Monday, January 20, 2014

2013 Was a Very Educational Year.

Bull markets can be just as informative as bear markets.

Behavioral economists and market observers have long noted that people respond differently to losses and gains.  The generalization is that people feel losses twice as intensively as gains.  In fact, from neuroscience we know that comparisons between the two are inappropriate.  They are actually felt quite differently by different parts of the brain.  Nevertheless, the generalization that losses are felt more intensively creates the risk that people will retain what they learn from things like the financial crisis and the associated market meltdown, but not things learned from the bull market recovery that has been going on since then.

Thus, it is appropriate to point out and stress the lessons to be learned from a bull market.  Last year’s performance provides an excellent opportunity to do that.  The next few postings will focus on what 2013 teaches about portfolio management with particular emphasis on management of the equity portion of one's portfolio.

There will be a series of postings that will address related topics:

First, what is to be learned about portfolio strategy?

The uniqueness of a bull market run like 2013 can be misleading.  It would be misleading if taken to be indicative of how to manage one's total portfolio.  Yet, it is appropriate to use the experience of 2013 as an opportunity to learn how to manage an equity portfolio. 

Real opportunities to time the market are rare.  Neither the media nor the financial service industry has any interest in pointing out that buy-and-hold stacks up quite well against any alternative.  While that's true within the equity portion of a portfolio, it does not eliminate the fact that rebalancing makes sense when applied within the context of the time horizon for the investor.

No discussion of any investment approach makes any sense without reference to the investment objective.  Nothing is more important than understanding why one is investing.  If excitement is the objective, tactical market timing and constant monitoring of every potential influence on the market is warranted.  It is entertaining, but if profit is the objective, boring is the most reliable approach.  One does not need to look for a moonshot in order to make money investing.

Second, what is to be learned about stock acquisition?

2013 provided some excellent examples of the fact that a quick 10% drop in the shares of a well-known company with a solid business and a promising future represent a nice entry point for investors with a long run outlook.  No portfolio should be thought of as a buy it and forget it portfolio.  One has to pay attention to how the companies and their stocks are performing.  But it does not require detailed financial analysis or sophisticated technical analysis tools.

If it is a long-term holding, the opportunities that arises it will not be fleeting.  One does not have to be monitoring the market every day in order to see the opportunities and have time to capitalize on them.  If the opportunities are real long-run opportunities, the average stock market investor should have enough time to act and still look like an expert market timer. 

If 2013 teaches investors nothing else, it made it infinitely clear that the key to success is individual stocks not the total market.  Trying to time the total market is totally irrelevant to the best opportunities. One does not have to invest in highly speculative stocks in order to achieve portfolio performance.

Third, what is to be learned for 2014 planning?

Bull markets created tremendous temptation to chase the performance of the winners.  However, the fact that they were winners argues against that approach.  Their portfolio weights are already out of portion.  It is also likely, that the best performers are not necessarily the most stable stocks. (High beta stocks may have appreciated the most).  In other words, a bull market can introduce additional risk into a portfolio.

The appropriate response is to readjust portfolio weights in an opportunistic fashion.  One step that may work is to change which stocks are set up for automatic dividend reinvestment.  Nevertheless, the portfolio will generate cash that should be invested as opportunities arise.  One can plan for those expected opportunities.  But it would be developments during 2014 that will actually determine when those opportunities exist.  So, it is possible the plan to 2014 as long as one realizes that the plan may have to be adjusted during the year.

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