 2009
Selling shares really is much easier than you think. You should do more of it.
Investors often find it difficult to sell their shares. If I had a pound for every time someone said to me "selling is the hardest investing decision", I'd be a rich person.
What hogwash. Selling is easy. Just click the sell button. Poof. Shares out, cash in.
It can't get much easier than that. And with trading commissions so low, there really is no reason not to sell.
Yet people still struggle to sell. Why?
Bad Reason #1 -- Laziness
The easy option is to do nothing. The same goes in business. Most businesses simply keep doing things the way they've always done them, "because we've always done it that way."
Why change? I'll tell you why. There is always a better way of doing things. You need to constantly challenge yourself, and challenge the status quo.
When it comes to investing, people don't challenge their investments. They don't look at them and say "this one is overvalued now" or "that one is struggling to grow its market share" or "I think there's trouble ahead for this sector".
Unfortunately, there are precious few "buy and hold forever" companies. Just ask the people who thought Royal Bank of Scotland (LSE: RBS) and Lloyds Banking Group (LSE: LLOY) were large, stable, high yielding and cheap companies.
Bad Reason #2 -- Boring
Buying is far more exciting. It's always fun looking for the "next big winner", the share that is going to make your investing fortune. People spend most of their time looking for this illusive company, the next Tullow Oil (LSE: TLW) or the next GlaxoSmithKline (LSE: GSK).
Whilst there is nothing wrong with looking for tomorrow's big winners, I'd suggest investors should spend much more time monitoring their existing portfolio stocks.
Things they need to keep an eye on include…
■The competitive environment. If you own shares in J Sainsbury (LSE: SBRY), you might want to think about whether the resurgence of Wm. Morrison (LSE: MRW) might impact on their future sales growth.
■The economy. In the past 12 months, as we all found out to our cost, ignoring the economy can be wealth destroying. If you think the economy is in for a rough time over the next few years, you might want to think about selling your shares in companies selling discretionary goods, like DSG International (LSE: DSGI) and Carpetright (LSE: CPR).
■Valuation. When a company reaches your estimate of fair value, you should start selling. It's as simple as that. So why don't people sell on valuation grounds? Read on…
Bad Reason #3 - Fear
People fail to sell because they fear of missing out on a huge winner. Fear and greed are the two most powerful emotions investors have to deal with, almost on a daily basis. Fear can come in many guises, but is most powerful when people fear losing money. How else do you explain the massive and indiscriminate selling spree witnessed in March this year? It was based on fear alone.
But there's another thing investors fear almost as much. They fear of selling too early. The stock market is littered with tales of people who bought Tesco (LSE: TSCO) shares in the early days and hung on all the way through to now, or Domino's Pizza (LSE: DOM), one of the best performing shares of the last decade.
The stories usually recount how these great performers were, at various times over the years, over-valued. Yet the companies kept growing, kept beating market expectations, and the share price ended up providing these canny investors with returns in the thousands of percentage points.
This is very much the exception rather than the rule. The intensely competitive environment usually puts a cap on the long-term growth prospects of most companies. For example, although Domino's Pizza dominates the takeaway pizza environment today, it wasn't too many years ago when many thought PizzaExpress would open hundreds of takeaway outlets and rule the world of ham, cheese, tomato, pineapple and anchovies.
Fear not. If a company in your portfolio is highly valued, just click and sell. You'll most likely get the chance to buy it back at a cheaper price anyway.
The Best Parts About Selling
If this choppy market has taught us anything, it should be that you need to sell at the right time. It's not that difficult. And you know the best parts about selling? 1) It's cheap and easy, and 2) you can't lose cash!
http://www.fool.co.uk/news/investing/investing-strategy/2009/07/24/3-really-bad-reasons-not-to-sell.aspx
Getting Out While the Getting's Good
Getting Out While the Getting's Good
By WALTER HAMILTON
September 18, 1998
When should you sell a stock? If you're bargain hunting in today's dicey market, the answer is sooner rather than later--that is, if the stock moves against you.
The market's summer plunge has made for some good buying opportunities. But it has also made for a risky investment climate in which it's easy to lose money quickly, experts note.
To protect against that, some investment pros say individual investors should take the bold step of jettisoning any stock that falls as little as 8% from the price at which they bought it.
The reasoning: For most of the 1990s' bull market, stocks often bounced back quickly from trouble as a rising tide lifted most boats. But today, a stock that begins to sink may quickly crash--and stay down.
"The very best investors I know have very set parameters for losses," said Jonathan Lee, managing partner at Hollister Asset Management, a money management firm in Century City. "They say: 'I'm going to buy and have very tight risk parameters. If it goes down 5%, I'm out.' "
Dumping a stock that drops 8% or so from your entry price may sound drastic. Even in a good market, prices naturally ebb and flow, and an investor who sells after a small loss could subsequently watch the stock rebound.
Indeed, conventional wisdom is that an investor needn't reexamine a stock unless it declines 15% or more. If a stock has fallen simply because of market sentiment--rather than because of a fundamental change in the company's prospects--traditional thinking says an investor should hold on.
But in a high-risk market like this one, one or two sizable losses can crush a portfolio.
Think about this: If an investor waits to sell a falling stock until the loss is 20%, and then reinvests the proceeds in another stock, that new holding must rise 25% just to recoup the original amount. After a loss of 30%, a fresh holding must climb 43% to get the investor back to even.
*
Some pros take a more basic view of why losers should quickly be sold.
"The best reason why you should not hold [a losing] stock is . . . you've made a mistake," said David Ryan, head of Ryan Capital Management, a Santa Monica-based hedge fund.
Ryan is a onetime protege of William O'Neil, an investment legend and founder of Investor's Business Daily newspaper. O'Neil has long been one of the more vocal proponents of the "8%-loss-and-out" sell rule.
Note that this rule applies only to newly purchased stocks--not to price moves in shares that an investor has owned for a while and that have appreciated in value.
In those cases, assuming you're holding the stock as a long-term investment, interim moves that may erase some of your gain (without reducing your original principal) are OK to ride out, so long as they reflect overall market weakness rather than problems specific to the company.
The conventional thinking about sticking with a stock that falls sharply from your purchase level also misses another point: A stock often turns down before an erosion in the company's fundamentals is readily apparent.
Even the most diligent investors have trouble getting access to the best information. They may not know exactly why a stock is going down, but they can often infer from the action in the shares that the company's outlook is dimming.
"Many times a stock will tell you something bad about the company before anyone else will," said Tom Barry, investment chief at George D. Bjurman & Associates in Century City, which manages $1 billion.
*
But what about the practical issues involved in quickly selling stocks that move against you? True, there are commission costs. And depending on market conditions, an investor may end up taking a large number of losses.
Still, better to take smaller losses than risk that they become major losses, many pros say.
Investment legend Peter Lynch has long noted that investors are likely to make the bulk of their profits in a relative handful of stocks that rise dramatically over time. Most stocks in a portfolio, Lynch has said, will be mediocre or poor performers. Thus, keeping losses to a minimum assures that your few big gainers aren't watered down by big losers.
Indeed, many pros insist that small investors' prime mistake usually is to hold losers too long, hoping to at least break even.
"There are too many companies where things are going great. Why not switch?" Barry said. "There are so many people who don't want to admit a loss, so they hold their losers. We do the opposite. We sell the losers and keep the winners."
Psychologically, the 8%-loss sell rule may be easiest to observe in the case of higher-priced stocks. An 8% drop in a $50 stock is $4, while for a $25 stock it's only $2.
Still, investors should remember to focus on the percentage loss, not the dollar amount.
*
To see the benefit of the 8% sell rule in action, imagine you bought Chase Manhattan at its July 31 peak of $77.56. Let's say you disregarded the sell rule, which would have gotten you out a mere two days later at about $71, as the stock slumped.
You might have figured that Chase, as a blue-chip stock, would be insulated from a sharp drop.
But amid deepening worries about U.S. banks' potential trading and loan losses overseas, Chase shares have plunged to $47.88 now--a drop of 38% from the peak.
It's entirely possible that the fears are overdone and that Chase will emerge unscathed from the current global turmoil.
But it remains to be seen whether an investor who has ridden the stock down will be able to claim the same thing.
*
Times staff writer Walter Hamilton can be reached by e-mail at walter.hamilton@latimes.com.
http://articles.latimes.com/1998/sep/18/business/fi-23902
By WALTER HAMILTON
September 18, 1998
When should you sell a stock? If you're bargain hunting in today's dicey market, the answer is sooner rather than later--that is, if the stock moves against you.
The market's summer plunge has made for some good buying opportunities. But it has also made for a risky investment climate in which it's easy to lose money quickly, experts note.
To protect against that, some investment pros say individual investors should take the bold step of jettisoning any stock that falls as little as 8% from the price at which they bought it.
The reasoning: For most of the 1990s' bull market, stocks often bounced back quickly from trouble as a rising tide lifted most boats. But today, a stock that begins to sink may quickly crash--and stay down.
"The very best investors I know have very set parameters for losses," said Jonathan Lee, managing partner at Hollister Asset Management, a money management firm in Century City. "They say: 'I'm going to buy and have very tight risk parameters. If it goes down 5%, I'm out.' "
Dumping a stock that drops 8% or so from your entry price may sound drastic. Even in a good market, prices naturally ebb and flow, and an investor who sells after a small loss could subsequently watch the stock rebound.
Indeed, conventional wisdom is that an investor needn't reexamine a stock unless it declines 15% or more. If a stock has fallen simply because of market sentiment--rather than because of a fundamental change in the company's prospects--traditional thinking says an investor should hold on.
But in a high-risk market like this one, one or two sizable losses can crush a portfolio.
Think about this: If an investor waits to sell a falling stock until the loss is 20%, and then reinvests the proceeds in another stock, that new holding must rise 25% just to recoup the original amount. After a loss of 30%, a fresh holding must climb 43% to get the investor back to even.
*
Some pros take a more basic view of why losers should quickly be sold.
"The best reason why you should not hold [a losing] stock is . . . you've made a mistake," said David Ryan, head of Ryan Capital Management, a Santa Monica-based hedge fund.
Ryan is a onetime protege of William O'Neil, an investment legend and founder of Investor's Business Daily newspaper. O'Neil has long been one of the more vocal proponents of the "8%-loss-and-out" sell rule.
