Portfolio Management

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As I said in my comment to my previous post, Anonymous’ questions raised a number of interesting points for me.  I will address them in the order they were raised.

XTR
First,  XTR (iShares Diversified Monthly Income Fund) is a fund of funds.  What that means is it costs me more to hold this particular fund.  Given the performance of XTR over the past three years, though, it would have been worth it.  Despite the (Canadian) diversification (equities, bonds, and REIT’s) the correction in 2008 was still around 50 percent.  This is why I believe even long-term holders should have a maximum loss, or stop loss at which they can take their money out of harms way. (and, why I don’t use mutual funds).

A Signal
I have misled Anonymous into thinking my approach using XIU (iShares TSX 60 ETF) is to put everything into that ETF and watch the 200-day moving average.  My stop loss is when the price of XIU crosses the 200-day moving average from above.  That is my signal to stop out of any Canadian equities at that point in time (if I haven‘t done so already).  This would not necessarily work so well for XTR since it is a blend of stocks and bonds (albeit Canadian ETF’s).  For XTR, I would simply use its own 200-day moving average as an indicator to begin stopping out.

How Much Is Too Much
If I didn’t know much about stocks or investing and was comfortable in thinking the returns given by the TSX are likely to be okay, I would not have a problem in putting everything into something like XIU (as long as I had a stop loss in mind), just not everything at once.  Jim Cramer seldom recommends ETF’s, but he does suggest doing one hour of homework per week for every stock we own.  On that basis, not many of us are going to have the time to manage twenty stocks.  XIU has sixty of some of the best companies in the world!  I know the TSX is under-represented in a number of sectors, but I, personally, would rather that than assume the risk associated with companies in emerging markets, and/or having to deal with the currency exchange.
 
Size Matters
I do like the suggestion by Anonymous to divide my portfolio into four, or five equal parts (personally, I subscribe to the 80/20 Rule).  I know some people advocate varying position size, but I make them all the same (in dollars) and stop out as soon as I begin to take a loss.  I use different markets (through Canadian ETF's),  seasonality (www.equityclock.com), and technical analysis (www.stockcharts.com), to determine what I want to invest in, and since I will take profits when I can, I never feel the need to be 100 percent invested all of the time.  The markets go up, down, and sideways.  I never try to get in early to wait, but normally, only put my money into newer trends.  I say normally because sometimes a trend will appear to break, and then, later, resume again.

Moving Averages
I would not, however, use moving averages less than 200 days as a signal to get in, or out.  For me, I just don’t see the reward.  For whatever reason, the 200-day moving average is a turning point for the market, and stocks in general.   Using a moving average of a lesser duration tends, too often, to result in getting out at one point, and getting back in again at a higher one - not what I want to do.  My own preference is for trend analysis - I take profits as the longer term trend grows tired (especially if it exceeds my target), and begin looking for the next one.

Again, thanks to Anonymous for the questions.

Anyone wish to share their point of view?  Does this bring up any other questions?

Position Size

80/20 Rule

Decisions, Decisions.
Size matters, or so I am told.  From "too big to fail", to sports like boxing, size is a factor.  The question is, how does size affect one's investment portfolio decisions?   For those who don't have a sell strategy (i.e.: Buy and Hold) diversification is the only hope, and what follows will be of little use.  Having a sell strategy provides me with a few more options.

Call Me Arrogant
First, I have heard it said that buying a whole position all at once is the dominion of the arrogant.  That may be true if we are not using technical analysis to time our entry points.  My method of determining when to buy has proven to me that what I call a buy signal is just that - the point in time when the odds are most in my favour.  Averaging into the market almost always reduces my returns, it does not improve them.  If I buy all at once, and I am only partially right, then I can begin to reduce the size of my position.  If I am completely wrong (read: losing money) then I sell everything I just bought.  I would rather be out the commission than lose capital.

Diversification
Next, we should talk about the size of a position.   I have seen academic studies that demonstrate even twenty stocks is not enough for any one portfolio.  (That study was probably commissioned, pardon the pun, by the financial services industry - cha ching!)  Note that a single broadly based Exchange Traded Fund (ETF) can contain well over the twenty stocks required to provide me with enough diversification.

Market Correlation
What I am saying is holding broadly based ETF's provides me with all of the diversification I need, thank you, even if I put my whole portfolio into one ETF!  "Wait!" the experts will say, "You need diversification between various regions of the world!"  Do you hear the cha ching in the background, again?  Since I have a sell strategy, if my investments in the TSX are under performing, when I do sell, nothing says I have to buy the TSX, next time around.  Understand that markets around the world are highly correlated, these days.  By that I mean when one market tanks, the others are likely to do so, also.  Maybe not at exactly the same time, but close enough.  

80/20 Rule
Having said all that, I believe in the 80/20 Rule.  Applied to investing, the rule tells us that 80 percent of our returns will come from 20 percent of our holdings.  Rather than watering down my returns by casting my money into everything in every market, I use seasonality, technical analysis, and fundamental analysis, to focus on the areas of the market that are working, and simply forget about everything else until the conditions change, again.

Returns
The major lesson the market has taught me is I don't have to have all of my money in the market all of the time.  I used to think I was wasting opportunities by not being all in!  Nothing could be further from the truth.  If I divide my portfolio into five, how much of a return do I need to make 20 percent, over all?  You get it, I still have to make 20 percent each time.  Each fifth of my portfolio that makes 20 percent contributes 4 percent to my overall results.  Do that five times, and at the end of the year I end up with 20 percent.  Or, I can make 10 percent on any one position (each time contributes 2 percent), and do that 10 times, and still end up with 20 percent per year.

Better Than Average
Do you get what I am saying?  I only need to have 20 or 40 percent of my portfolio in the market at any one time, and as long as it returns 10 percent in a month, or two, I can take two months of the year off, and still make a twenty percent return.  Not bad, when the average annual rate of return for the markets is around 8 or 9 percent! (Which, by the way, most active fund managers fail to do over the longer term, after expenses). 

Sleep Tight
I am not saying this is what you should do with your own portfolio.  I am not qualified to give that kind of advice.  I am saying, with practice, and experience, it is possible.  Consider the possibilities that not having everything in the stock market all of the time creates.  If nothing else, it helps me sleep better, especially in these crazy markets!

How do you decide how much to put into any one investment?