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A semiretired attorney. Robert became more involved with investments after retiring from an oil company.
  • A View from the Peanut Gallery
    Some readers will be old enough to remember the Peanut Gallery from the early TV epic, The Howdy Doody show. If not, an alternate title to this article could be Amateur Hour. I am a semi-retired attorney having accumulated a portfolio with the proceeds of a career of trying law suits and managing a portfolio of litigation. My career experience has given me a real world appreciation of risk. My first takeaway was that I should leave investment decisions in the hands of professionals. I was a “buy and hold” (with professional advice) investor.
    Along with everyone in the market, I watched my retirement assets meager performance during the “lost decade” and the “great recession.” After 2008, apprehension drove me to open an internet portfolio and start actively managing a relatively small portion of my investments. I was fortunate in opening the account in March 2009 because I felt that stocks were artificially low and, therefore, went heavy (>95%) in equities. I have modestly outperformed the S&P 500 and spent a great deal of time keeping up with investment media and trying to educate myself so that I could understand what I was reading. Since baby boomers are trying to retire in droves, I thought that a discussion of my efforts to move from amateur status to intermediate investor status might be helpful to other gray haired amateurs.
    None of this article is intended to be investment advice but rather is a discussion of the discourse you will be confronted with and why you should read it even though 40% of the authors will be shouting black, 40% will be shouting white and the remainder will be saying gray or nothing that makes sense. With respect to my performance noted above, the discourse offers two comments: (a) past performance is no guarantee of future results and (b) don’t confuse a bull market with smarts.
    Just as lawyers and doctors have their own jargon, investment writers employ special terms. You must become familiar with this jargon since many writers who seem to disagree about something actually are using terms with differing definitions for the same term.
              Time Horizon
    One of the most egregious areas of false controversy has to do with the time horizon associated with the advice under discussion. It is very possible for one writer (a day trader) to advocate selling a stock while another advocates buying the same stock (with a horizon of over six months) and both to be proven right in the course of time. Careful authors should specify their time horizon. Failing that you can sometime discern time horizon by following the author over some period so you can conclude that the author is always talking about the same time period. If you can’t figure out what time horizon is under discussion, you should disregard the advice and probably quit reading the author.
              Fundamental Analysis and Technical Analysis
    Fundamental analysis refers to an examination of numbers relating to the past performance and projected future performance of a business or sector. Discounted cash flow, price to earning ratios and historic dividend performance are but a few measures. A fundamental analyst will recommend buying a stock when its current price is “significantly” less than its predicted future price. When comparing advice from different sources, one must look to the tools each source uses as the tools to predict future earnings, etc. When looking at the analysts associated with brokerage houses, there is definitely a bias toward buy recommendations. The computer homily, “garbage in garbage out” also applies since the best fundamental analysis will fail if the numbers input are false.
    Technical analysis is an approach “based on the belief that price reflects all that is knowable about a security at any given time.) Bollinger on Bollinger Bands at p. 214. Again, there are myriad ways to look at the data so technical analysts can differ on recommendation even though the historic price of a stock is fixed and knowable. Technical analysts take issue with the homily that “past performance is no guarantee of future results” as most would say past performance is an indication of future performance. Technical analysis tends to focus on a shorter time horizon.
    Overbought suggests that the price of a stock has risen too far and/or too fast. It is a statistic usually related to a construction of lines which are x number of standard deviations above and below some baseline (usually a moving average). Again, if one changes the numbers of standard deviations or uses a different moving average one will get different results. It is important to understand that overbought does not necessarily mean “sell.” The art of using this technical indicator is deciding whether price will regress to the mean (“sell”) or the trend will continue (“buy” or “hold”). Oversold is the opposite of overbought. 
              Other Technical Indicators
    Other indicators include Momentum, Trend, Sentiment and Volume. Bollinger on Bollinger Bands at p. 140. Each of these indicators is generated by some mathematical formula. It is beyond the scope of this article to go through each of these. The takeaway is that you must understand the system of inputs in order to evaluate the advice and if someone advocates action based on one indicator (XYZ stock is oversold, so “buy”), you should be skeptical.
              Risk Assets and Riskfree Assets
    This is a particularly confusing set of terms for me. In general, I think that “risk assets” refers to equities and “riskfree assets” refers to the sovereign debt of the United States usually expressed as 10 year treasury notes. My semantic quarrel is that the concept of viewing the sovereign debt of the United States as riskfree from the perspective of an individual is ridiculous. One of the great investment impediments currently facing retirement portfolios is that is difficult to find a place to put the cash portion of your portfolios. The time honored use of laddered CDs runs the very real risk of losing money if inflation exceeds the interest rate. We have credit rating organizations raising the possibility of lowering the credit rating of US debt.
    The meaningful use of these terms is as an indicator. The flow of money out of T-bills and into stocks tends to drive the market up as buyers outnumber sellers (sometimes referred to as a “virtuous cycle”). Flow of money out of stocks and into T-bills has the opposite effect.
