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Some Guiding Principles for Managing One's Portfolio

Since virtually no one will be familiar with over a decade of posts to my own site as well as to the Safehaven site, it seems to make sense to try to present simply some of the main portfolio management principles that I have previously advocated. Certainly one of my goals over these years has not been to suggest that anyone needs to rely on me, but rather, to provide insights into how anyone can apply what I've learned over more than 30 years of studying, investing, and researching funds, if they care to do so.

In this article, then, I will summarize some of the considerations I deem the most important in dealing with your investments over time in order to get the best results. These suggestions are designed to help enable you to achieve your long-term objectives while still allowing you to sleep at night knowing you are not going too far out on a limb with any one "surefire," but perhaps, ultimately unwise investment idea.

For a more in-depth version of these principles, see my March Newsletter at the above link.

1. "Buy and Hold" is a great option, but not necessarily the best option, for long-term investors.

Buy and Hold is pretty much the antithesis of managing your portfolio. It can be highly effective but is best mainly if you truly don't have the time, or the interest, in making new decisions about your investments.

2. It is important to recognize that, in virtually all cases, there are limits to how well a given fund investment, or asset category will do over periods of time, and how it will do relative to other possible choices.

In managing a portfolio, no investment, or class of investments, will be the leader indefinitely. While some types of investment returns, such as, for example, for stocks in general right now, may appear likely to continue to excel, they can't be expected to remain this way forever. In fact, it is far more likely that extremely high returns will return to more "normal," average returns.

What this means is this: Observed excessively high returns will eventually return to a normal value by subsequently performing poorly, typically until a more "average" return is restored (or even lower as performance tends to "overcorrect"). Expressed as a simple formula, past great returns plus upcoming poor returns should average out to long-term normal returns. The formula should also work to eventually help restore currently poorly returning assets to their prior long-term averages.

The implication is that, while the timing is admittedly extremely difficult to get correct, investors can benefit from pro-actively moving from excessively high returning investments to underperforming ones, and vice versa.

3. Related to 2., I believe it important to be willing to settle for sustained good returns when they become available.

This is another way of saying investors should try to avoid becoming greedy. Sure, possible returns of 10 to 15% or more a year would seem to be hard to pass up. But, usually, investors should be willing to do just that.

I define "good returns" as anything above average. And how would I define "average?" Average returns for stocks should be considered in the 10% range. Average for bonds would be highly dependent on whether interest rates have been trending up or down, since falling rates are good for bonds, and rising rates are bad; if rates are trending down, it might be 6% or so; if trending up, it might be as little as 3%.

Upon earning above average returns for a number of years running, it makes sense to capture some of those returns by seeking out either less currently above average performing categories of funds, or, less risk in cash. By "settling" for good returns, you are reducing your risk, essential for prudently managing your portfolio.

4. Look for performance trends as well as potential reversals.

Many people might think that investments are totally unpredictable from year to year. Therefore, they tend to accept staying put in most or all of their investments. However, such a belief seems to me to be clearly only a partial truth. Although true that sometimes almost anything can happen comparing one year to the next, when one looks at multi-year periods, it is most often the case that a given investment class keeps on performing in the same way, either above average, below average, or close to average ("average" defined as above).

But friendly long-lived trends can, and often do, become the investor's enemy. Can anyone know when this will happen? Although literally thousands of articles are written on this subject every year, accurately forecasting when a severe change of direction is close at hand is next to impossible. However, by prudently taking some of one's profits (see 3.), one can guarantee coming out ahead for a portion of one's investments no matter what happens next.

By following performance trends, you can see when a given category of investments has started to reverse its prior performance, although you can never be sure this change of direction will last significantly long enough to justify making a portfolio change. Some good rules of thumb might be a drop of 5 to 10%, or better yet, an extended period of subpar performance lasting at least 6 months, but more reliably, lasting for 12 months or more.

5. Unfortunately, there are very few economic indicators, if any, which are consistently useful in helping you decide when to alter your investments.

Although typically used as the basis for making portfolio decisions, in reality, many closely watched measures of the economy are difficult to predict, or even to interpret as to their ramifications, and turn out to be not as closely related to investment performance as one might expect. Further, many of these releases are reported "too late." This means that once they are reported and confirmed by subsequent reports, your investments may have already moved considerably, down or up, preventing you from getting much benefit if you haven't already adjusted your portfolio ahead of the data.

One exception might be the evolving direction of interest rates. As suggested above, as rates trend up, more and more, you should be willing to let go of some of your bond funds, even if it means exchanging into cash and getting very little or no return as a result.

Rising interest rates do not appear to have as immediate an effect on overall stock market performance as they do with bonds, especially when rates are starting from a low base, such as would be the case now. Eventually, however, rising rates will cause most stock funds to suffer.

6. There are very few actual occasions which offer above average, or even exceptional, opportunities for investors, so when these do occur, one who acts may be able to achieve exceptional results.

Consistent, regularly occurring investing, such as through scheduled payroll deductions to a retirement account, is as good a way to add to your investments as any. However, perhaps once every 5 to 10 years, stocks (or bonds) go completely out of favor due to severe underperformance, or even gut wrenching bear markets. Investors should recognize that these times are indeed likely the best times to add extra amounts to affected investments, but only in moderation with a long-term perspective.

Years of strong investment performance (much like we have with stocks right now) are typically hard to resist. Likewise, investing after an asset has been severely battered is not something that most investors, other than perhaps some traders, are going to feel comfortable with. But patient investors who are able to shake off this adverse psychology are likely to come out well ahead.

7. Avoid negatively "pre-judging" any investment category.

Some people have a strong "bias" against bond funds, while others the same regarding stocks. (The same applies to particular types of bonds or stock funds, such as high yield bonds or certain sector stock funds.) Some of their reasons might be: "This type of investment has never worked out well for me when I tried it," or, "bond returns will never do as well as stock returns." (However, in some cases, people may correctly size up their risk tolerance causing them to rule out certain investments as appropriate for them.)

In truth, each type of investment does well some of the time, besting other categories of investments. Pre-judgments tend to preclude the possibility of taking advantage of these winning periods which often last for years at a time. And, since not all categories of either stocks or bonds are always going to perform equally well, one should not be quick to rule out a particular type of stock or bond fund just because they may be unfamiliar with it, so long as its expense cost is reasonable and it has not exhibited (or has the potential) for extreme price movements.

8. Be aware of which funds are highly volatile and only invest in such funds with your "eyes wide open."

A fund that can go up 40-50% in a single year can easily go down an equal amount in a subsequent year. Unless you consider yourself an aggressive investor willing to take big chances in order to earn occasional big rewards, most of your fund choices should be steady Eddies, not funds that tend to top the charts.

In conclusion, I urge investors not accept the cynical and now prevailing view that monkeys throwing darts at a list of funds (or anyone by just investing in index funds) can usually do as well as a disciplined and knowledgeable investor when it comes to picking stocks and/or funds. Various strategies can enhance performance, and on the other side of the coin, cushion losses.


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