Note that this rule applies only to newly purchased stocks--not to price moves in shares that an investor has owned for a while and that have appreciated in value.
In those cases, assuming you're holding the stock as a long-term investment, interim moves that may erase some of your gain (without reducing your original principal) are OK to ride out, so long as they reflect overall market weakness rather than problems specific to the company.
The conventional thinking about sticking with a stock that falls sharply from your purchase level also misses another point: A stock often turns down before an erosion in the company's fundamentals is readily apparent.
Even the most diligent investors have trouble getting access to the best information. They may not know exactly why a stock is going down, but they can often infer from the action in the shares that the company's outlook is dimming.
"Many times a stock will tell you something bad about the company before anyone else will," said Tom Barry, investment chief at George D. Bjurman & Associates in Century City, which manages $1 billion.
*
But what about the practical issues involved in quickly selling stocks that move against you? True, there are commission costs. And depending on market conditions, an investor may end up taking a large number of losses.
Still, better to take smaller losses than risk that they become major losses, many pros say.
Investment legend Peter Lynch has long noted that investors are likely to make the bulk of their profits in a relative handful of stocks that rise dramatically over time. Most stocks in a portfolio, Lynch has said, will be mediocre or poor performers. Thus, keeping losses to a minimum assures that your few big gainers aren't watered down by big losers.
Indeed, many pros insist that small investors' prime mistake usually is to hold losers too long, hoping to at least break even.
"There are too many companies where things are going great. Why not switch?" Barry said. "There are so many people who don't want to admit a loss, so they hold their losers. We do the opposite. We sell the losers and keep the winners."
Psychologically, the 8%-loss sell rule may be easiest to observe in the case of higher-priced stocks. An 8% drop in a $50 stock is $4, while for a $25 stock it's only $2.
Still, investors should remember to focus on the percentage loss, not the dollar amount.
*
To see the benefit of the 8% sell rule in action, imagine you bought Chase Manhattan at its July 31 peak of $77.56. Let's say you disregarded the sell rule, which would have gotten you out a mere two days later at about $71, as the stock slumped.
You might have figured that Chase, as a blue-chip stock, would be insulated from a sharp drop.
But amid deepening worries about U.S. banks' potential trading and loan losses overseas, Chase shares have plunged to $47.88 now--a drop of 38% from the peak.
It's entirely possible that the fears are overdone and that Chase will emerge unscathed from the current global turmoil.
But it remains to be seen whether an investor who has ridden the stock down will be able to claim the same thing.
*
Times staff writer Walter Hamilton can be reached by e-mail at walter.hamilton@latimes.com.
http://articles.latimes.com/1998/sep/18/business/fi-23902
Learning from a 10-bagger
Learning from a 10-bagger
Posted Aug 30 2009, 11:57 PM
by AllStar Portfolio Rating: Filed under: investing, CAPS
Since I'm sure you're just as tired as I am with blogs about “calling” Sirius (SIRI) at 5 cents, and since I'm equally sure you don't want to hear someone bragging about how great of an investor they are, especially if your portfolio is still down from the recent carnage, let me be clear that you won't find that in this post! (I’ll leave that for when I score my 10th or so 10-bagger, not my first, especially when I have some serious losses to more than help balance my ego).
An investor who wants to be successful (and don't we all!), should spend some time and effort examining the stocks in their portfolio, both the winners and the losers to see what they can learn from the investment. I think investors DO spend a great deal of time considering those stocks that didn't perform as as they had hoped.
They are either angry at themselves, blaming company management, blaming the economy, blaming "Mr. Market" for being foolish or contrary, or blaming their third grade teacher for not doing a better job of teaching them basic math. Rather than blaming anyone, a thorough analysis of what they may have left out would be a better use of their time if they want to avoid similar mistakes.
Less obvious: We should study our winners. This could be equally as beneficial, but I suspect we rarely take this route either. A ten bagger -- a stock that has gone up 10 times its purchase price -- can happen without a great deal of investment skills, especially in the current market.
Pharmaceuticals
Whether it's a ride on a pharmaceutical that gets good news or a stock that Mr. Market has left for dead, 10-baggers can be found, especially in this economy, without having to ride them up for decades.
While being savvy enough, (or lucky enough), to jump on Human Genome Sciences (HGSI) soon after it plummeted to 50 cents on March 11th and riding it up to $20 on August 26th would have been a thrilling ride, and a great “trade”, it’s not quite the investing multi-bagger I’m referring to.
Pharmaceuticals are certainly an area where you might have a chance for a 10+ bagger in quick order. If one trades these, however, they should understand that the losers will outnumber the winners. (The FDA is more fickle than pretty much anything else you can think of, including.....well, I'll let you finish that sentence, I'm not sure if my relatives will read this).
Having held Dendreon (DNDN) for the longer leg up, I can relate that it’s easy to day dream. This might be acceptable if you’re willing to risk a small part of your portfolio, but such trading should not be your plan for an early retirement. Likewise in this market, taking a chance on a stock that Mr. Market priced for bankruptcy in the 60-cent range and riding it up to $8 is another way to “trade” your way into a 10-bagger, (examples being TRW Automotive (TRW), Dollar Thrifty (DTO), Las Vegas Sands (LVS), Tenneco (TEN) and many others).
For me, those would be good trades, but not quite what I consider an investment-grade 10-bagger. For me, it’s the home-grown, getting in when the equity is fair-valued by fundamental standards, and riding it up as it grows in earnings and potential.
This type of 10-bagger use to be more prevalent back in the tech days of the 90’s. In fact it was only a fraction of what EMC (EMC), Dell (DELL), Amazon (AMZN), and other Internet potential stocks achieved. Of course the bubble bursting shows you can ride a 10-bagger back down as fast or faster as you rode it up. You can also grow a 10-bagger over decades such as General Electric (GE) or Wal-Mart (WMT).
My first 10-bagger goes more along the lines of the tech bubble stocks, achieving the 10-bagger status for me in just under a year.
STEC (STEC) spent the eight years of its relatively young history often cycling between $2 and $12. As a designer and manufacturer of computer memory modules, it was at the whim of the tech industry to keep it's product "current" with each new computer technology. Each new memory generation was a source of renewed sales, but a nightmare controlling the inventory on now obsolete parts. Supply and demand controlled the earnings reports.
Enter the year of solid state disk drives. Most disk drive companies had decided that solid state hard drives, made entiredly from memory modules, were too expensive and would not be embraced by the market for several years. In the area of disruptive technology, STEC decided that there would be some cases where data-intensive applications might be make the user willing to pay a premium for speed and reliability, with no moving parts. There were also technical challenges, especially in regard to static memory being subjected to many thousands of writes and erasures.
STEC's share price has gone from $3.55, when I purchased a small stake, to $39.90 on Aug. 28. While development took a great deal of time, STEC did find willing partners to help evaluate the technology. When EMC validated that the technology was sound and the time IS NOW, (in limited quantities and specific applications), the major disk drive vendors were left flat-footed. It can take a year or more for a company to qualify technology. IBM (IBM) , Sun Microsystems (JAVA), Hitachi (HIT), and other storage companies soon certified the STEC drive. Other drive manufacturers are struggling to catch up, but for now, STEC dominates the market.
So what have I learned from my 10-bagger?
•Buy what you know. This old adage tells us that we should have some understanding of what we invest in. It doesn’t mean that we need to be an aeronautics engineer to buy Boeing. It doesn’t mean that we need to be a doctor to buy HGSI. It does mean that we should understand something about the industry. The more the better so we can make intelligent decisions about how wide someone’s moat is, how competition will affect our thesis, how regulation or environment rules might restrict bring a product to market, or how a recession might affect our potential.
•It’s NOT all in the Fundamentals: I still see people shorting STEC. Each month, there is a fresh round of shorts whose only thesis appears to be “too far too fast”, “overvalued”, “P/E over 100”, “bad five-year chart”. Yes, a rapidly growing company can look a little “scary” as the stock price climbs and the P/E looks out of whack. Yes, current P/E does “seem” high, but what about the forward P/E, 18, not bad in the tech field. Quarterly growth was1,269%, not bad in any industry. Toss in market domination, no serious competition, no debt, expanded manufacturing capabilities, and you have a recipe for growth that can’t be measured on past data.
•Ride your winners: This is a lesson that I’m still struggling with as STEC exceeds my target ratio of any individual stock in my portfolio. For some, selling a third or half is a good compromise to lock in gains, especially if one isn’t sure why the stock rose so high, or what the real upside might be. The “ride your winners” may be the hardest thing to do to score that elusive 10-bagger as you will have ample time to talk yourself out of “risking” that new found gain, especially in this type of market. The key is to reevaluate your thesis, why you bought the stock in the first place. If I feel a stock got beaten down too far by Mr. Market and the stock rises back to a new five year high, and then some, all while having earnings that are topped off well below historical highs, then it might be time to sell. Having a hard target to sell without reevaluating can be an easy way to play the stock, but certainly doesn’t give you an opportunity to ride winners that have a fresh outlook. Rebalancing is an issue that investors need to determine based on their own risk/reward.
•Small Cap stocks have the best chance to have rapid returns: Plenty of larger companies have show the way to stellar gains, but it's a little harder to double when you're market cap is $1 Billion than it is when it's $100 Million, and if you want to grow a 10-bagger, it's harder still for big companies. There is nothing wrong with the large companies, giving you steady growth, value, and dividends. Every portfolio should have a good mix. From my reflections, however, I will always have a few small caps in my portfolio. Do expect volitility to be higher, and do plan on reevaluating them more often. Companies with "disruptive technology" and a wide moat can give you the most growth and best chance of holding the growth. These terms are oft used and while some people think disruptive technology can only happen in the tech world, like STEC, there can be disruption, or wide moats in many industries.
• I never buy enough of my winners: No explanation needed here, but the lesson is that we can't get greedy, and we'll never be totally happy, even with 10-baggers! I learned this lesson well with Dendreon, but as a high risk “trade”, I’m not sorry. By the same token, having a plan when you go into a stock, an initial thesis for why you would sell, and your own definition of diversity in your portfolio means that you should be less likely to waste valuable self reflection second guessing yourself! I try hard not to spend my time playing the “if”, “should have, could have” game. Although I do play the “glad I didn’t” game! It would be nice if our biggest problem was when to sell our winners, but yes, we do need to learn from our losers as well, however, I’ll save that for another day.
