How I Stopped Being A Jerk With My Money

| About: SPDR S&P (SPY)


I learned a very tough lesson from the Greek stock market.

Fortunately, thanks to the implementation of some strict rules in the management of my portfolio, I achieved a major turnaround.

In this article, I provide these rules of portfolio management.

About a week ago, I read a very interesting article by SA editor Robyn Conti, in which she described some mistakes she made in her finances in the past. It was an exceptional and emotional article, probably the most interesting I have read in the last few weeks. I strongly admire Robyn for her exceptional writing and editing skills. Inspired by her, in this article, I will describe how I stopped being a jerk with my own money.

When the global economy started to collapse in 2008, I considered it an exceptional investing opportunity. Therefore, I added funds of some of my relatives to my own funds and invested all the capital between October 2008 and April 2009. While I do not boast of having exceptional timing skills and I believe that no one possesses such skills, I can boast that my timing was perfect in that instance. All the funds were invested in Greek stocks, during a period in which the Greek stock market was bottoming. Looking back, I can state with a great degree of certainty that my timing was so perfect, mostly thanks to the fact that I had remained on the sidelines until that moment. Investors who are on the sidelines usually have a much better judgment than those who are bleeding during a bear market.

As everyone knows, the global stock markets, including the Greek market, bottomed in March 2009. Therefore, my entry points were ideal and thus my portfolio doubled in value in October 2009. In other words, I achieved 100% returns in just 12 months from my initial investment. I was extremely excited and, even better, it seemed that the global economy was just in the beginning of a strong recovery. This has proven correct, as 7 years have passed since then and the bull market in the US is still in place.

Unfortunately, that was not the case for my portfolio. For the first time in its history, the Greek stock market started to diverge from the other stock markets. The Greek stock market peaked in October 2009 and has been experiencing an unprecedented bear market since then. Therefore, my profits began to evaporate after the top was in place. Even worse, while I was waiting for the Greek stock market to catch up with the foreign ones, all my profits disappeared, in just 4 months. As the prospects of the Greek economy were becoming increasingly gloomy, I decided to close my positions and try to repurchase them after the storm had passed, at hopefully much lower entry points.

Unfortunately, this is much easier said than done. At some points, there were encouraging headlines for the Greek drama and the Greek stocks strongly rallied on such news. I was afraid that I might miss the train and was thus enticed to repurchase my positions. Of course, the Greek economy never improved and hence the Greek stock market resumed its plunge after every relief rally, as all those rallies proved short-lived. Consequently, by November 2011, not only had I lost all my profits, but my portfolio had lost almost 50% of the initial capital. To make a long story short, I had plunged from +100% to -50% in just 2 years.

Ironically, when a great trader I know heard that I was fully invested in the Greek stock market until the end of 2011, he congratulated me on my losses, saying "if you have lost only 50%, you are exceptional." He said that because all the Greek banks had essentially gone to zero and most Greek investors had shares of those banks, as they were the most popular Greek stocks. Fortunately, I had seen the upcoming bankruptcy of Greek banks coming and hence I had invested in other stocks. Still my losses were devastating for me.

I could blame my luck for investing in Greek stocks at the first time in the history in which they diverged from global markets but still I should have protected my profits much better. For instance, when a position provides exceptional returns, it is a shame to let all the profits evaporate; you should at least take some profits from a highly profitable stock when it starts falling. I started to strictly implement that rule after that painful experience.

At that point I realized that, if I kept making the same mistakes, my fund would probably incur catastrophic, irreversible losses. Even worse, the fund included, not only my own money, but also my relatives' money. That would be a disaster that I had to prevent. Therefore, I had to change my strategy. The first thing that impressed me was the catastrophic effect of high commissions on my returns. Despite my undeniable huge mistakes, I observed that my total losses were almost equal to the total commissions I had paid to my broker. While those commissions passed unnoticed while I was enjoying my great profits in the beginning, they eventually weighed heavily on my performance. Consequently, I switched to a discount broker in May 2012. Thus my commissions plunged from about 0.7% (cost of opening and closing a position) to only 0.02%. That was a 97% decrease in commissions, a major factor in my turnaround.

Moreover, I stopped monitoring the Greek stock market and instead I focused fully on the US stock market. While the US stock market had almost doubled from its recession bottom, it turned out that it still had plenty of upsides to help me retrieve my losses. Indeed, the US stock market has recorded an additional 50% profit since then. Even better, thanks to the strict management of my portfolio, my portfolio has almost tripled in value since then. In other words, in the last 4 years, my portfolio has climbed from -50% to +40%. This is a 180% return (=140/50-1) in just 4 years, a pronounced outperformance vs. S&P (NYSEARCA:SPY), which rallied 50% during the same period. To be fair, I have enjoyed a 10% boost from the strong dollar and hence my comparable return is about 160%.

