Can Money Managers Add Value To Your Portfolio?

Based on a dismal record of money managers to outperform benchmarks, we have to take the argument that markets are efficient very seriously.  Recent statistics shows that 0.002% of Hedge Fund managers outperform the S&P 500 over a period of 5 years time!

When we go about building our investment strategy, benchmark, style, or passive and active investing, we must consider the overall average performance of each investment class over a period of at least five years.  Doing so, ensures your money has staying power.

In our own practice, we use only institutional-class index funds.  Today it is possible to index almost the entire world.  I think that approach gives us the highest probability of a successful outcome with the lowest risk.  To the extent possible, I want to see predictable results.  I hate underperforming the benchmark more than I would enjoy overperforming.  That makes me pretty much like my clients: risk averse. 

On a side note:

A special thanks to Dr. Karl W. Einolf, Ph.D. of Mount St. Mary’s University for allowing me the opportunity to lecture his Corporate Finance classes yesterday.  It’s truly an honor and I hope I was able to impart some practical knowledge for the students as they go on to graduation and beyond! 

Invest Every Month, No Matter How Small the Investment

Being a successful investor is all about keeping your money in play, especially during various cycles in the economy.  When you’re starting out, it’s reasonable to believe that you must deploy your large pile of savings to buying stocks and be done with the process in a matter of minutes.  Success in investing is hardly a one and done activity.  What builds true wealth is investing on a regular basis (at least once a month).

Investing means you’re not spending.

When you don’t invest regularly, you’re not keeping your money in play.  Money that’s not in the market doesn’t reap the benefits of time and compounding.  Of course, many will argue that it would be safer to stay on the sidelines for now, because of current economic conditions.  But the fact is, money that’s not invested in some way is eventually money that’s spent on worthless stuff.  And money that’s spent creates a negative return.

I’m guilty of it too and I still spend on worthless stuff, but the spending on me has been replaced with spending on ‘them’ (i.e., kids).  The stuff you buy usually costs more than the initial price tag.  Homes require insurance, maintenance, utilities, and furniture.  Autos require gasoline, insurance, and maintenance.  Clothing requires cleaning and mending, not to mention new clothes to go with the clothes you just bought.  Computers require Internet connections, printers, toner cartridges, software, and paper.  And so on.  It’s rare to find something that costs no more than the initial price you paid.

If you spend instead of invest, you’re not just losing returns on the money you spend.  The money you spend generates negative return because you spend more money to support the stuff you buy.  That’s why spending is so dangerous (and I won’t even go into the dangers of spending on credit)!  It has a negative multiplier effect and it’s the opposite of compounding rate of returns. 

If you invest every month, even if it is only a few bucks, you rid yourself of money that, if spent, will cost you even more money in the long run.  That’s why it pays to invest even a little amount each month, $15, $100, whatever you can afford.  Don’t wait until you save a larger amount to invest.  The problem with waiting until you accumulate funds is that the money is readily available and tempts you to spend on some foolish toy.  Get the money into your investment account as soon as possible, automate it whenever necessary so it becomes part of your daily life.  You’ll be much better off in the long run.

Five Things to Ignore on the Way to Becoming a Successful Investor

1. Hot Tips.  I’ve found (and Twitter is littered with them) that most hot tips are designed to enrich the person touting them and are rarely researched or present good long-term investments. 
2. Selling when a company is doing well.  Your goal as an investor is to reinvest and compound your profits, not enrich a broker.  If you’ve done your homework, keep on investing. The stock will split and you can buy more shares.  Of course, if your plan is to sell at a certain price point, then follow your plan to the letter!
3. Taking risks.  We all take risks crossing the street, driving to work, getting in and out of the bathtub, eating greasy foods.  The stock market is the least-risky investment vehicle long term.  I’m emphasizing “long term” here because right now, the world has a short-sighted field of view. 
4. Professional advice.  While a heart surgeon can reasonably predict how a bypass operation will go and a lawyer can reasonably predict how an estate plan will avoid taxes, no “professional” is good at predicting or timing the stock market.  Even the best ones fumble from time to time.  If you learn about the various investment vehicles out there, and do what you feel works for you, you will be guided by facts, not promises.
5. You don’t know anything about, so you won’t learn.  I’m always amazed at people’s capacity for convincing themselves they can’t learn.  But many of us have been brainwashed to believe this horrible lie.  We can learn at any age at any time at very little cost.  The information is free and the knowledge is priceless.