May all of you learn some lessons from your own 10-bagger investment.
VISIT Allstarportfolio at WallStreetSurvivor.com
BLOG entry by Motley Fool, Allstarportfolio contributor TSIF on Caps.
Allstarportfolio is a collection of investors using community intelligence as one tool for investing. STEC is a holding in the allstarportfolio wallstreetsurvivor portfolio. At the time of this posting, the author is LONG on STEC, and believes it has room to grow. The writer also is also long EMC and GE and has long options in Dell. The writer has no holdings in any other stock referenced in this article, including WDC, STX, DNDN, IBM, DTO, TRW, JAVA, HIT, HGSI, LVS, TEN, or WMT
http://blogs.moneycentral.msn.com/topstocks/archive/2009/08/30/learning-from-our-winners-what-i-learned-from-a-10-bagger.aspx
Posted Aug 30 2009, 11:57 PM
by AllStar Portfolio Rating: Filed under: investing, CAPS
Since I'm sure you're just as tired as I am with blogs about “calling” Sirius (SIRI) at 5 cents, and since I'm equally sure you don't want to hear someone bragging about how great of an investor they are, especially if your portfolio is still down from the recent carnage, let me be clear that you won't find that in this post! (I’ll leave that for when I score my 10th or so 10-bagger, not my first, especially when I have some serious losses to more than help balance my ego).
An investor who wants to be successful (and don't we all!), should spend some time and effort examining the stocks in their portfolio, both the winners and the losers to see what they can learn from the investment. I think investors DO spend a great deal of time considering those stocks that didn't perform as as they had hoped.
They are either angry at themselves, blaming company management, blaming the economy, blaming "Mr. Market" for being foolish or contrary, or blaming their third grade teacher for not doing a better job of teaching them basic math. Rather than blaming anyone, a thorough analysis of what they may have left out would be a better use of their time if they want to avoid similar mistakes.
Less obvious: We should study our winners. This could be equally as beneficial, but I suspect we rarely take this route either. A ten bagger -- a stock that has gone up 10 times its purchase price -- can happen without a great deal of investment skills, especially in the current market.
Pharmaceuticals
Whether it's a ride on a pharmaceutical that gets good news or a stock that Mr. Market has left for dead, 10-baggers can be found, especially in this economy, without having to ride them up for decades.
While being savvy enough, (or lucky enough), to jump on Human Genome Sciences (HGSI) soon after it plummeted to 50 cents on March 11th and riding it up to $20 on August 26th would have been a thrilling ride, and a great “trade”, it’s not quite the investing multi-bagger I’m referring to.
Pharmaceuticals are certainly an area where you might have a chance for a 10+ bagger in quick order. If one trades these, however, they should understand that the losers will outnumber the winners. (The FDA is more fickle than pretty much anything else you can think of, including.....well, I'll let you finish that sentence, I'm not sure if my relatives will read this).
Having held Dendreon (DNDN) for the longer leg up, I can relate that it’s easy to day dream. This might be acceptable if you’re willing to risk a small part of your portfolio, but such trading should not be your plan for an early retirement. Likewise in this market, taking a chance on a stock that Mr. Market priced for bankruptcy in the 60-cent range and riding it up to $8 is another way to “trade” your way into a 10-bagger, (examples being TRW Automotive (TRW), Dollar Thrifty (DTO), Las Vegas Sands (LVS), Tenneco (TEN) and many others).
For me, those would be good trades, but not quite what I consider an investment-grade 10-bagger. For me, it’s the home-grown, getting in when the equity is fair-valued by fundamental standards, and riding it up as it grows in earnings and potential.
This type of 10-bagger use to be more prevalent back in the tech days of the 90’s. In fact it was only a fraction of what EMC (EMC), Dell (DELL), Amazon (AMZN), and other Internet potential stocks achieved. Of course the bubble bursting shows you can ride a 10-bagger back down as fast or faster as you rode it up. You can also grow a 10-bagger over decades such as General Electric (GE) or Wal-Mart (WMT).
My first 10-bagger goes more along the lines of the tech bubble stocks, achieving the 10-bagger status for me in just under a year.
STEC (STEC) spent the eight years of its relatively young history often cycling between $2 and $12. As a designer and manufacturer of computer memory modules, it was at the whim of the tech industry to keep it's product "current" with each new computer technology. Each new memory generation was a source of renewed sales, but a nightmare controlling the inventory on now obsolete parts. Supply and demand controlled the earnings reports.
Enter the year of solid state disk drives. Most disk drive companies had decided that solid state hard drives, made entiredly from memory modules, were too expensive and would not be embraced by the market for several years. In the area of disruptive technology, STEC decided that there would be some cases where data-intensive applications might be make the user willing to pay a premium for speed and reliability, with no moving parts. There were also technical challenges, especially in regard to static memory being subjected to many thousands of writes and erasures.
STEC's share price has gone from $3.55, when I purchased a small stake, to $39.90 on Aug. 28. While development took a great deal of time, STEC did find willing partners to help evaluate the technology. When EMC validated that the technology was sound and the time IS NOW, (in limited quantities and specific applications), the major disk drive vendors were left flat-footed. It can take a year or more for a company to qualify technology. IBM (IBM) , Sun Microsystems (JAVA), Hitachi (HIT), and other storage companies soon certified the STEC drive. Other drive manufacturers are struggling to catch up, but for now, STEC dominates the market.
So what have I learned from my 10-bagger?
•Buy what you know. This old adage tells us that we should have some understanding of what we invest in. It doesn’t mean that we need to be an aeronautics engineer to buy Boeing. It doesn’t mean that we need to be a doctor to buy HGSI. It does mean that we should understand something about the industry. The more the better so we can make intelligent decisions about how wide someone’s moat is, how competition will affect our thesis, how regulation or environment rules might restrict bring a product to market, or how a recession might affect our potential.
•It’s NOT all in the Fundamentals: I still see people shorting STEC. Each month, there is a fresh round of shorts whose only thesis appears to be “too far too fast”, “overvalued”, “P/E over 100”, “bad five-year chart”. Yes, a rapidly growing company can look a little “scary” as the stock price climbs and the P/E looks out of whack. Yes, current P/E does “seem” high, but what about the forward P/E, 18, not bad in the tech field. Quarterly growth was1,269%, not bad in any industry. Toss in market domination, no serious competition, no debt, expanded manufacturing capabilities, and you have a recipe for growth that can’t be measured on past data.
•Ride your winners: This is a lesson that I’m still struggling with as STEC exceeds my target ratio of any individual stock in my portfolio. For some, selling a third or half is a good compromise to lock in gains, especially if one isn’t sure why the stock rose so high, or what the real upside might be. The “ride your winners” may be the hardest thing to do to score that elusive 10-bagger as you will have ample time to talk yourself out of “risking” that new found gain, especially in this type of market. The key is to reevaluate your thesis, why you bought the stock in the first place. If I feel a stock got beaten down too far by Mr. Market and the stock rises back to a new five year high, and then some, all while having earnings that are topped off well below historical highs, then it might be time to sell. Having a hard target to sell without reevaluating can be an easy way to play the stock, but certainly doesn’t give you an opportunity to ride winners that have a fresh outlook. Rebalancing is an issue that investors need to determine based on their own risk/reward.
•Small Cap stocks have the best chance to have rapid returns: Plenty of larger companies have show the way to stellar gains, but it's a little harder to double when you're market cap is $1 Billion than it is when it's $100 Million, and if you want to grow a 10-bagger, it's harder still for big companies. There is nothing wrong with the large companies, giving you steady growth, value, and dividends. Every portfolio should have a good mix. From my reflections, however, I will always have a few small caps in my portfolio. Do expect volitility to be higher, and do plan on reevaluating them more often. Companies with "disruptive technology" and a wide moat can give you the most growth and best chance of holding the growth. These terms are oft used and while some people think disruptive technology can only happen in the tech world, like STEC, there can be disruption, or wide moats in many industries.
• I never buy enough of my winners: No explanation needed here, but the lesson is that we can't get greedy, and we'll never be totally happy, even with 10-baggers! I learned this lesson well with Dendreon, but as a high risk “trade”, I’m not sorry. By the same token, having a plan when you go into a stock, an initial thesis for why you would sell, and your own definition of diversity in your portfolio means that you should be less likely to waste valuable self reflection second guessing yourself! I try hard not to spend my time playing the “if”, “should have, could have” game. Although I do play the “glad I didn’t” game! It would be nice if our biggest problem was when to sell our winners, but yes, we do need to learn from our losers as well, however, I’ll save that for another day.
May all of you learn some lessons from your own 10-bagger investment.
VISIT Allstarportfolio at WallStreetSurvivor.com
BLOG entry by Motley Fool, Allstarportfolio contributor TSIF on Caps.
Allstarportfolio is a collection of investors using community intelligence as one tool for investing. STEC is a holding in the allstarportfolio wallstreetsurvivor portfolio. At the time of this posting, the author is LONG on STEC, and believes it has room to grow. The writer also is also long EMC and GE and has long options in Dell. The writer has no holdings in any other stock referenced in this article, including WDC, STX, DNDN, IBM, DTO, TRW, JAVA, HIT, HGSI, LVS, TEN, or WMT
http://blogs.moneycentral.msn.com/topstocks/archive/2009/08/30/learning-from-our-winners-what-i-learned-from-a-10-bagger.aspx
Loss Aversion versus Risk Aversion
http://www.ppfas.com/media/articles/how-the-wish.pdf
"It makes sense to ride the winners and sell the losers, but loss aversion makes people do the exact opposite."
Why do most portfolios have a few winners but a long list of losers? Why are your profits from your winners smaller than your losses from your losers? Due to loss aversion, investors sell their winners fast and hold on to the losers. Investors behave as if the loss occurs when the sale is made, when in fact the loss has already occurred, with the depreciation in price. Offsetting a loss against other income has tax benefits, too - it makes good sense to ride the winners and sell the losers. But loss aversion makes people do the exact opposite.
"It makes sense to ride the winners and sell the losers, but loss aversion makes people do the exact opposite."
Why do most portfolios have a few winners but a long list of losers? Why are your profits from your winners smaller than your losses from your losers? Due to loss aversion, investors sell their winners fast and hold on to the losers. Investors behave as if the loss occurs when the sale is made, when in fact the loss has already occurred, with the depreciation in price. Offsetting a loss against other income has tax benefits, too - it makes good sense to ride the winners and sell the losers. But loss aversion makes people do the exact opposite.