My great results can be attributed to a great extent to a great selection of stocks. I purchased Torchmark (NYSE:TMK), Anthem (NYSE:ANTM), Credit Acceptance (NASDAQ:CACC), L-3 Communications (NYSE:LLL) at single-digit P/E ratios, and they all managed to grow their earnings per share since my purchase. Even better, the market appreciated their results and rewarded them with a much higher P/E. AutoZone (NYSE:AZO) also maintained its exceptional growth streak. Therefore, I was rewarded with a double bonus; higher earnings and a higher P/E ratio.

Another major contributor to my great results was the profit-taking strategy. I noticed that too often some of my stocks recorded remarkable gains but gave them back later. Unfortunately, for the advocates of the buy-and-forget strategy, the competition has heated so much in almost every single sector, that the buy-and-hold forever strategy is no longer viable. Even the best-of-breed companies, such as Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Wal-Mart (NYSE:WMT) and American Express (NYSE:AXP) have failed to grow in the last 3 years due to the markedly intense competition they have faced. Therefore, whenever a stock has provided great returns and has reached full valuation I have taken my profits and have started to search for the next candidate.

In addition, I have used a reasonable amount of leverage in selling weekly and monthly out-of-the-money put options of solid stocks, which have strong fundamentals and tend to move much more slowly than the overall market. In the very few weeks in which the market has plunged I have not made profits and I have even incurred some losses. However, the great returns during most of the weeks have greatly contributed to the overall performance of my portfolio. Even more importantly, these are profits that are taken off the table every week and hence they result in the pronounced outperformance of my portfolio vs. the market. More specifically, S&P has traded range bound in the last 2 years, between 1800 and 2150. Nevertheless, thanks to my profit-taking strategy, every time S&P hits a certain level, e.g. 2000, my portfolio is greater in value than the last time that S&P was at that level. All in all, while S&P remains range bound, my portfolio keeps climbing.

Of course, this has not been an easy achievement, without any setbacks. While I mentioned some of my great stock picks above, I also made some poor choices. More specifically, I purchased some oil stocks before the price of oil began to collapse. Just like the managements of most oil companies, I had been convinced that the $100 oil was the norm. Therefore, I incurred some major losses from the relentless bear market of oil. Fortunately, most of my stocks were oil majors, such as BP (NYSE:BP), Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX), which incurred limited losses until I sold them. However, on the other hand, my portfolio also included my worst stock ever, namely Ensco (NYSE:ESV). I was attracted by its extremely low, single-digit P/E ratio in 2014 while the analysts were expecting 15% earnings growth that year and the same for the year after. Unfortunately, due to the leverage of Ensco on the price of oil, the collapse of the oil price caused the stock to collapse. And while my No. 1 rule is the No. 1 rule of Buffett (never sell at a loss), about 6 months ago, I took the painful decision and sold the stock at a 50% loss. While that was one of the most painful decisions I have ever made, it started to bear fruit immediately and marked a major turning point for my portfolio. More specifically, the bleeding of my portfolio from this stock stopped and my portfolio has rallied 15% since then while S&P has remained essentially flat.

So this is my story, which describes how I stopped being a jerk with my (and my relatives') money. Of course, I cannot claim that the vast outperformance of my portfolio vs. S&P can be fully attributed to my strategy. A great amount of luck is required in every successful portfolio. If the US experienced a fierce bear market in the last few years, there is no way I could have enjoyed such great returns. In addition, investors cannot know their stocks so well as to claim that they do not need any luck in order to succeed. Moreover, my strategy is highly profitable when the market rises, remains flat or slightly falls. Fortunately, the market has not collapsed in the last few years. On the other hand, I would like to summarize some points, which helped me a lot and can help investors improve their performance:

1. Commissions are extremely important in long-term performance. Investors should select the broker with the lowest commissions.

2. I purchase a stock only after extensive due diligence and only if I have great confidence in the stock. It is this great confidence that has helped me tolerate the short-term losses of some stocks, which then turned into profits. If investors are prone to panic selling on the first negative news of a stock, they should not purchase that stock.

3. I do my best to avoid selling at a loss. While it is impossible to avoid it completely, investors should avoid selling at a loss frequently, because their performance is greatly impacted by such losses, even if they seem relatively small. In order to avoid selling at a loss, investors should have great confidence in their holdings.

4. I have concentrated my portfolio into 3 stocks. I cannot keep monitoring 8-10 stocks, let alone more. The business landscape changes so fast that it is impossible to keep monitoring plenty of stocks. The fewer the stocks of my portfolio the better I know them and the more confidence I have in them. Buffett seems to agree on this, as he has allocated 50% of his funds into just 3 stocks. I have also noticed that it is almost impossible to outperform S&P while having many stocks. You can have a few exceptional picks but you cannot have a dozen of exceptional picks, even Buffett can't.

5. I purchase an additional stock when it falls to undervalued territory and sell it when it returns a decent profit in a short period. Profit taking is a major component of investing success. As the business landscape has become extremely fast-changing, it is very important to take significant profits off the table when a stock reaches full valuation. Letting profits evaporate can be very costly.

Disclosure: I am/we are long AZO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.