Bamp;H is just dandy if youre capital-rich
But not if you are time-pressure poor. Were not talking about meeting the rent-money needs here. What is at issue is the lurking problem for those that think they are time-rich. Or for those that used to think so, then listened to the Bamp;H platitudes, and now find themselves time-paupers, when they look at their todays inadequately increased capital in comparison to the calendar of offspring college expense needs, retirement continuing expense requirements, or medical emergency expense needs.
As we have spelled out in SA articles here, here, and here, the power of financial compounding resides in the passage of time. We all only have from now on. We cant go back and get a re-fill. And time is, for many, far easier to squander than money. All we have to do is just not pay attention.
And the Bamp;H seduction is so appealing
You dont have to work continually at Buy amp; Hold. Just do a little superficial scouting around now for stocks or ETFs that cant fail and have steady growth records, buy em – some now and some more every month, quarter, or year – if you remember to – or whenever you have extra cash. Dont worry about timing, because nobody can time investments or the markets. So just take what everybody gets – the average, including some dividends. And never sell, because uncertainty will likely keep you from getting back in when you should have. (That point in time will be obvious after the fact, and who wants to wear that Was I dumb? Kick me sign.)
This is the Bamp;H sales pitch.
But what is the reality?
How much do the averages grow, including reinvested dividends? Over 30 years the major stock price indexes have grown in price at a compound annual rate of +8.7% for the Dow Jones 30 (NYSEARCA:DIA), +8.1% for the Samp;P 500 (NYSEARCA:SPY), +12.5% for the Nasdaq 100 (NASDAQ:QQQ), and +7.2% for the Russell 2000 (NYSEARCA:IWM) (small cap stocks, 28 years). To add in dividends on the Samp;P500, in the ETF form of SPY during its 21-year history, dividends have added +1 frac34;% to its growth rate, so figure nearly +10% a year, total.
Savings bankers, insurance salesmen, mutual fund peddlers, and financial planners all love to talk about how those numbers can turn a $10,000 investment into variously $100,000 to $340,000 if simply held for 30 years. Simple, if you have the 30 years before you need the money, and of course, the $10,000 available in your early years.
Somehow, turning $1,000 proportionately into $34,000 over 30 years doesnt sound so impressive. If you saved up the $1,000 then by riding the bus, so that you could buy a car now — well, you get the idea.
The exigencies of life constantly seem to get in the way for many of us, attacking the good intentions and wise parental counseling of thrift, restraint, sensibility, and self-discipline we know are right – usually; but right now we need to… That is what makes time so valuable.
How to buy time (?)
We cant. But we can seek to grow our financial resources faster than average; the 8% to 12% a year that markets seem to offer without any real continuing effort.
In a place as avaricious and competitive as the investment markets, everything has a cost. The most inclusive description of investment cost is risk. Usually the bigger the return (the more that is won on a given investment in a shorter time period) the higher the risk cost is likely to be. But we need to be careful about what risk really means.
Investment risk really means a realized (not potential) loss of capital. Much of the investment literature seriously confuses uncertainty with risk. Uncertainty can contain the setting for risk, but it also contains the setting for opportunity. Statistical measurement of historical price uncertainty uses a measure (standard deviation) that equates the price deviations – from the mean price – to the upside as well as to the downside.
What the measure is saying is that there is as much upside price change opportunity as there is of downside risk exposure. But what if thats not so? Some 50 years ago two Stanford University professors, Amos Tversky and Daniel Kahnemann performed Nobel Prize-winning experimental analyses which showed that investors feared loss more than they were attracted by gain. Interesting, but they never determined that investors were repelled by gains.
Other academics of the era sought to concoct an elegant and elaborate means of measuring risk that could be incorporated into risk~return tradeoff analyses. The standard deviation of returns suited their purposes if one simply ignored the positive side of the distribution and instead focused on the negative. Unfortunately, the intellectual dishonesty of that approach, while commercially successful for consultants, turned the Capital Asset Pricing Model from CAPM into CrAPM.
Real life investment risk~reward tradeoff situations are rarely symmetrical in their arrays of opportunity vs. danger. In the investment world the commercial liability of revealing the true extent of negative exposures of equity investment propositions is that the revealer becomes a despised person among the community of proposers.
