Monthly Archives: March 2016
Blog: Cut your losses
Investors know (or should know) that in order to make money in the markets you have to let your profits run and cut your losses short. It all makes sense. Doing it, however, is hard for most people. When I take on new clients we usually start out with a portfolio review and discuss the “corpses in the closet” the stocks that fell a significant amount and that the investor is still holding hoping for a turnaround. After all, he or she is a serious long term investor and in the long term the stock will be all right. Maybe, maybe not.
Blog: Super Mistakes
After owner occupied residential property super is often the biggest asset of a household. In spite of its financial importance super investments are very often neglected with many super holders or super trustees in the case of an SMSF and investor often mak the following quite common super mistakes
When I talk to new acquaintances in a social gathering the subject usually comes to what I do professionally and we then talk about investment and super. It usually strikes me how inexperienced most people are with everything concerning investments. Many people usually totally ignore their super. They know that the super guarantee payment is put into their super on a regular basis but usually do not know and do not really care in which asset classes the super is invested, what insurance coverage they have (and if they really need it), how much the insurance costs, what the fees are and what the performance over the last few years was. Many super holders simply do not have a plan. Super just sits there on auto-pilot, neglected, put in the ‘too hard’ basked. Given that super is a major asset of a household it deserve its proper attention and the holder needs a considered plan on what to do with it and how to invest.
Super, as we all know, is supposed to fund our retirement so that we do not have to rely (solely) on the government pension. As such, super is a long term investment, starting when we begin our career and ending when we die (with hopefully still some funds left for the kids). Super is therefore a long term game and we need a long term strategy. Short term returns do not really matter in the big scheme of things. We need a long term strategy seeking to achieve reasonable long term returns which compound over a working life. Jumping in and out of assets with a short term trading strategy is usually not helpful.
Many super investors simply do not have an investment strategy. Even if they know the insurance cover, the fees and charges and the performance, they are very often in the default option suggested by the super provider be it a private or industry super fund. This will usually be a balanced fund with a bit of cash, a few bonds and a few shares, mostly Australian but hopefully also some international shares. This allocation may not always we right at the life stage of the super holder and will very often be too conservative given out increased life expectancy. Younger the super investors should have a higher the share of equities as the equities return over a longer time period tends to be higher (and often significantly higher) than cash and bonds. If the super holder does not have a high degree of financial literacy and does not want to do something about it and does not want to allocate time for investment decisions a long term buy and hold strategy with a high degree of equities both domestic and international would be warranted. This would result in an average return of about 8 % to 10 % per annum for most 10 year holding periods with some holding periods showing no return or even slightly negative return. The advantage of such a strategy is that is requires practically no time from the part of the investor. It results in dollar cost averaging whereby the same amount of money is allocated to equities on a regular basis buying more shares in a bear market and fewer shares in a bull market. The problem with such a strategy is that the investor must not do anything; he must not be overly enthusiastic in a bull market and not overly depressed in a bear market. He must stick to his guns and be able to handle every so often a drawdown up to 50 % or so. This is psychologically not easy. An alternative would be to try market timing and reduce equity exposure at the onset of a bear market and increase equities at the beginning of a new bull market. This requires knowledge, the discipline to look at the markets on a regular basis (let’s say weekly), and an investment strategy which tells the investor when the market has turns so that equity exposure can be adjusted. The time required does not have to be significant and the changes in investment options does not have to be frequent but the super investment needs to be on the investor’s mind requiring a large amount of self discipline. This is not easy but can be achieved and this would allow if successful increasing the performance by a significant percentage. Increasing yearly returns by just a few percentage points will make a huge difference through compounding over the lifetime and as such the effort and time spent on developing and implementing an investment strategy will be very worthwhile.
“Past returns are not indicative of future returns.” Every product disclosure document tells you that and we sort of know it but obviously still look at past returns and still believe that past returns will provide a guideline for future returns. However, looking at just a few years and extrapolating those returns immediately into the future will give us very often falls hope or unjustified despair. Markets are always changing (and as they change stay the same) but you cannot presume that the last let’s say three years returns will also occur the next three years. So it is important not to be over enthusiastic after a longer bull run and not overly depressed after a bear market. Markets change and no bull and bear market lasts forever and after a period of outperformance a period of underperformance, i.e. regression to the means, will follow. A sound investment strategy will allow the investor knowing when markets change and thus lead to change in asset allocation.
