Happy New Year! Jan. 1, 2014

It's Audit Time! Zeb’s VUE

Tis the season to Look Over Your Investments:

Would you take my advice?  Take a hard look at your investments.  Do this for everything you hold; stocks, houses, and any investment asset.  Ask yourself, If I was not in this position already, would I invest in it now? 

This does not usually take much time, but analyzing your investment will go a long way toward consistent profitability.  It is something everyone should do at least once a year.  If you are a shorter term trader (6 mos to two years) you should analyze your assets every month.

Ask yourself the following question.

If I was not in invested in this asset already, would I invest in it now?  If the answer is no, sell it immediately. 

The major problem almost every retail trader struggles with is admitting a mistake, taking a loss, and investing again.  We tend to hold losses and hope for a comeback.  Hope is a killer in the investment world.

Many times, investors ignore their losers, and they go from a small 20%+ loss to 60%-80% loss.  It is the giant losses that decimate the portfolio's performance (and the devastates the capital to invest with if we have a crash such as in 2008). 

Investing is not like any other effort in life.  In fact, what often works in real-life is distasterous in investing.  Take for example, a super-star pitcher in baseball.  If the pitcher gives up 7 runs in 3 innings, he'd better get over it before the next outing.  He will need that self-confidence in the next outing. 

Investing is not like that.  Losing investments are like cancer, where if you catch it early, it won't destroy you.  The goal of regular audits is to confront the mistakes, and cut them out of your portfolio before they ruin you.

This idea is correct for either fundamental trading or technical trading.  Whatever the reason was for getting in, if that reason no longer exists (even if the investment is profitable), get out.

For example, imagine you invested in an emerging market China Bull ETF (YINN) because you believed that emerging markets would outperform the US stock market.  You now analyze the position, and realize that emerging markets have been underperforming by a large amount.  Your analysis of China's growth suggest slightly lower growth coming for 2014.  You bought at the bottom (lucky you) at $15, but your analysis shows the ETF has become very volatile and is on a downward trajectory.  China is also having a war of words with Japan.  With this analysis finished, you decide to liquidate.  However, you want to be invested in Asia.  So, you look at MSCI Frontier (FM).  FM is a top performing ETF, and is worthy of allocating some portion of your investment portfolio. 

Holding money that could be used to deploy into new and better ideas is not wise.  In my life time, the best examples were the programmers I worked with in San Francisco.  We were all smart, but several of them bought shares in all kinds of dot com business.  They did not cut their losses, and they could not participate in the emerging bull markets in commodity assets.  Many of my friends ended up broke (as they leveraged), and that was sad then and still sad to me this day.

However, now the question must be asked: How do you cut without cutting your future winners? 

The key is to ask yourself (as I did on the China Bull ETF) is the reason you invested still there?  What was your goal in entering the position?  If the goal and the reason is still there, you do not liquidate a winner.  Winning begets winning.

For example, Intel several months ago was very cheap in every form of fundamental value you could measure.  Imagine you invested when it was eight times cash flow, and you expected the stock to gain because the market would pay 12 times cash flow for Intel.  This was a short term strategy for you.  You were right, and Intel rose in price.  (Look at an Intel chart).  Now you notice your original goal is still intact, and you think that 2014 will be all right for the stock market (maybe not perform like 2013, but all right).  You would hold Intel, and look to take profits once your objective is reached - 12 times cash flow objective. 

In this example, you are letting your winners run, and cutting your losses as in the China ETF. 

The key performance metric, however, is focusing on losers.  Those positions need to be given the third degree.

 

Perform and audit at least once a year if a long term investor of all your assets.  Perform an audit more often if your time horizon is less than 2 years for an asset.