One of the major lessons we can take from the 2008 bear market is the need to take responsibility for the management of our money, investments and general financial well-being. The issue with bull markets, and extended ones in particular, is that they breed complacency. Investors become complacent in their approach to the markets and a level of irresponsibility begins to creep into their trading and investing decisions. Mistakes are covered up by bull markets. Shares that have a correction or pull back in price are lifted again by the market as “the rising tide lifts all boats”. As euphoria spreads due to making big profits stops are ignored, position sizing models go out the window, and bigger and bigger risks are taken as traders and investors clamber to make money from the rising market. As prices are pushed higher and higher on a seemingly never ending upward price thrust many of the basic tenents of investing are ignored or forgotten and leverage balloons as more people assume a riskless mindset. Many traders begin taking ‘hot tips’ from friends, contacts, brokers and anyone with an opinion on the market. Worse still, many people abdicate responsibility for their decisions and place their trust in any number of so-called experts or professional money managers. A few examples were detailed in last week’s blog.
These ‘experts’ have a fundamentally flawed belief that equity prices will continue to rise, and that investors need to remain fully invested at all times. This premis is based on historical performance of an equity index such as the All Ordinaries, and various charts are produced to show how equities “always’ rise over the long term. The problem is that the stocks that comprise the basket represented by the index will change over the years. So, whilst the index may appear to rise consistently, many of the stocks within the index will be removed as they drop out of the index for a variety of reasons, including insolvency. ABC Learning, Centro Properties and Allco Finance were all constituents of the ASX200 Index and were replaced by other relatively stronger stocks. Indices therefore have a “survivor bias”, unlike your portfolio.
These “experts” also engage in the age old fallacy of averaging down – buying more as prices fall. I have lost count of the newsletters, broker reports, TV shows and fund manager reports I have seen over the past 12 months advising people to invest as the prices for shares were in a severe downtrend. Why invest capital in a stock that is trending down? Examples include ABC Learning, Babcock and Brown, Allco, MFS and Centro Properties, Lehman Bros to name but a few. The outcomes of many of these ‘recommendations’ speak for themselves. Many of these recommendations stem from sources that have a vested interest in you continuing to buy – stock brokers whose sole job is to encourage you to buy in order for them to generate an income from the brokerage earned on your transactions. Does the outcome of the trade really matter to them ? Do they really care about you and your investments? Whilst a handful may, the vast majority are simply sales people generating commissions from your business.
Likewise, the majority of financial planners generate their income from commissions and fees received from selling managed funds. They are more than happy to encourage you to continue to invest as prices crash because their income comes from the sale of the fund and regular ongoing contributions to the funds. It is not linked to the performance of the fund. They too tout the line that shares will always outperform other investments over the long term. Problem is, how long? And when they stop outperforming , what risk management strategy do they have to protect profits and capital?
The simple way to avoid these mistakes is to take responsibility for your trading and investing decisions and become proactive and decisive in the management of your investments. It can be done. There has been a huge movement in the USA over the last 12 months towards investors managing their own capital. Many of our clients, by acquiring the necessary skills and following their trading plans, and mechanically and unemotionally executing ALL the buy and sell orders generated from the SPA3 system are able to consistently outperform both the All Ordinaries Index and the majority of fund managers.
They have clear cut and unambiguous entry, exit and money management rules that allow them to achieve this. Not only that, but they have peace of mind knowing that they are managing their money in a structured and rigorous manner. They are not subject to outside influences in their decision making processes. Better still, the decisions they make aren’t based on the need to generate a sales or fee related income stream – decisions are based on price action in the market. They are truly independent and mechanical in their approach to the market. By following the rules that they have established they are able to implement their trading and investing strategies with clarity, commitment and confidence.
The point of this week’s posting is to educate investors that there is another way. The marketing approach of the large institutions will always allow them to generate business, at your expense. My question to you is if you haven’t already started learning about Active Investment and taking active responsibility for managing your investments, when will you? The fact is that what might initially seem like a lot of hard work may actually cost you 100’s of 1000’s of dollars over your investing lifetime through non action, and through abdicating responsibility to the so-called ‘experts’. When you ‘get it’ there really is far less time and effort spent on managing your own portfolios than you would expect.
In a future posting we will talk about performance research undertaken by John C Bogle and Charles D Ellis on American mutual funds over 25 years from 1980 to 2005 . The outcomes may astound you.
If you would like to see either SPA3 or SPA3CFD in action, you can register for an online demonstration at the link below.
hi gary im from your home town of durban rsa.i was amazed at your lecture reg spa 3 in durban 2008.thanks for promoting the diy investor regards mike keys
Response to Comment by Anne:
Writing covered calls is a far more difficult and active strategy than most promoters will admit to.
Writing puts likewise. If caught on the wrong side of a large move profits and capital can be wiped out very quickly. I am aware of promoters writing puts on RIO when it was at $100 having dropped from nearly $160 believing that it couldn’t go any lower. Writing near dated puts at $90 was a sure thing!
Then again in early October when the markets dropped 20% in a week and RIO fell to $60, writing puts at $50 was definitely a sure thing this time. Well for a month it was as RIO ralllied to $80 almost like the set up for the Big Sting (starring Robert Redford & Paul Newman). Writing November puts at $70 would have seemed like a good idea. RIO plummetted to $30 in the space of a month!!
The old justification for put writing that you just buy the stock if it falls through your strike price because it will always recover has proven to be naive and incorrect. In this example, for every RIO put contract the put writer would need to come up with $70,000 cash per contract which in a couple of weeks would have dropped to $30,000 in value and still be sitting on a loss of $20,000 per contract as at 9 Feb!!
Some put writing promoters would have you rolling down as the price falls thereby avoiding the need to come up with the cash but every roll down genetaing more and more options losses. This strategy is equivalent to averaging down as discussed above or to doubling up in a casino which are martingale systems which are no-no’s for investing.
Directional option strategies work well most of the time but have a major problem – you only need one outlier event to take place or one major trading mistake at the wrong time and with the leverage and options pricing structure can lose an entire portfolio plus more in one hit.
Response to Comment by Mike:
Time flies when you are having fun. I was last in Durban in June 2007!
Go Sharks!
paying adviser $800 per month had 730,000 in pension now recovered to 500,000 from low of 425,000 do you think i should sack him and doit myself joe
have taken responsibility,sold smsf shares in august 07, great but then panicked & bought back in nov 07 down from there. used to write covered call or puts but don’t now as if I’m exercised would take a big loss eg bhp bought at $45! sitting on my hands learning as much as I can about cfd’s, & everything