Improving Your Trading and Investing Mechanics

Paper trading (when you place buy, hold or sell orders without the use of real money), note taking, and back-testing are the strategies that I have found to be most helpful to the improvement of trader mechanics.

Novice traders (and at times, we all feel this way, regardless of experience), tend to think of trading merely as the acts of buying and selling.  They don't recognize the considerable role that mechanics play in success.  Reducing trading to buying and selling is like describing NASCAR racing as stopping and going.  Take a look at just a few of the mechanics of trading and the difference they make toward profitability.  Obviously, not all of these apply to all traders as we each have our own niches in the market.

Specific Skills that Comprise Trading Mechanics

• Idea Development:  Translating observations about the market into specific trade ideas on the Macro level.
• Assessment of Market Conditions:  Recognizing the current state of the market's trends.  Whether it is range-bound, volatile, or low volume.
• Order Division:  Scaling into positions to reduce risk exposure and obtain superior average entry prices (Dollar Cost Averaging).  Scaling out of positions to secure profits and possibly benefit from favorable movement.
• Position Sizing:  Risking enough on a trade to make a meaningful contribution to profitability while avoiding risk of ruin under adverse circumstances.  
• Exit Flexibility:  Moving stop-loss points to protect profits while retaining profit potential.

Clearly, trading is not a skill, but rather a complex, coordinated set of skills not unlike athletics or medical practice.  An inexperienced trader will look at a stock chart and say, "I think we're going higher."  He will then buy at the market with his maximum position size and see if the trade works out.  The trades are neither planned nor systematic in their execution.  The performance is not far different from that of a quarterback who calls for a passing play on 4th and 10.

Trading and Investing Psychology Continued...

There are a number of behaviors that will almost guarantee losses in the markets.  These behaviors, the antithesis of the way successful traders operate, include:

• Lack of discipline:  It takes and accumulation of knowledge and sharp focus to trade successfully, and more importantly; with consistent results!  Many would rather listen to the advice of others than take the time to learn for themselves.  People are lazy when it comes to the education needed for trading.
• Impatience:  People have an insatiable need for action.  It may be the adrenaline rush they're after, their "gambler's high".  Trading is about patience and objective decision-making, with a long-term perspective on a desired outcome (profit), not action addiction.
• No objectivity:  We tend not to cut our losses fast enough.  It goes "against the grain" to sell.  At the same time, we often get out of winners too soon.  In both cases, we are unable to disengage emotionally from the market.  We marry our positions, and like marriage, we cut our losses when we're too deeply invested.
• Greed:  Traders (and let's face it, EVERYONE) try to pick tops or bottoms in hopes they'll be able to "time" their trades to maximize their profits.  A desire for quick profits can blind traders to the real hard work needed to win.
• Refusal to accept truth:  Traders do not want to believe the only truth is price action.  As a result, they act contrary to their trading plan, and set the stage for the losses that almost always arrive.
• Impulsive Behavior:  Traders often jump into a market based on a story in the morning paper.  And if you're a new brokerage account holder, it's likely that you bought your first stock on the day your funds cleared the account!  Markets discount news by the time it is publicized.  Thinking that if you act quickly, somehow you will beat everybody else in the great day-trading race is a grand recipe for failure. 
• Inability to stay in the present:  To be a successful trader, you can't spend your time thinking about how you're going to spend your profits.  Trading because you have to have money is not a wise state of mind in which to make decisions.  This was a hard lesson for us to learn (and I personally believe, this particular subject is ongoing).  
• Avoid false parallels:  Just because the market behaved one way in 1930, does not mean a similar pattern today will give the same result.

 If you try to bridge the gap between the present and the future with predictions about the market direction, you're guaranteed to be in a continual state of uncertainty whether you admit to it or not.    

Create Your Trading Plan or Investment Plan and Write it Down in Specific Precise Language Before You Trade

Don't confuse trading rules with a black-box system.  Your trading plan should be a set of Rules, which you follow implicitly time and again.  Sure, you can build in some flexibility, combinations and additions to these Rules, but write them down, understand them and implement them.  Also keep them handy, particularly when you're trading or making a trade decision.

A mind map is the best way to achieving this in a direct and visual way.  A mind map is simply an illustration, like if you imagine a series of branches off a central tree, where you're using different colors and symbols to depict the rules, as opposed to simply writing them down in a list.  Ideally, you should do both.

The Rules need to embrace when to enter, when to exit, when to use a specific options strategy (if options are in the plan) and when to activate your Stop Losses (which often change depending on the strategy you're trading).