The Perfect [sic] Investment Strategy
Let me be blunt.
At any given time and place, there is only one set of investments that will outperform all others. This is the manna of investments, the perfect portfolio, which we are all trying to discover. If found, that perfect allocation, in a very short time, will no longer be perfect. A modified set of investments will outperform. Going from one position to another, at the least cost, would constitute the perfect investment strategy.
Even you you knew this optimal strategy, this illusive strategy to end all strategies, it might still be reckless for you to pursue it. What is good for the goose is simply not always good for the gander.
How do you know then, if you are a goose or a gander? Three factors play a role:
1) Investment Horizon
Let’s say you knew with perfect certainty that an investment would triple in 10 years in real terms – that is, after accounting for inflation. Sounds pretty good, right? But it might only make all its money in the last two years, and prior to that be worth far less than what you paid for it. If you unexpectedly needed access to your funds earlier than 10 years -say after 5 years – you could get clobbered because the assets could be illiquid and demand for them temporarily low. You might lose 20%, 30% or even 70% of your money.
So your investment horizon – the time you can afford to put your money aside and forget it, even in an emergency – is a critical factor in selecting proper investments for your portfolio.
2) Risk Tolerance
Using the example above, even if you felt reasonably certain that in the long run your investment would do well and you were not pressed for time and did not need to acess your funds prematurely, the mental pain and anguish of watching your investment fluctuate could drive you nuts! Suppose a month after you buy something, it’s lost 20% of its value, next month, down another 10%. In this scenario, you might panic and unload the investment prematurely and – Murphy’s law strikes again – take the worst possible financial hit. Even if you let your intellect override your guts and resist selling, you could still lose out as the sheer misery causes you to end up in the hospital with ulcers or worse! And if you yourself can take it, make sure your spouse can. Divorces tend to be costly…
So for the conservative or moderate investor, sanity is worth the sacrifice of 2%, 3% or even 10%gains. Before you start investing one single penny, take the advice of my favorite 4th century BC investment counselor: “Know thyself”!
3) Portfolio Size
Finally, the size of your investment portfolio can play a large role in limiting the types of investments that make sense. Let’s say you invested $200 in a stock and that represented 10 percent of your total portfolio of $2000. If you bought and sold that even through a discount brokerage at $10 per trade, that transaction would eat up 10% of your invested funds, so to be even modestly ahead of the game your stock would have to appreciate by at least 11 percent overall. If you were wealthier and could afford to buy $50000 of the same stock, things would be different. This would still represent 10 percent of your half-million dollar portfolio, but now total trading costs would amount to only 0.04% or 4 basis points of the overall trade. Even a 2 percent move in the stock, for you Mr Moneybags, would now be profitable.
This is simple math, but its amazing how many start up investors – otherwise bright people – never perform this calculation when they first start investing.
Generally speaking, the higher your portfolio size, the more you can afford to trade in individual stocks and the more frequently you can afford to trade. Smaller investors, even when using a discount brokerage, will have difficulty making money in individual stocks due to the size of their trades. They will inevitably do better with mutual funds, unit investment trusts, and exchange-traded funds due to much lower transactional costs.
A way around this problem, for the small investor, is to use leverage by trading options or futures. But that’s not for investors who are faint of heart, dull of wit, or short of time.
Your Best Strategy
So what’s the perfect investment strategy for you, Mr Goose and Mrs Gander?
Orthodox financial thinking would say, if you have a lot of money, consider buying individual stocks and bonds over mutual funds and diversify widely for safety. If you are moderate or low of means, buy mutual funds, index funds and etf’s for diversification at low cost, at the expense of some performance.
As for the allocation to equities (stocks) over fixed assets (cd’s, bonds) , conventional thinking would have you subtract your age from 100, and put the percentage representing the difference in equities. For example, at 20 year old would invest 80% in equities, 20% in bonds; vice-versa for the 80 year old.
That is where the Strategic Investor departs from financial orthodoxy. Investments are complex. Easy investment formulas often do more harm then good. In times of imminent raging inflation, telling an 80 year old man to hold all his assets in fixed bonds or a CD at 3 percent is not wise or prudent, it is either unwittingly stupid or uncaringly sadistic. In times of deflation and recession, the same counsel might be visionary.
So it is imperative to consider the overall macro-economic picture, global politics and societal trends when making investments. These are the proverbial tides that float all boats, big and small. The currents and eddies and waves along the way make the task of calculating the tides and the winds difficult. But it is critical to try, to keep a sharp watch to try to avoid the icebergs and the squalls.
And if an unexpected hurricane or tornado appears, you may need to batten down your hatches and bring down your sails. Expect the unexpected, react and be nimble.
Investing is complex. Albert Einstein sums it up nicely with his statement:
“Everything should be made as simple as possible, but not simpler.”.
Find a good advisor, or do it yourself. Or both. But consider well and pay attention, it’s your money and your future.