Emodons Rule
Seeking Pride and Avoiding Regret
People avoid actions that create regret and seek actions that cause pride. Regret is the emotional pain that comes with realizing that a previous decision has turned out badly. Pride is the emotional joy of realizing that a decision has turned out to be a good decision.
Say you've been playing the lottery.
You have been selecting the same lottery ticket numbers every week for months. Not surprisingly, you have not won. A friend suggests a different set of numbers. Do you change numbers?
Clearly, the likelihood of the old set of numbers winning is the same as the likelihood of the new set of numbers winning. There are two possible sources of regret in this example. Regret may be felt if you stick with the old numbers and the new numbers win, called the regret of omission (not taking an action).
Alternatively, regret would also be felt if you switch to the new numbers and the old numbers win. The regret of an action you took is the regret of commission. In which case would the pain of regret be stronger? The stronger regret is most likely from switching to the new numbers because you have a lot of emotional capital in the old numbers - after all, you have been selecting them for months. A regret of commission is more painful than a regret of omission.
DISPOSITION EFFECT
Avoiding regret and seeking pride affects people's behavior, but how does it affect investment decisions? This is called the disposition effect.
Consider the situation in which you wish to invest in a particular stock, Lucent. However, you have no cash and must sell a position in another stock in order to buy the purchase it in the nrst place. You enjoy pride at locking in your profit. Selling Microsoft at a loss means realizing that your decision to purchase it was bad. You would feel the pain of regret. The disposition effect predicts that you will sell the winner, IBM. Selling IBM triggers the feeling of pride and avoids the feeling of regret.
It's common sense that because of this you may sell your winners more frequently than your losers. Why is this a problem? One reason that this is a problem is because of the U.S. tax code. The taxation of capital gains causes the selling of losers to be the wealth-maximizing strategy. Selling a winner causes the realization of a capital gain and thus the payment of taxes. Those taxes reduce your profit. Selling the losers gives you a chance to reduce your taxes, thus decreasing the amount of the loss. Reconsider the IBM/Microsoft example and assume that capital gains are taxed at the 20% rate. If your positions in Microsoft and IBM are each valued at $1,000, then the original purchase price of IBM must have been $833 to have earned a 20% return. Likewise, the purchase price of Microsoft must have been $1,250 to have experienced a 20% loss. Table 5.1 shows which stock would be more advantageous to sell when you look at the total picture.
If you sell IBM, you receive $1,000, but you pay taxes of $33, so your net gain is $967. Alternatively, you could sell Microsoft and receive $1,000, plus gain a tax credit of $50 to be used against other capital gains in your portfolio; so your net gain is $1,050. If the tax rate is higher than 20% (as in the case of gains realized within one year of the stock purchase), then the advantage of selling the loser is even greater. The disposition effect predicts the selling of winners. However, it is the selling of losers that is the wealth-maximizing strategy!
This is not a recommendation to sell a stock as soon as it goes down in price - stock prices do frequently fluctuate. Instead, the disposition effect refers to hanging on to stocks that have fallen during the past six or nine months, when you really should be considering selling them. This is a psychological bias that affects you over a fairly long period of time. We'll discuss a similar, but opposite behavior in the next chapter, one that happens very quickly - where there is a quick drop in price and the "snake-bit" investor dumps the stocks quickly.
SELLING TO MAXIMIZE WEALTH
SEEKING PRIDE AND AVOIDING REGRET
DO WE REALLY SELL WINNERS?
So, do you behave in a rational manner and predominately sell losers, or are you affected by your psychology and have a tendency to sell your winners? Several studies provide insight into what investors really do.
One study examined 75,000 round-trip trades of a national brokerage house. A round-trip trade is a stock purchase followed later by the sale of the stock. Which stocks did investors sell - the winners or the losers? The study examined the length of time the stock was held and the return that was received. Are investors quick to close out a position when it has taken a loss or when it has a gain? Figure 5.1 shows the average annualized return for positions held 0-30 days, 31-182 days, 183-365 days, and over 365 days. Figure 5.1 indicates that investors are quick to realize their gains. The average annualized return for stocks purchased and then sold within the first 30 days was 45%. The returns for stocks held 31-182 days, 183-365 days, and over 365 days were 7.8%, 5.1%, and 4.5%, respectively.
It is apparent that investors are quick to sell winners. If you buy a stock and it quickly jumps in price, you become tempted to sell it and lock in the profit. You can now go out and seek pride by telling your neighbors about your quick profit. On the other hand, if you buy a stock and it goes down in price, you wait. Later, if it goes back up, you may sell or wait longer. However, selling the winner creates tax payments!
ANNUALIZED RETURN FOR DIFFERENT INVESTOR HOLDING PERIODS.
This behavior can be seen after initial public offering (IPO) shares hit the market. Shares of the IPO are first sold to the clients of the investment banks and brokerage firms helping the company go public. As we will discuss in detail in the next chapter, the price paid by these initial shareholders is often substantially less than the initial sales price of the stock on the stock exchange. These original shareholders often quickly sell the stock on the stock market for a quick profit - so often, in fact, that it has a special name: flipping IPOs. There are times, however, that the IPO does not start trading at a higher price on the stock exchange. Sometimes the price falls. The volume of shares traded is lower for these declining-price IPOs than for the increasing-price IPOs. The original investors are quick to flip increasing-price IPOs, but they tend to hold the declining-price IPOs hoping for a rebound.
Another study by Terrance Odean examined the trades of 10,000 accounts from a nationwide discount brokerage. He found that, when investors sell winners, the sale represents 23% of the total gains of the investor's portfolio. In other words, investors sell the big winners - one stock representing one quarter of the profits. He also found that, on average, investors are 50% more likely to sell a winner than a loser. Investors are prone to letting their losses ride.
Do you avoid selling losers? If you hear yourself in any of the following comments, you hold on to losers.
SEEKING PRIDE AND AVOIDING REGRET
■ The stock price has dropped so much, I can't sell it now!
■ I will hold this stock because it can't possibly fall any farther.
Sound familiar? Many investors will not sell anything at a loss because they don't want to give up the hope of making their money back. Meanwhile, they could be making money somewhere else.
Selling Winners Too Soon and Holding Losers Too Long
Not only does the disposition effect predict the selling of winners, it also suggests that the winners are sold too soon and the losers are held too long*.
What does selling too soon or holding too long imply? Selling a winner too soon suggests that it would have continued to perform well for you if you had not sold it. Holding losers too long suggests that your stocks with price declines will continue to perform poorly and will not rebound with the speed you hope for.
Do investors sell winners too soon and hold losers too long, as suggested by the disposition effect? Odean's study found that, when an investor sold a winner stock, the stock beat the market during the next year by an average of 2.35%. In other words, it continued to perform pretty well. During this same year, the loser stocks that the investor kept underperformed the market by -1.06%. In short, you tend to sell the stock that ends up providing a high return and keep the stock that provides a lower return.
So we've seen that the fear of regret and the seeking of pride hurts your wealth in two ways:
■ You are paying more in taxes because of the disposition to sell winners instead of losers.
■ You earn a lower return on your portfolio because you sell the winners too early and hold on to poorly performing stocks that continue to perform poorly.
React to a news story? Buy, sell, hold? I examined the trades of individual investors with holdings in 144 New York Stock Exchange companies in relation to news reports.5 I specifically studied investor reaction either to news about the company or to news about the economy. News about a company mostly affects the price of just that company's stock, whereas economic news affects the stock prices of all companies. The results are interesting. Good news about a company resulting in an increase in the stock price induces investors to sell (selling winners). Bad news about a company does not induce investors to sell (holding losers). This is consistent with avoiding regret and seeking pride.
However, news about the economy does not induce investor trading. Although good economic news increases stock prices and bad economic news lowers stock prices, this does not cause individual investors to sell. In fact, investors are less likely than usual to sell winners after good economic news. Investor reaction to economic news is not consistent with the disposition effect.
This illustrates an interesting characteristic of regret. After taking a stock loss, investors feel stronger regret if the loss can be tied to their own decision. However, if the investor can attribute the loss to things out of his or her control, then the feeling of regret is weaker. For example, if the stock you hold declines in price when the stock market itself is advancing, then you have made a bad choice and regret is strong. In this case, you would avoid selling the stock because you want to avoid the strong regret feelings. Alternatively, if the stock you hold drops in price during a general market decline, then this is divine intervention and out of your control. The feeling of regret is weak and you may be more inclined to sell.
In the case of news about a company, your actions are consistent with the disposition effect because the feeling of regret is strong. In the case of economic news, you have a weaker feeling of regret because the outcome is considered out of your control. This leads to actions that are not consistent with the predictions of the disposition effect.
http://www.wdc-econdev.com/THE-INVESTMENT-ENVIRONMENT/emodons-rule-investment-banks.html
People avoid actions that create regret and seek actions that cause pride. Regret is the emotional pain that comes with realizing that a previous decision has turned out badly. Pride is the emotional joy of realizing that a decision has turned out to be a good decision.
Say you've been playing the lottery.
You have been selecting the same lottery ticket numbers every week for months. Not surprisingly, you have not won. A friend suggests a different set of numbers. Do you change numbers?
Clearly, the likelihood of the old set of numbers winning is the same as the likelihood of the new set of numbers winning. There are two possible sources of regret in this example. Regret may be felt if you stick with the old numbers and the new numbers win, called the regret of omission (not taking an action).
Alternatively, regret would also be felt if you switch to the new numbers and the old numbers win. The regret of an action you took is the regret of commission. In which case would the pain of regret be stronger? The stronger regret is most likely from switching to the new numbers because you have a lot of emotional capital in the old numbers - after all, you have been selecting them for months. A regret of commission is more painful than a regret of omission.
DISPOSITION EFFECT
Avoiding regret and seeking pride affects people's behavior, but how does it affect investment decisions? This is called the disposition effect.
Consider the situation in which you wish to invest in a particular stock, Lucent. However, you have no cash and must sell a position in another stock in order to buy the purchase it in the nrst place. You enjoy pride at locking in your profit. Selling Microsoft at a loss means realizing that your decision to purchase it was bad. You would feel the pain of regret. The disposition effect predicts that you will sell the winner, IBM. Selling IBM triggers the feeling of pride and avoids the feeling of regret.