Please re-read that last sentence, because it explains the behavior of otherwise intelligent persons. So consultants, academics, and investment bankers do as much as is possible to obfuscate risk realities.
Unfortunately, even professional investment societies have been taken in by such community social pressures. Only after several decades of the demonstrated failure of widely accepted practices (like CAPM) are the true problems being recognized, and the focus is starting to shift toward alternative means.
An alternative branch instead focuses on what skilled investment players do that is right, and is becoming regarded as Intelligent Behavior Analysis. It forms the basis for logical price range forecasts being made by essential market-making professionals. These forecasts are powerful wealth-building tools when used in a disciplined portfolio management process.
Instead of producing the average single- to low-double-digit annual rates of gain, they regularly offer net realized rates of gain of +40% to +60% or more. That happens because instances of triple-digit and even quadruple-digit annual rates are interspersed with many strong double-digit gains and infrequent experiences of unavoidable low double digit realized losses.
The Win-Loss ratio and what odds are about
If timing investments means never taking a loss, then the naysayers are right, nobody can time the markets – except for frauds like Madoff.
Loss experiences in making equity investments are inevitable, if you care about the high cost of time erosion. If you dont, and follow the NEVER SELL maxim, it will be your heirs that realize the losses as they take over the remains of your accounts. With far less to relieve their then financial needs than could have been provided.
Think Eastman Kodak and other Dow Jones Index departees.
The key to handling losses is to have a sensible understanding of how likely and how large a capital loss exposure may be, and to have a disciplined plan for either recovery or acceptance of loss. Without such a plan and discipline, human emotions take over and losses become destructive.
Here is where the price range forecasts of experienced market professionals that are derived through Intelligent-Behavior analysis make another significant contribution. Those forecasts are being made by a systematic examination of contemporaneous forward-looking judgments, a system that is consistent across time. The system is consistent because it produces anticipations that are constantly changing.
So, what good is a consistent system that produces varying results? Answer: The results can be observed and recorded across time, the same way that life insurance actuaries build morbidity tables, and sports fans build player batting averages or yardage gains. Those results have forecasting value, as long as the scorekeeping system does not change.
Actuaries have it made; when youre dead, youre dead, and its absolute. Then, over time they can observe how long the average person lives, or how that is changing thru time. Or how it may differ from the average among people pursuing high-risk occupations, like flight-deck crews on naval aircraft carriers.
By keeping the Intelligent-Behavior analysis consistent across decades, as has been done, we can observe important things about specific securities, like how far their prices might decline before they recover to forecasted heights, or to new record heights. Consistent analysis provides records of how frequently the balance between upside and downside price change potentials occur at various levels through time. And then, what the price decline and recovery experiences have been subsequently for the security at any given level of that prospective upside to downside balance. Like todays balance.
That lets us build tables of odds for price recoveries during specified position holding time-limit periods. If price declines are inevitable in virtually all equity securities, does that sound like useful information to have? It is. When such information is at hand, the decision to either accept a loss or hold off for a recovery becomes a reasoned process, rather than an emotional one. Now investment risk has a chance to be understood, and investment management has a better chance to be fit to the investors preferences.
It has a much better chance than by investors getting risk-pacified by some managers vague, obscure, dimensionless fuzzy notions, accompanied by a lot of hand-waving. (Hands later waving bye-bye to gonzo investment capital?)
Buy amp; Hold is literally a waste of time
It is, because it operates from the presumption that all equity investments, especially the one(s) you own, will always rise (sometime before you become actuary-bait), no matter how far they may have fallen, or how long it may take. Where recoveries do occur, those price round-trips consume precious time, while providing no additions to return amounts. This is the high cost of undisciplined time erosion.
Any portfolio management philosophy that does not ration investment holding period time is not a discipline, it is an excuse. When done by a hired manager, the chances are he is more concerned about losing a customer through acts of commission (making active investment decisions that dont work out) than by acts of omission (passive investing decisions that may work out). The apparent attitude is: Let sleeping (fee-paying) dogs lie and let their rates of return erode. If you are your own manager, you need not let this happen.