Many super investors don’t know what to do with their super and the constantly changing market conditions and the hype, drama and fear mongering of the financial press will usually frighten many investors. The logical but wrong response would be to play it safe and keep the super in cash as cash is safe. However, cash scarcely ever beat inflation and after tax usually does not maintain the purchasing power. The peace of mind achieved with investment in cash is a price too high to pay as it does not allow increasing the super fund balance through compounding over time. There is a time and a place for cash if and when the investor has a thought through investment strategy trying to time the market. However, if the investor is unable or unwilling to educate himself to develop and apply such an investment strategy he would be better served with a buy and hold strategy and dollar cost averaging having (depending on age) a higher allocation in equities.
Blog: Entry does not matter
Or put another way: When to buy a stock does not matter.
Well, that is meant to be a bit of a provocation to get a point across. We will obviously try to get the entry timing right. We’ll choose a stock that has decent earnings momentum, rising quarterly, half yearly and/or yearly earnings per share, a good return on equity that is hopefully not excessively priced. However, forecasting is always difficult and as such there is always a chance to get it wrong. There are earnings disappointments out there, stocks can be re-rated from darlings of the street to pariahs and all good and bad things can happen. Yes, we try our best to get the right stock at the right time and for most investors that’s the end of the story. They believe that once they get the entry/purchase right everything is sorted.
Well, not really. Before we bought the stock we did not have a problem but now we have one. The stock can either go down, we lose money, and we have to decide if we should hang in there or cut our losses. Alternatively, the stock can go up and at this stage we have to decide when and how we are going to take profits. Should we grab a quick profit out of fear the stock is falling again in price or should we let it run? How long for?
As human beings we rate the pain of losing a certain amount of money double to the pleasure of making the same amount of money. Losing money hurts more than the satisfaction of making money. Therefore as investors and human beings we tend to let losses run (“She’ll be all right, mate.”) hoping for the best, hoping that the stock price turns around again into the profit zone. On the other hand, once we have a small profit we tend to take the profit quickly as we are afraid that the stock falls again and our small profit vanishes. We let losses run and cut profits short. Just the opposite of what we should be doing. Everybody knows that we should let profits run and cut losses short but it’s just so hard to do it as it is against human nature. We thus need a crutch to help us overcome our human weakness as investors and do the opposite of what we should be doing. This is obviously not easy. In order to help us we need a trading system that helps us overcoming our built in bias as an investor.
Yes, we do need a rule how to get in but that is relatively easy. Above all we need a rule how to get out with a loss and how to take profits.
I have been trading futures for quite a long time and am constantly tweaking my system to increase performance and I guess I’ll never be finished. At some stage I was testing different exit strategies, i.e. how to take profits. I was not too fussed about entry; I was quite happy what I had. In order to make my simulation process easier I just programmed random entry. Basically I flipped the coin and heads I would go short and tails I would go long. And guess what: Even with random entry I could make money if I had the right exit strategy which allowed me to cut losses short and let profits run. In real trading I would obviously not choose random entry but the point I am making here is that entry alone is overrated and in order to make money you need an entire system where entry is just one part of the overall system.
Exit must be considered and you must have rules how to get out (with a profit or a loss) BEFORE you buy the stock. This way you have a plan, you are prepared for different scenarios and it is much easier to stay disciplined and overcome our built in biases.
TradingPro tends to get out with a small loss in stocks once the stock falls 8 % + from entry. This allows us to keep 92 % of our capital to go and try again. Sometimes we buy the same stock again once entry conditions are met again, and sometimes even at a higher price. Once the stock goes into our favour the temptation is to take profits quickly so we have a way to stay patient and only really exit once the trend changes to a downtrend or once we have a sharp selloff in an accelerating, hyperbolic up market. The exit rules are somewhat discretionary but are nonetheless rules to live by. Losers will be cut quickly but winners can stay in our portfolio for quite a long time, as long as a major uptrend prevails.
Blog: How to invest in International Share Markets
Australia represents about 2 % of world market capitalisation. Most Australian investors have most of their assets in Australia. Given that we Aussies love bricks and mortar we tend to have a high proportion of our assets in housing with the primary residence usually being the largest asset. Most middle class investors also have negatively geared property and some even have property in their SMSF often representing a large (or too large?) part of the total funds assets. The rest tends to be in Australian shares with the usual suspects being the banks, BHP and RIO, Telstra, Woolies…. The percentage of non Australian assets tends to be very small. This tends to make sense when the Australian share market outperforms other world markets AND the Australian Dollar appreciates against most other currencies. However once the Aussie depreciates and/or Australian share underperform it is imperative to look at overseas equity investments.