It's common sense that because of this you may sell your winners more frequently than your losers. Why is this a problem? One reason that this is a problem is because of the U.S. tax code. The taxation of capital gains causes the selling of losers to be the wealth-maximizing strategy. Selling a winner causes the realization of a capital gain and thus the payment of taxes. Those taxes reduce your profit. Selling the losers gives you a chance to reduce your taxes, thus decreasing the amount of the loss. Reconsider the IBM/Microsoft example and assume that capital gains are taxed at the 20% rate. If your positions in Microsoft and IBM are each valued at $1,000, then the original purchase price of IBM must have been $833 to have earned a 20% return. Likewise, the purchase price of Microsoft must have been $1,250 to have experienced a 20% loss. Table 5.1 shows which stock would be more advantageous to sell when you look at the total picture.
If you sell IBM, you receive $1,000, but you pay taxes of $33, so your net gain is $967. Alternatively, you could sell Microsoft and receive $1,000, plus gain a tax credit of $50 to be used against other capital gains in your portfolio; so your net gain is $1,050. If the tax rate is higher than 20% (as in the case of gains realized within one year of the stock purchase), then the advantage of selling the loser is even greater. The disposition effect predicts the selling of winners. However, it is the selling of losers that is the wealth-maximizing strategy!
This is not a recommendation to sell a stock as soon as it goes down in price - stock prices do frequently fluctuate. Instead, the disposition effect refers to hanging on to stocks that have fallen during the past six or nine months, when you really should be considering selling them. This is a psychological bias that affects you over a fairly long period of time. We'll discuss a similar, but opposite behavior in the next chapter, one that happens very quickly - where there is a quick drop in price and the "snake-bit" investor dumps the stocks quickly.
SELLING TO MAXIMIZE WEALTH
SEEKING PRIDE AND AVOIDING REGRET
DO WE REALLY SELL WINNERS?
So, do you behave in a rational manner and predominately sell losers, or are you affected by your psychology and have a tendency to sell your winners? Several studies provide insight into what investors really do.
One study examined 75,000 round-trip trades of a national brokerage house. A round-trip trade is a stock purchase followed later by the sale of the stock. Which stocks did investors sell - the winners or the losers? The study examined the length of time the stock was held and the return that was received. Are investors quick to close out a position when it has taken a loss or when it has a gain? Figure 5.1 shows the average annualized return for positions held 0-30 days, 31-182 days, 183-365 days, and over 365 days. Figure 5.1 indicates that investors are quick to realize their gains. The average annualized return for stocks purchased and then sold within the first 30 days was 45%. The returns for stocks held 31-182 days, 183-365 days, and over 365 days were 7.8%, 5.1%, and 4.5%, respectively.
It is apparent that investors are quick to sell winners. If you buy a stock and it quickly jumps in price, you become tempted to sell it and lock in the profit. You can now go out and seek pride by telling your neighbors about your quick profit. On the other hand, if you buy a stock and it goes down in price, you wait. Later, if it goes back up, you may sell or wait longer. However, selling the winner creates tax payments!
ANNUALIZED RETURN FOR DIFFERENT INVESTOR HOLDING PERIODS.
This behavior can be seen after initial public offering (IPO) shares hit the market. Shares of the IPO are first sold to the clients of the investment banks and brokerage firms helping the company go public. As we will discuss in detail in the next chapter, the price paid by these initial shareholders is often substantially less than the initial sales price of the stock on the stock exchange. These original shareholders often quickly sell the stock on the stock market for a quick profit - so often, in fact, that it has a special name: flipping IPOs. There are times, however, that the IPO does not start trading at a higher price on the stock exchange. Sometimes the price falls. The volume of shares traded is lower for these declining-price IPOs than for the increasing-price IPOs. The original investors are quick to flip increasing-price IPOs, but they tend to hold the declining-price IPOs hoping for a rebound.
Another study by Terrance Odean examined the trades of 10,000 accounts from a nationwide discount brokerage. He found that, when investors sell winners, the sale represents 23% of the total gains of the investor's portfolio. In other words, investors sell the big winners - one stock representing one quarter of the profits. He also found that, on average, investors are 50% more likely to sell a winner than a loser. Investors are prone to letting their losses ride.
Do you avoid selling losers? If you hear yourself in any of the following comments, you hold on to losers.
SEEKING PRIDE AND AVOIDING REGRET
■ The stock price has dropped so much, I can't sell it now!
■ I will hold this stock because it can't possibly fall any farther.
Sound familiar? Many investors will not sell anything at a loss because they don't want to give up the hope of making their money back. Meanwhile, they could be making money somewhere else.
Selling Winners Too Soon and Holding Losers Too Long
Not only does the disposition effect predict the selling of winners, it also suggests that the winners are sold too soon and the losers are held too long*.
What does selling too soon or holding too long imply? Selling a winner too soon suggests that it would have continued to perform well for you if you had not sold it. Holding losers too long suggests that your stocks with price declines will continue to perform poorly and will not rebound with the speed you hope for.
Do investors sell winners too soon and hold losers too long, as suggested by the disposition effect? Odean's study found that, when an investor sold a winner stock, the stock beat the market during the next year by an average of 2.35%. In other words, it continued to perform pretty well. During this same year, the loser stocks that the investor kept underperformed the market by -1.06%. In short, you tend to sell the stock that ends up providing a high return and keep the stock that provides a lower return.
So we've seen that the fear of regret and the seeking of pride hurts your wealth in two ways:
■ You are paying more in taxes because of the disposition to sell winners instead of losers.
■ You earn a lower return on your portfolio because you sell the winners too early and hold on to poorly performing stocks that continue to perform poorly.
React to a news story? Buy, sell, hold? I examined the trades of individual investors with holdings in 144 New York Stock Exchange companies in relation to news reports.5 I specifically studied investor reaction either to news about the company or to news about the economy. News about a company mostly affects the price of just that company's stock, whereas economic news affects the stock prices of all companies. The results are interesting. Good news about a company resulting in an increase in the stock price induces investors to sell (selling winners). Bad news about a company does not induce investors to sell (holding losers). This is consistent with avoiding regret and seeking pride.
However, news about the economy does not induce investor trading. Although good economic news increases stock prices and bad economic news lowers stock prices, this does not cause individual investors to sell. In fact, investors are less likely than usual to sell winners after good economic news. Investor reaction to economic news is not consistent with the disposition effect.
This illustrates an interesting characteristic of regret. After taking a stock loss, investors feel stronger regret if the loss can be tied to their own decision. However, if the investor can attribute the loss to things out of his or her control, then the feeling of regret is weaker. For example, if the stock you hold declines in price when the stock market itself is advancing, then you have made a bad choice and regret is strong. In this case, you would avoid selling the stock because you want to avoid the strong regret feelings. Alternatively, if the stock you hold drops in price during a general market decline, then this is divine intervention and out of your control. The feeling of regret is weak and you may be more inclined to sell.
In the case of news about a company, your actions are consistent with the disposition effect because the feeling of regret is strong. In the case of economic news, you have a weaker feeling of regret because the outcome is considered out of your control. This leads to actions that are not consistent with the predictions of the disposition effect.
http://www.wdc-econdev.com/THE-INVESTMENT-ENVIRONMENT/emodons-rule-investment-banks.html
Tuesday, 1 September 2009
Riding the Dot-Com Bubble
Tracking Finances: Riding the Dot-Com Bubble
In the late 90’s when the world was ablaze with dotcom millionaires and it looked as though the stock market could make me wealthy too, I bought a lot of technology stocks — including some start-ups and IPOs (Linux, Red Hat, Pilgrim Technology Fund, EMC and others that I have since become an amnesiac for, thankfully). I rode them all up on a wild ride, and then rode them all down again. When I was tracking finances, I was riding a roller coaster
The actual dollar cost I lost wasn’t too traumatizing, but not selling when the P/E ratios were in the stratosphere was a big mistake that has cost me in the neighborhood of $100,000. To add insult to injury, during this time I came across a beach area lot that I bought, because of its terrific price… but of course, the proceeds I used were from selling my highest-quality investments, and I was left with the speculative garbage or what remained of them. Sell the losers and the low-quality first, and keep the long term winners.
Train Wreck Tuesdays are a weekly post of horrible financial mistakes. They are posted anonymously. Submit your story; if you’re selected, you get a free personal finance book. The best comment gets the same prize! Check out past Train Wreck stories.
http://www.mint.com/blog/train-wreck/tracking-finances-tuesday-train-wreck-dot-com-bubble/
In the late 90’s when the world was ablaze with dotcom millionaires and it looked as though the stock market could make me wealthy too, I bought a lot of technology stocks — including some start-ups and IPOs (Linux, Red Hat, Pilgrim Technology Fund, EMC and others that I have since become an amnesiac for, thankfully). I rode them all up on a wild ride, and then rode them all down again. When I was tracking finances, I was riding a roller coaster
The actual dollar cost I lost wasn’t too traumatizing, but not selling when the P/E ratios were in the stratosphere was a big mistake that has cost me in the neighborhood of $100,000. To add insult to injury, during this time I came across a beach area lot that I bought, because of its terrific price… but of course, the proceeds I used were from selling my highest-quality investments, and I was left with the speculative garbage or what remained of them. Sell the losers and the low-quality first, and keep the long term winners.
Train Wreck Tuesdays are a weekly post of horrible financial mistakes. They are posted anonymously. Submit your story; if you’re selected, you get a free personal finance book. The best comment gets the same prize! Check out past Train Wreck stories.
http://www.mint.com/blog/train-wreck/tracking-finances-tuesday-train-wreck-dot-com-bubble/
Stock market strategy for the winners
Stock market strategy for the winners
by Tejinder Singh Rawal
The recent fall of indices resulted in many speculators and day traders losing their shirts. Crores of rupees worth of capitalisation was lost in a week. The momentum investors who were jubilant at the rising charts during the last six months were suddenly cornered, and many of them lost a substantial part of the gain that they had made. This has prompted me to write about the strategy that most successful investors have followed to beat the street irrespective of which way the indices were going. An investor who plans his investment prudently, keeping a long-term horizon in mind, will succeed even if the indices go down. Here are the suggestions.