Risk and recovery understanding typifies active investment management
As discussed earlier, the avoidance of equity investments with high price volatility because they are risky really means the avoidance of equity investments with the largest opportunities for wealth building because the information to manage them effectively is not present.
What is needed is an adequate history of win-odds of recoveries from interim unrealized loss exposures, due to a discipline of limited holding-times. This needs to be coupled with a knowledge of worst-case interim price decline exposure during said holding period. When that is available, there then is basis for informed and rational choices to be made among desired portfolio candidates. Investment candidates can be selected based on their historical credentials earned under similar contemporary forecast experiences.
How often such alternative choice contests come about is a product of holding-period time limits, price gain target expectations, and by market circumstances that may be otherwise unpredictable. But two of those three conditions can be defined and/or adjusted.
Since at every day-end we find several investment candidates with very competitive credible prospects, we believe it pays for the wealth-builder to stay fully invested by using them when the time management or profit management discipline frees up available capital.
How to make it work
We have found that using the top of the forecast price range as a sell target works quite well as a signal to move on to a currently-chosen alternative capital commitment. That goal needs to be bounded by a holding time patience limit of 3 to 4 months to avoid spending that scarce time resource unproductively. Some opportunities will get cut short. But it usually turns out that the alternatives become more productive, from a rate of return point of view, than hanging on longer to a tired or late-blooming position.
Further, constraining holdings to a known price objective or time limit helps to make rational decisions about investments that, in transition, are not working out. With prior experience history there is a sense of the odds of recovery within the bounded time, and a sense of certainty of length of capital commitment while waiting for that recovery. Both help the investor to act rationally during periods of stress, not emotionally — where mistakes usually get made.
What evidence is there that Intelligent Behavior analysis works?
This is an analysis that has been conducted for decades in an intentionally unpublished environment because it works by converting the wasteful activities of some investors into profit benefits of others. That opportunity, while large, is not endless. On the other hand, the capital-gathering skills of the professional investment management community are such that market-price-moving quantities of money can be quickly directed to any approach that appears to work. So doing usually destroys the viability of the approach. Publishing explanations in professional literature invites this inevitability.
We hope that modest exposures in circles more visited by individual investors with smaller amounts of capital to apply will be both beneficial to a larger number of investors and encourage more effective market-making than by enhancing the present advantage imbalance held by investment establishment giants. So we are starting to talk about what we do in Seeking Alpha.
We now have some two years of live, published recommendations involving 1400+ equities on Seeking Alpha in 2013 and 2014, along with daily buy list recommendations in 2014. Profits have been made in 77% of those positions, at the average simple percent price change of 6.2%, taking 49 calendar days to reach. The typical annual rate of net gains on 205 buys in 2013 was +58% while the rate of gain for the Samp;P500 index was +36%. In 2014, over 880 recommendations, closed out and currently marked to market where still open, averaged 39% annually, while the Samp;P 500 struggled to show 17%.
These add to several years of live investment forecasts maintained and used by selectively limited numbers of institutional and private investors. Since the markets are full of oblique references of fish tales about the ones that could have been caught, we prefer to back up our story by results from ex-ante published forecasts even when we know more appealing unpublished examples abound.
Investors have a wide range of objectives that they seek. The one set of purposes where we can be helpful is the accumulation of capital under time constraints, often referred to as wealth building. The principal differentiation from this activity and just plain greed has to do with the pressure of time.
Conventional investment wisdom, for many reasons, has had the effect of abusing time, to the point where prevailing practice provides significant opportunity for investors who are intent on using it more intelligently, and have the resources (including information and discipline) to do so. What is involved is active management instead of passive, index-average investing.
There are investment professionals, who rarely have contact with individual investors. They have specialized skills and information flow resources that make possible, for them, an odds-on sense of how specific future equity prices are likely to behave. Their own self-protective actions in pursuing their daily work allow an insight into their future price expectations.
Those insights are key to active investment management pursuits, with better-than-average success in achieving better-than-average price gains. Such information will be illustrated in a next part of this portfolio strategy series, utilizing two well-known stocks to illustrate how alternative choice decisions may be quickly reached, flexibly, within the individual preferences of the investor.
A following article is intended to illustrate how sequential decisions made this way can compound to build wealth more rapidly and more assuredly than buy and hold or other portfolio management practices.