Investing 102

I am in need of some discipline. It is not often that I get to say this to myself, but when it comes to investing it seems to be the truth. I meant to write this piece a week ago when my portfolio was down something like 10% because I would have written with much more conviction then. You see right now, I am up 12%, and frankly I don’t feel as foolish as I did then. Regardless of whether I am up or down, there are some things that I can learn from my first approach to investing.

First let me describe to you my investment strategy. Me and my friend Jon sat around one day and listed all the stocks that we had any interest in. I believe that list was around 50 stocks. We then looked at what the 52 week spread (lowest price in a year to the highest price in a year) of that particular stock, and chose a price suitably lower than the 52-week low.

For example: Bank of America… that company is good, and look how low the stock price is. I think I will buy it if it hits 18 bucks, seeing as how the lowest price in a year has been 22.

So the stock hits 18 bucks, and I buy that stock. Buy is a little of an understatement, ‘pounce’ is a better word. This price is soooo cheap, I better get it now. I chose BAC as an example, because it taught my first lesson in how not to invest. Never ‘pounce’ on a stock. Right now BAC is second to last in returns in my portfolio with a loss of 15%. I similarly pounced on Citigroup, which was un-godly low in price at like 4.50. I watched that stock lose about 40% of its value from the time I bought it, but it is now leading my portfolio in returns with a 76% return on investment (ROI). So here are two examples of pounces, one unsuccessful, one wildly successful, but both completely unexpected. You see, pouncing introduces unnecessary risk because you do not take the time to look at the reason that a stock is behaving the way it does. If I would have taken the time to do my research into why BAC and C stock dropped so dramatically, I would have noticed the little news report that stated that Paulson (our Treasury Secretary) decided to renege on his promise to use the $700B bailout money to buy toxic assets (all those bad mortgages and credit default swaps that started this whole mess). So if the government was not buying them, the banks would have to swallow them and that equals lots of losses for the banks. Hence the drop in price across the financial sector. Hypothetically, knowing this, I would have said… ‘let’s wait until this news is accepted by the market, and the prices of these companies bottom out’. If that would have happened, I would have bought the BAC stock at 10 bucks instead of the 18 I bought it at, or C at 3 instead of 4.50. This would account for a 50% and +100% respectively on each stock by now, and it all it would have cost is patience. So lesson number one. Be patient when buying, and learn the reason for the drop.

My second lesson is in volume. In a market as tumultuous as this one, it is tempting to take advantage of many of the genuine discounts that pop up every day. But falling into a buying frenzy may leave your budget expended before the real steals come along. On my spending forecast, I am way ahead of plan. Don’t get me wrong, I have bought some bargains, but I have bought too many too fast that I now have to be stingy when it comes to any future purchases. This would be okay if purchasing were free, but brokerage fees of up to 10 bucks a trade will automatically eat into any gains from a stock price increase. Like in life, bulk is cheaper, and having invested heavily in the front-end, I decrease my ability to buy in bulk on the back end. Having said this, it is best to make sure you don’t try and time the market for a bottom, because markets roar back to life usually as quickly as they dropped. Which in this markets case, could mean a gain of 40% in a few days or weeks. Lesson number two: set up a timetable for fund expenditure, and stick to it. This recession is probably not going to end for a bit so there was really no need to rush in so quickly.

Lesson number three, diversify and spread your risk. While they say that high risk pays over time, you should still balance your high risk bets with some stable ones. They classify stocks into generally three categories, growth, value, and income. Growth is risky but has the potential to well, grow. Value are stocks that are priced well now and expected to moderately appreciate in value over time. Income stocks have high dividends, where you might not get a large growth in stock price, but you will get quarterly dividends for every share of stock you own. I have no interest in income stocks because those are for old people who need money to live on in retirement, so I am exclusively in growth and value stocks. What I would like to do is balance my somewhat risky stock profile with some less risky funds. Most people know about mutual funds, but it may pay to do some research on Exchange Traded Funds (ETFs). All funds are supposed to track a sector, the difference is that mutual funds are actively managed and ETF’s are passively managed. Basically, a mutual fund will have higher management fees because there is a person actively picking stocks and selling stock to maximize the returns of a specific sector. So if you were investing in commodities, a mutual fund would have a person buying and selling commodity stocks to give you the best returns available in that sector. A ETF is passive, which in short means a computer model buys and sells shares in lieu of an actual person. The two benefit that an ETF offer are lower management fees (which seriously boost your balance sheet in the long run) and you can trade ETFs on the market just like stock (a mutual fund can only be traded at the close of the market, ETFs can be sold anytime). ETFs are not new, but they have become extremely popular lately because they seem to do just as well or better at tracking a sector without charging an arm and a leg just to get in the door with them. A benefit I left out, MFs often have high minimum balances (ex. 10K) but ETFs can be bought by the share if you so desired. I have gotten long winded with this one, but the lesson is to diversify the risk of your portfolio, and I intend to do that through ETF investing. Likely with ETFs that match Small Cap stocks (VB), Financials (VFH), and publicly traded Chinese companies (FXI). I have not made the mistake of being non-diversified yet, but if there is one thing I have learned from friends and colleagues, is that betting heavily in one or two stocks can have disastrous results.

As of now I own the following stocks: BAC, BHP, C, CCJ, CWCO, GE, GM, GOOG, GS, MON, NUE, PBR, POT, STP, and XOM. My return is at 12.4%.

I have to say this yet again. It is very EASY to make money in this market because everything is so cheap. I am making money despite my ignorance of investing because the market conditions are in the investors favor. I hope you all can take advantage of the times.

I am holding off on investing until this current market rally subsides (maybe a week, maybe a month), but then I plan to dive into the following areas:

Buying more of the stock that I own already. Particularly if they offer a good bargain.

Buying the ETFs that I listed before as appropriate. Hopefully Financials first, then China stocks, then Small Caps.

Investing in electrical infrastructure and utilities. If Obama’s plans to increase our energy efficiency are enacted, the electric grid is going to be one of the first things that need an overhaul. With his plans to build roads and such, commodities and construction equipment companies should be a good bet as well.

*Disclaimer: I have given up on studying the ‘fundamentals’ of a company. I.E. studying the balance sheet and their corporate earning reports. I simply ask myself if the business that this company is in will do well in the immediate and long term future, and if its price represents a good value on its past price and performance. The last part is supposedly bad practice since a stocks price is a stochastic process meaning its future is independent of its past… but I have not been convinced of that yet.