Invest for the long term: When Keynes said, in the long run we are all dead, he was certainly not referring to the stock market. The success in stock market largely depends upon your ability to stay invested for a long period. It is strange few people heed this advice! Most investors in Indian markets continue to be short-term investors, and speculators. Day trading is an important characteristic of Indian stock markets. Short-term investment is nothing more than a speculation, and you can rather try your luck at horse races, or at casinos where the probability of success is higher!
Do not time the market: A long-term investor does not try to predict the direction the market is going to take. You should not wait for the market to rise or fall before you decide to invest. Since as a long-term investor you will be focussing on the value of individual share, rather than the frenzy of the market, market direction should not be a cause of concern, as long as you are sure that the investment you are making is attractive, and has a sufficient margin of safety built into it. As a long-term investor, you should not hold your cash, waiting for the market to fall, so that you can invest when the prices are low. You should know the time value of money, which means that the early you invest the higher will be your return. Moreover, if you invest regularly, you are able to take advantage of 'rupee averaging', which takes care of market fluctuations.
Do your homework: As a long-term investor you should know the fundamental value of the share you are buying. Remember that PE ratio is not the acid test of investment. Low PE ratio does not on its own make a particular company worthy of investment, and high PE, per se, does not make a share less attractive. Other factors like the quality of management, break-up value of the share, debt-equity ratio, interest coverage ratio are equally important.
Do not invest in penny stocks: Penny stocks and junk scripts look attractive to the investor when the indices are rising, since the price of these shares usually rise faster than the rise in prices of other shares. However, when the market falls, the investor is left with junk, which has no value. As a matter of principle, you should invest in stock of the only such companies whose fundamentals are known to you. Do not depend on tips, however reliable the source of tip may be. Most of the tips are generated by people with vested interest. Even when the source of the tip is genuine, the time frame the issuer has in mind may be different. If you are tempted to act on a tip, study facts before you decide to go ahead.
Do not panic: This is very important. More money is made in stock market by remaining inactive. It is foolish for a long-term investor to be excited or subdued by the market ticker. CNBC channel is for the short-term traders and day-traders, do not let the opinions expressed there affect your investment decision. If you are confident your investment is fundamentally strong, every fall should give you an opportunity to buy rather than sell. Of course, while you do that keep in mind the principle I have narrated in the next paragraph.
Don't pull your flowers and water your weeds: This strong advice comes from Warren Buffet, the most successful disciple of Ben Graham. The greatest mistake most investors make is to sell the shares that have appreciated, and hold the ones, which are giving a negative return. The investment strategy should be the other way round; you should sell the losers and let the winners ride. I do not mean that you should sell every share that has depreciated. The right course is to keep pruning your field regularly to identify the weed so that they could be removed, and to identify the flowers that should be watered as long as their fundamental value is below the prevailing market price.
Do not invest in the company and sector whose business you do not understand: If you can understand a business and you find value there, invest. Do not be tempted to invest in industry about which you do not have much idea. While there is so much money to be made in technology shares, yet if you do not understand the business, it is better you do not go into it. My personal investment philosophy is to invest in the business, which I would be comfortable running on my own. I apply the same principles even when my investment is as low as 10 shares.
Do your own research: Security analysis is not as difficult as it may seem. You do not have to be a qualified analyst to do the analysis. A basic book on reading the financial statements of a company will be a great investment. When I say that more money is made by being inactive in the market, I certainly do not mean that you should invest and forget. On the other hand, you should keep reviewing the performance of the company you have invested in. If there is a fundamental change in the situation of your company, which has altered the premise based on which you had bought the shares, decide if the change warrants a change in your portfolio.
These principles have been perfected by masters and are time-tested technique for long-term investment in the market. While this is not the only way one can invest, this method is more scientific and if applied consistently, it would make the process of investment a less risky proposition with higher margin of safety.
You can reach him at: tsrawal@tsrawal.com
http://news.indiainfo.com/columns/tejinder/040105investment-strategy.html
by Tejinder Singh Rawal
The recent fall of indices resulted in many speculators and day traders losing their shirts. Crores of rupees worth of capitalisation was lost in a week. The momentum investors who were jubilant at the rising charts during the last six months were suddenly cornered, and many of them lost a substantial part of the gain that they had made. This has prompted me to write about the strategy that most successful investors have followed to beat the street irrespective of which way the indices were going. An investor who plans his investment prudently, keeping a long-term horizon in mind, will succeed even if the indices go down. Here are the suggestions.
Invest for the long term: When Keynes said, in the long run we are all dead, he was certainly not referring to the stock market. The success in stock market largely depends upon your ability to stay invested for a long period. It is strange few people heed this advice! Most investors in Indian markets continue to be short-term investors, and speculators. Day trading is an important characteristic of Indian stock markets. Short-term investment is nothing more than a speculation, and you can rather try your luck at horse races, or at casinos where the probability of success is higher!
Do not time the market: A long-term investor does not try to predict the direction the market is going to take. You should not wait for the market to rise or fall before you decide to invest. Since as a long-term investor you will be focussing on the value of individual share, rather than the frenzy of the market, market direction should not be a cause of concern, as long as you are sure that the investment you are making is attractive, and has a sufficient margin of safety built into it. As a long-term investor, you should not hold your cash, waiting for the market to fall, so that you can invest when the prices are low. You should know the time value of money, which means that the early you invest the higher will be your return. Moreover, if you invest regularly, you are able to take advantage of 'rupee averaging', which takes care of market fluctuations.
Do your homework: As a long-term investor you should know the fundamental value of the share you are buying. Remember that PE ratio is not the acid test of investment. Low PE ratio does not on its own make a particular company worthy of investment, and high PE, per se, does not make a share less attractive. Other factors like the quality of management, break-up value of the share, debt-equity ratio, interest coverage ratio are equally important.
Do not invest in penny stocks: Penny stocks and junk scripts look attractive to the investor when the indices are rising, since the price of these shares usually rise faster than the rise in prices of other shares. However, when the market falls, the investor is left with junk, which has no value. As a matter of principle, you should invest in stock of the only such companies whose fundamentals are known to you. Do not depend on tips, however reliable the source of tip may be. Most of the tips are generated by people with vested interest. Even when the source of the tip is genuine, the time frame the issuer has in mind may be different. If you are tempted to act on a tip, study facts before you decide to go ahead.
Do not panic: This is very important. More money is made in stock market by remaining inactive. It is foolish for a long-term investor to be excited or subdued by the market ticker. CNBC channel is for the short-term traders and day-traders, do not let the opinions expressed there affect your investment decision. If you are confident your investment is fundamentally strong, every fall should give you an opportunity to buy rather than sell. Of course, while you do that keep in mind the principle I have narrated in the next paragraph.
Don't pull your flowers and water your weeds: This strong advice comes from Warren Buffet, the most successful disciple of Ben Graham. The greatest mistake most investors make is to sell the shares that have appreciated, and hold the ones, which are giving a negative return. The investment strategy should be the other way round; you should sell the losers and let the winners ride. I do not mean that you should sell every share that has depreciated. The right course is to keep pruning your field regularly to identify the weed so that they could be removed, and to identify the flowers that should be watered as long as their fundamental value is below the prevailing market price.
Do not invest in the company and sector whose business you do not understand: If you can understand a business and you find value there, invest. Do not be tempted to invest in industry about which you do not have much idea. While there is so much money to be made in technology shares, yet if you do not understand the business, it is better you do not go into it. My personal investment philosophy is to invest in the business, which I would be comfortable running on my own. I apply the same principles even when my investment is as low as 10 shares.
Do your own research: Security analysis is not as difficult as it may seem. You do not have to be a qualified analyst to do the analysis. A basic book on reading the financial statements of a company will be a great investment. When I say that more money is made by being inactive in the market, I certainly do not mean that you should invest and forget. On the other hand, you should keep reviewing the performance of the company you have invested in. If there is a fundamental change in the situation of your company, which has altered the premise based on which you had bought the shares, decide if the change warrants a change in your portfolio.
These principles have been perfected by masters and are time-tested technique for long-term investment in the market. While this is not the only way one can invest, this method is more scientific and if applied consistently, it would make the process of investment a less risky proposition with higher margin of safety.
You can reach him at: tsrawal@tsrawal.com
http://news.indiainfo.com/columns/tejinder/040105investment-strategy.html
Ride your Winners, Dump your Losers
Ride your Winners, Dump your Losers
--------------------------------------------------------------------------------
If you are a momentum trader that trade purely on the basis of a surge in price and high trading volume, it is wise to scramble for the exit when the stock loses its momentum. However if you have picked the stock on the basis of its valuation, the fact that it drops more means it is even better value – time to buy more instead of sell. Obviously if the fundamentals (future prospects and changing sector conditions) of the company have deteriorated, you may need to admit your mistake and sell.
This theory sounds more credible than it really is in countering the human tendency to keep the losers. The fact that it identifies a stock as a winner or loser on the basis of the entry price already introduces an element of subjectivity. An emotion free investor would only look objectively at the fundamentals and the valuation of the stock, instead of getting hung up on the entry price.
http://www.italkcash.com/forum/general-stock-market/98561-ride-your-winners-dump-your-losers.html
--------------------------------------------------------------------------------
If you are a momentum trader that trade purely on the basis of a surge in price and high trading volume, it is wise to scramble for the exit when the stock loses its momentum. However if you have picked the stock on the basis of its valuation, the fact that it drops more means it is even better value – time to buy more instead of sell. Obviously if the fundamentals (future prospects and changing sector conditions) of the company have deteriorated, you may need to admit your mistake and sell.