    Managing Risk
    The first thing to understand is that risk can be managed, it cannot be eliminated. People drink bottled water because they are concerned about the safety of their tap water (a minute risk). The same folks are cavalier about driving their car within three miles of their home (a risk several orders of magnitude greater). The next thing to absorb is that management of risk frequently is the management of perception of risk. Law suits settle because of perception of risk. The markets price in perception of risk.
    There are a number of well known emotional factors which complicate the management of financial risk. Loss aversion is particularly perverse. Loss aversion is the behavior resulting from the reality that more pain results from losing a particular sum than pleasure results from gaining the same sum. It is one reason that an individual tends to hang on to a stock when it is going down because of unwillingness to take a loss on the transaction. It explains the tendency of fund managers to go with the herd so the acquisition of a particular stock will be easier to explain.
    Another factor is emotional attachment to a stock. This attachment coupled with outcome bias explains the willingness of folks to ride a stock to the bottom.
    For a good discussion of emotional factors, see Value Investing by James Montier. These behavioral factors come in to play both when considering one’s own perception of risk and when consider how the crowd perceives a risk.
    One fairly clear technique for managing risk is to have a plan and execute the plan. First, identify the risk you want to manage. In the retirement scenario, this is typically a desire not to run out of money before death. Retirement planners have exquisite spreadsheets that will tell you at x rate of return, x inflation rate and x spending per year whether and when you can expect to run out of money. I certainly recommend that you make use of their services.
    But while perusing the spreadsheet is useful to identify how various factors impact your retirement goals, it is not the management of risk. How much you spend per year is discretionary for those folks who were fortunate enough to accumulate significant assets outside of their home and Social Security and this spending decision is risk management. How you allocate your portfolio depends, in part, on your forecast of inflation and this is risk management. How you deploy your assets in an attempt to secure x rate of return is certainly risk management.
    Most folks will discover that maintaining their standard of living and not running out of money will require taking on perceived risk that exceeds their comfort level. If your plan calls for a significant percentage of your broker managed portfolio to be invested in equities, you need to be sure you have a plan for selling. I have discovered that the decision to sell is much harder than the decision to buy and that brokers who are quite willing to make the decision to buy equities for you are much less likely to make the sell decision for you. I am stating this as a fact and not a criticism as I am pretty sure I would behave the same way if I was a broker. I am covering areas that you need to cover in your plan. My current plan is to sell a portion of my portfolio when the S&P 500 reaches certain levels and retain the proceeds as cash or cash equivalents and then repeat the process when it reaches the next level. A more sophisticated approach would be the use of trailing stops. If you attempt to pick out individual stocks to sell, then you are not using the broker’s expertise which you are paying for.
    If there are portions of your portfolio which you have no plan to sell, then realize you have implicitly or explicitly decided to ride those investments down to the bottom. Diversification provided little protection in the last downturn.
    Most folks will want to investigate methods of generating income from some portion of their portfolio either to directly achieve some retirement goal or as some protection when riding stocks down. Here are some ways to do that.
              Puts and Calls
    Even defining puts and calls is beyond the scope of this article. If you are making a plan (whether or not you use a broker) you should take the time to understand the use of puts and calls to generate income. It’s easier to understand if you start with selling covered calls on stocks you already own. The next step is learning than selling a naked (i.e., not covered) put has the same profit and loss picture as selling covered calls. This has the side benefit of avoiding dealing with stocks you love, i.e., sell naked puts on stock that you have no emotional attachment for. You can also get paid to buy on dips by selling naked puts at the price you would buy the stock for anyway. Selling out of the money covered calls can also be used as part of a “sell” plan. You pick the price that you are willing to take and exit the stock and sell a covered call with that price as the strike price. If the stock does not go up you have pocketed the premium. If it goes up to or past the strike price, you get the premium and the price you were willing to sell for. Of course, if the stock goes way past the strike price it was not a good deal (assuming that you were clever enough to figure to hold on to the stock beyond a price that you have already determined you would sell for. If the stock goes down significantly, then the trend would be less favorable that if you has sold on a trailing stop. As always, be skeptical of anyone who says these are guaranteed techniques to make money. Puts and calls do give you added flexibility to meet some of the goals in your plan. I read and recommend the books of Larry McMillan on options.
              Blue chips and dividends
    Another way to produce income and manage risk is through dividends. If you are not going to sell your stocks on a downturn, you should certainly consider stocks likely not to go down as far as the market (blue chips) and which continue to pay the dividend. Be advised that very stout stocks, like GE, were unable to continue paying dividends in the downturn. There is always risk. If you need to generate more income, take a look at the energy master limited partnerships. As always, the perceived risk is higher when the dividend is higher.
              Other Ideas and Education
    You should try to get exposed to optimistic as well as pessimistic views. Seeking Alpha is an easy way to read lots of different views. RealClearMarkets is another good website. There are many more.
    As you read and experience the vast disagreement among experts about investment, please consider that the person really responsible for your investments is you. Achieving a greater knowledge about investment techniques will not only help you with investment choices that you make individually but can be very helpful as you work with an advisor to construct a portfolio that optimizes your retirement plan.

    Disclosure: I am long GE, PVR.
    Dec 17 1:25 PM | Link | Comment!
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