This theory sounds more credible than it really is in countering the human tendency to keep the losers. The fact that it identifies a stock as a winner or loser on the basis of the entry price already introduces an element of subjectivity. An emotion free investor would only look objectively at the fundamentals and the valuation of the stock, instead of getting hung up on the entry price.
http://www.italkcash.com/forum/general-stock-market/98561-ride-your-winners-dump-your-losers.html
Cramer's 25 Investing Rules
1. Pigs Get Slaughtered
2. It's OK to Pay the Taxes
3. Don't Buy All at Once
4. Buy Damaged Stocks
5. Diversify to Control Risk
6. Do Your Homework
7. Don't Panic
8. Buy Best-of-Breed
9. Defend Some Stocks
10. Don't Bet on Bad Stocks
11. Own Fewer Names
12. Cash Is for Winners
13. No Regrets
14. Expect Corrections
15. Know Bonds
16. Don't Subsidize Losers
17. No Room for Hope
18. Be Flexible
19. Quit When Execs Do
20. Patience Is a Virtue
21. Be a TV Critic
22. When to Wait 30 Days
23. Beware the Hype
24. Explain Your Picks
25. Find the Bull Market
2. It's OK to Pay the Taxes
3. Don't Buy All at Once
4. Buy Damaged Stocks
5. Diversify to Control Risk
6. Do Your Homework
7. Don't Panic
8. Buy Best-of-Breed
9. Defend Some Stocks
10. Don't Bet on Bad Stocks
11. Own Fewer Names
12. Cash Is for Winners
13. No Regrets
14. Expect Corrections
15. Know Bonds
16. Don't Subsidize Losers
17. No Room for Hope
18. Be Flexible
19. Quit When Execs Do
20. Patience Is a Virtue
21. Be a TV Critic
22. When to Wait 30 Days
23. Beware the Hype
24. Explain Your Picks
25. Find the Bull Market
Never Subsidize Losers With Winners
Never Subsidize Losers With Winners
Professionals and amateurs alike hate selling their dogs. They keep hoping, keep assuming, that a sinking stock is wrong in its direction. They rationalize that the weakness or lack of interest they see is and will be fleeting, and that people soon will recognize the value that the holder sees in the stock.
That's all well and good, until you need money.
Most fund managers have fabulous marketing teams that are able to hype their funds regardless of performance. Despite that and despite the shameless way this industry supports just about anyone who runs money if the money-runner is willing to kick back to the sources of funds, managers do get cash calls. They periodically have to redeem shares they own for cash to send back to unlucky investors.
When they do, that tendency to keep the dogs develops a sinister side: Good stocks get sold to subsidize the losers. You then get a self-fulfilling spiral as the bad stocks stay bad. They usually keep going down. And the fund, without the good stocks, keeps sinking. They never learn my rule:
Never subsidize losers with winners.
Individuals do the same thing. They have only a finite amount of capital to invest. Rather than take the medicine -- the loss -- they hold on to the losers and sell their winners.
My advice to anyone who is stuck in this position is quite simple: Sell the losers and wait a day. If you really want them, go buy them back the next day. I also am certain that you never will.
http://www.thestreet.com/story/10292298/never-subsidize-losers-with-winners.html
Professionals and amateurs alike hate selling their dogs. They keep hoping, keep assuming, that a sinking stock is wrong in its direction. They rationalize that the weakness or lack of interest they see is and will be fleeting, and that people soon will recognize the value that the holder sees in the stock.
That's all well and good, until you need money.
Most fund managers have fabulous marketing teams that are able to hype their funds regardless of performance. Despite that and despite the shameless way this industry supports just about anyone who runs money if the money-runner is willing to kick back to the sources of funds, managers do get cash calls. They periodically have to redeem shares they own for cash to send back to unlucky investors.
When they do, that tendency to keep the dogs develops a sinister side: Good stocks get sold to subsidize the losers. You then get a self-fulfilling spiral as the bad stocks stay bad. They usually keep going down. And the fund, without the good stocks, keeps sinking. They never learn my rule:
Never subsidize losers with winners.
Individuals do the same thing. They have only a finite amount of capital to invest. Rather than take the medicine -- the loss -- they hold on to the losers and sell their winners.
My advice to anyone who is stuck in this position is quite simple: Sell the losers and wait a day. If you really want them, go buy them back the next day. I also am certain that you never will.
http://www.thestreet.com/story/10292298/never-subsidize-losers-with-winners.html
Eject the losers and the winners will lift the portfolio.
It is the percentage of time that most of a portfolio is invested in rising stocks that determines how good performance will be. Eject the losers and the winners will lift the portfolio.
The Fundamental vs. the Technical in Stock Buy and Sell Decisions
The Fundamental vs. the Technical in Stock Buy and Sell Decisions
Author: Dr. Winton Felt
http://www.articlesbase.com/investing-articles/the-fundamental-vs-the-technical-in-stock-buy-and-sell-decisions-899280.html
Author: Dr. Winton Felt
Positive technical signals tend to precede good financial reports from a company. That is, the technical patterns precede and anticipate the fundamental reports. Stock price patterns reflect the buying and selling of all the people who have intimate knowledge about the company. The rest of the investment world creates the noise in stock behavior that accompanies the pattern created by those with knowledge. That is why sell strategies based on fundamentals are too slow in a volatile market.
Before the crash in 2000, many investment managers had relied on "fundamentals" to tell them when to sell. However, as the market crash approached it was often the case that by the time the company announced that earnings were going to be "soft," the stock had already declined. Sell strategies based on fundamentals (earnings, cash flow, order backlog, etc.) turned out to be much too "sluggish" in relation to market action and in comparison with sell signals based on technical analysis (volume & price patterns of the stock). The problem was compounded by the fact that analysts were often far from accurate in their forecasts regarding the financial prospects of companies. Some of the shortcomings of fundamental analysis are addressed by technical analysis.
Technical analysis offers its proponents the opportunity of responding in "real-time" to a stock's behavior. Technicians do not have to wait for the next quarterly report from the company. In other words, technicians can quickly respond to what is (current stock behavior) rather than wait to see if what ought to be (projections by fundamental analysts) actually happens (if the company actually generates the earnings expected by analysts). Each company has links with suppliers, competitors, officers, and employees. These in turn have families and friends. Many of these people are investors. There are also outside investors, thinkers, reporters, and others who are watchers of these people and their companies. The total knowledge of all these people is reflected in stock behavior. The cumulative effect of all the buying and selling activity of these people, and of those who watch these people, defines the regions of supply and demand (resistance and support) evident in the market activity of the stock and consequently in the patterns evident in the stock's behavior.
That is why stock behavior often precedes a company's announcement about earnings performance over the last quarter. The suppliers of a company know if that company has been increasing or decreasing orders for the supplies, equipment, or support needed to produce products or deliver services (people associated with these suppliers and their friends buy and sell stock). The competitors of a company know who is exerting the strongest pull on customers (people associated with these competitors and their friends buy and sell stock). Family members of employees and all their friends also have a general "feel" for how well a company is doing even without the use of "insider information" (these people and their friends also buy and sell stock). The sum total of all this "knowledge" is reflected in stock behavior much faster than analysts can get their next quarterly report written and published. Statistically, their combined actions reduce "noise" ("noise" is created by the actions of the uninformed) and increase order or "pattern" in stock behavior.
After the last market crash, portfolio managers and strategists proclaimed that the old "buy and hold" philosophy of investing is no longer viable. They said, "the market is simply too volatile for that kind of approach. Even well-established companies can go bankrupt. The slightest bad news can cause a stock to plummet." Lately, some managers are once again investing with the prior intent of holding all positions for several years (though some do say they will sell if the fundamentals change). It is as if they have learned nothing from their recent experience. Such an attitude tends to lock an investor or advisor into a pattern of thinking that all losses are only temporary, and everything will be fine five years from now anyway.
The problem with this mentality is that it reduces vigilance. Why bother to watch a portfolio closely or even to think about strategy issues if everything will work out in the long run? What are these advisors being paid to do? We know from past experience that everything may not turn out okay in five years. We can recite a very long list of stocks that have dropped over 60% from what they were five years ago and they still have not come close to recovering (I actually named a number of these companies in another article). Many of these stocks no longer exist or are now virtually worthless.
The point is that all these stocks looked good to many of the analysts who studied the fundamentals of these businesses. There were, after all, some honest analysts who joined the dishonest ones in repeatedly recommending their purchase and who gave glowing reports about their prospects. These stocks were touted as great investments at prices that later proved to be much too high (they did not seem particularly high at the time because they had been much higher before that). Nevertheless, some of the analysts who studied these companies really believed that they were very good picks. They kept recommending these stocks even though they kept falling. Why? They did so because they concluded that these stocks ought to go higher. Technicians who study price, volume, and various other stock behavior patterns, on the other hand, sold when their stop-losses were triggered or when technical sell signals were registered. They did not argue with themselves that these stocks ought to go higher. They acted on what was, not on what ought to be. They were the smart ones.
Yes, some day these stocks may recover. However, an investor who ejected himself from these situations could have been accumulating profits during the following years rather than watching his stocks decline or hoping for a recovery some day. Those who merely hang on through "thick and thin" are the real gamblers. Contrary to their own opinions of themselves, they are not really investors but speculators guided by hopes and dreams. They have no real sell disciplines. They merely buy "good companies" and blindly hold on with no plans for selling except "someday, at a profit." It is far better to get rid of losers and to keep the winners. If you do not "weed your garden," you will end up with nothing but "weeds." If you keep pulling the weeds, your garden will have only flowers. The same is true of your portfolio. It is the percentage of time that most of a portfolio is invested in rising stocks that determines how good performance will be. Eject the losers and the winners will lift the portfolio.
We prefer to invest in companies whose long-term financial prospects are good because, in the long run, it is earnings that drive stock prices. In other words, a stock that is in an up-trend because the company is doing well financially (good fundamentals) will tend to hold that up-trend better than a stock that is rising only because of unjustified momentum. However, as the basis for a primary selling discipline, fundamentals leave much to be desired. They tend to evolve at a rate that is inherently too sluggish for them to serve in that capacity, especially in volatile markets. Poor fundamentals still give us a good reason to sell. However, a stock will usually give a technical sell signal long before the company reports the poor fundamentals. Stockdisciplines.com traders prefer to respond to whatever signal they get first. You can benefit from their experience by using the same approach. They found that the first sell signal is almost always technical rather than fundamental in nature. If you make it a practice to sell only when the fundamentals are deteriorating, then you must reconcile yourself to much larger losses.
The same things may be said regarding the buy side of investing. We usually see technical buy signals before the company makes a positive earnings report. In other words, all those "watchers" of the company mentioned above know the company is doing well so they have been buying its stock and have therefore caused the technical buy signal to be generated. The profile of a stock's accumulation pattern can reveal much about whether there is something substantive behind the new buying activity. When the fundamentals are released, those who bought the stock because of the technical buy signal will benefit from the new surge of buying that follows the release of positive fundamentals.
Even so, we have a very high regard for fundamentals. If we get a technical buy signal, we like to check the stock's fundamental profile in Value Line, Morningstar, or in The Valuator before we make a purchase. If the technical signal is good but not outstanding, then outstanding fundamentals can make a big difference in how we see a stock (fundamentals tend to have momentum). However, if a stock has a lousy technical profile, we are not going to be interested regardless of how attractive a stock is fundamentally (it doesn’t pass the "smell" test). There are also times when a stock's technical pattern is so compelling that we can feel justified in basing our buy decision on technical measurements, patterns, or signals alone. Good financial reports often follow in the wake of positive technical signals.
Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com
Dr. Winton Felt has market reviews, stock alerts, and free tutorials at http://www.stockdisciplines.com Information and videos about stock alerts and pre-surge "setups" are at http://www.stockdisciplines.com/stock-alerts Information and videos about traditional as well as volatility based stop losses are at http://www.stockdisciplines.com/stop-losses
Article Source: ArticlesBase.com - The Fundamental vs. the Technical in Stock Buy and Sell Decisions
http://www.articlesbase.com/investing-articles/the-fundamental-vs-the-technical-in-stock-buy-and-sell-decisions-899280.html
Keep your investments balanced
Keep your investments balanced
Daniel Jimenez • Bankrate.com
The market's ups and downs can leave an investor feeling nauseated. To help settle your stomach, evaluate your investments periodically to make sure they are still doing the job.
If the word "balance" makes you think of car tires rather than investments, now may be a good time to review your assets. Unfortunately, many investors don't have the blend of stocks, bonds and mutual funds that meet their needs. Knowing the right time to rebalance your portfolio is just as important as knowing what types of investments to carry.
Choosing the right mix
You've probably heard that you should keep a variety of investments including foreign, domestic, small-cap and large-cap stocks and funds. But what constitutes a good balance? It depends on your goals, plans and tolerance for risk.
William Green, a certified financial planner for Green/White Advisers in Houston, believes that investors should set goals in terms of at least three years so that market volatility doesn't become as large an issue. A stock market plunge can keep an investor from meeting goals if there isn't enough time for the investment to recover. That is why a person who has a one-year time horizon should place his money in conservative investments like money market accounts, certificates of deposit or government securities.
If you have a short horizon then you can't afford the volatility that can be in the market," Green says. "At least if you have a three-year horizon then it should've come back by then. The shorter your time horizon, the safer you have to be."
Investment advisers use a series of questions to determine the right mix for their clients, but their recommendations vary. For example, Gregory Fenton, a planner with Cambridge/Cape Cod Advisers in Massachusetts, thinks investors should take 90 percent of their holdings and divide them equally between interest-earning vehicles, real estate and equities, with the final 10 percent kept in cash. On the other hand, Green recommends a balanced fund that covers several asset classes for those with only a few thousand dollars to invest.
Some advisers allow their clients a small amount of "play money" to be set aside for riskier investments. But in general, the experts agree that a widely diverse portfolio provides the lowest volatility and the highest rate of return.
Time for a change
Planners take great care to develop a client's initial portfolio, but there are times when changes can be beneficial. Sameer Shah, a certified financial planner with Shah & Associates in Tampa, Fla., tells his clients that a systematic rebalancing of their assets can boost their returns by as much as 1 percent a year and lower risk at the same time.
"This can work even for a simple portfolio based on three asset classes (e.g., domestic large-cap stocks, domestic small-cap stocks, international stocks)," Shah says. "Say you start with a portfolio of 50 percent large cap, 25 percent international, and 25 percent small cap. If at the end of the year you end up with 60 percent large cap, 20 percent international, and 20 percent small cap, you should sell enough of the large cap, and buy international and small cap, so that you return to the original percentages."
Shah adds that active rebalancing is often more important in the long run than the initial actual allocation targets. Of course, this should be done, as much as possible, in tax-advantaged accounts such as a 401(k) or IRA because there are no tax consequences to moving different funds around.
There is little doubt that occasional rebalancing can be wise. But some people tend to treat their investments like a toddler who can't be left unattended for more than a few minutes. So a down market often leaves them wondering whether the baby needs tending.
If you're regularly investing on your own, rebalance the mix by shifting your purchases, rather than selling what you already have to purchase something else. For example, if the bull market has left your portfolio heavily weighed toward stocks, rebalance by purchasing more bonds. If you sell the stocks to get money to buy bonds for a quick fix, you will end up paying capital gains taxes on the stocks you sold.
Most experts caution against overreacting to market dips. Frank Armstrong III, president of Managed Account Services in Miami and chief investment strategist for directadvice.com, says investors should ignore magazine articles touting the "10 hottest funds" and focus instead on a more disciplined strategy based on sound theory.
"I don't think that investors should shuffle their portfolio more than once a year," Armstrong adds. "And that's only if one of the assets was really dropping. That would be something like 3 to 4 percent."
Shah stresses that investors must look at the portfolio's overall performance rather than focusing on one particular investment that may be faltering. Frequent changes are not recommended since individual market sectors often rebound, becoming stronger than they were before.
"I'll have a client who's got an under-performing small cap or international fund come to me and say, 'Let's dump this,'" Shah says. "That's when I explain to them, 'No, this is exactly the time when you want to stay in.'"
Cambridge's Fenton discourages major overhauls as well because of the tax consequences of selling stocks that have performed well. His firm believes that annual or biannual portfolio reviews offer an opportunity to purge bad stocks while retaining their gains.
"Every other year we sell the losers and keep the winners," Fenton says. "That is a way for us to keep making gains and not have to pay any taxes. The losses are offset by the gains."
No one can stop you from looking at your investments' progress on a monthly or even daily basis. But investors who learn not to micromanage their portfolio can rest easy as long as they are still on pace to reach their goals. Not only will they stop worrying so much about market fluctuations, but they may also find that their blood pressure will drop back to normal.
http://www.bankrate.com/brm/news/advice/19991105d.asp
Daniel Jimenez • Bankrate.com
The market's ups and downs can leave an investor feeling nauseated. To help settle your stomach, evaluate your investments periodically to make sure they are still doing the job.
If the word "balance" makes you think of car tires rather than investments, now may be a good time to review your assets. Unfortunately, many investors don't have the blend of stocks, bonds and mutual funds that meet their needs. Knowing the right time to rebalance your portfolio is just as important as knowing what types of investments to carry.
Choosing the right mix
You've probably heard that you should keep a variety of investments including foreign, domestic, small-cap and large-cap stocks and funds. But what constitutes a good balance? It depends on your goals, plans and tolerance for risk.
William Green, a certified financial planner for Green/White Advisers in Houston, believes that investors should set goals in terms of at least three years so that market volatility doesn't become as large an issue. A stock market plunge can keep an investor from meeting goals if there isn't enough time for the investment to recover. That is why a person who has a one-year time horizon should place his money in conservative investments like money market accounts, certificates of deposit or government securities.
If you have a short horizon then you can't afford the volatility that can be in the market," Green says. "At least if you have a three-year horizon then it should've come back by then. The shorter your time horizon, the safer you have to be."
Investment advisers use a series of questions to determine the right mix for their clients, but their recommendations vary. For example, Gregory Fenton, a planner with Cambridge/Cape Cod Advisers in Massachusetts, thinks investors should take 90 percent of their holdings and divide them equally between interest-earning vehicles, real estate and equities, with the final 10 percent kept in cash. On the other hand, Green recommends a balanced fund that covers several asset classes for those with only a few thousand dollars to invest.
Some advisers allow their clients a small amount of "play money" to be set aside for riskier investments. But in general, the experts agree that a widely diverse portfolio provides the lowest volatility and the highest rate of return.
Time for a change
Planners take great care to develop a client's initial portfolio, but there are times when changes can be beneficial. Sameer Shah, a certified financial planner with Shah & Associates in Tampa, Fla., tells his clients that a systematic rebalancing of their assets can boost their returns by as much as 1 percent a year and lower risk at the same time.
"This can work even for a simple portfolio based on three asset classes (e.g., domestic large-cap stocks, domestic small-cap stocks, international stocks)," Shah says. "Say you start with a portfolio of 50 percent large cap, 25 percent international, and 25 percent small cap. If at the end of the year you end up with 60 percent large cap, 20 percent international, and 20 percent small cap, you should sell enough of the large cap, and buy international and small cap, so that you return to the original percentages."
Shah adds that active rebalancing is often more important in the long run than the initial actual allocation targets. Of course, this should be done, as much as possible, in tax-advantaged accounts such as a 401(k) or IRA because there are no tax consequences to moving different funds around.
There is little doubt that occasional rebalancing can be wise. But some people tend to treat their investments like a toddler who can't be left unattended for more than a few minutes. So a down market often leaves them wondering whether the baby needs tending.
If you're regularly investing on your own, rebalance the mix by shifting your purchases, rather than selling what you already have to purchase something else. For example, if the bull market has left your portfolio heavily weighed toward stocks, rebalance by purchasing more bonds. If you sell the stocks to get money to buy bonds for a quick fix, you will end up paying capital gains taxes on the stocks you sold.
Most experts caution against overreacting to market dips. Frank Armstrong III, president of Managed Account Services in Miami and chief investment strategist for directadvice.com, says investors should ignore magazine articles touting the "10 hottest funds" and focus instead on a more disciplined strategy based on sound theory.
"I don't think that investors should shuffle their portfolio more than once a year," Armstrong adds. "And that's only if one of the assets was really dropping. That would be something like 3 to 4 percent."
Shah stresses that investors must look at the portfolio's overall performance rather than focusing on one particular investment that may be faltering. Frequent changes are not recommended since individual market sectors often rebound, becoming stronger than they were before.
"I'll have a client who's got an under-performing small cap or international fund come to me and say, 'Let's dump this,'" Shah says. "That's when I explain to them, 'No, this is exactly the time when you want to stay in.'"
Cambridge's Fenton discourages major overhauls as well because of the tax consequences of selling stocks that have performed well. His firm believes that annual or biannual portfolio reviews offer an opportunity to purge bad stocks while retaining their gains.
"Every other year we sell the losers and keep the winners," Fenton says. "That is a way for us to keep making gains and not have to pay any taxes. The losses are offset by the gains."
No one can stop you from looking at your investments' progress on a monthly or even daily basis. But investors who learn not to micromanage their portfolio can rest easy as long as they are still on pace to reach their goals. Not only will they stop worrying so much about market fluctuations, but they may also find that their blood pressure will drop back to normal.
http://www.bankrate.com/brm/news/advice/19991105d.asp
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