Investment Strategies: What To Do After A Vacation Has Come and Gone
By Alan Gruver on Jan, 25 2012
“January. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, October, September, April, November, May, March, June, December, August, and February,” Mark Twain.
Mark Twain was a joker, but January can be a treacherous month in the financial markets. Investors are back from their vacations, and they're watching the market closely. Investors, who have positions and have their stops and limit orders in place, can buy stocks as they go on “sale” and take profits when stocks exceed target prices. Up, down, sideways —January is an active month. Potentially it is a profitable month, and now is the time to prepare; to evaluate strategies.
Strategy One: Do What You Know Because It's All About Cash Flow
A business that doesn't produce adequate cash flow is an expensive hobby. According to Stanley and Danko, businesses such as coal mining can be very profitable, and they mention law and dentistry as two professions with relatively low overhead and high gross profit margins. Consultants who are able to work at home or with laptops, cellphones, and PDAs while on the road are able to keep expenses down also. There are certainly many other professions and enterprises that fit into the category of cash cow. The world is always going to need accountants, pest exterminators, plumbers, mechanics, tool and die makers, architects, and morticians. Whether the enterprise is a small mechanic's shop or a sophisticated law office, successful business people know what their cost structure includes every month. Also, they understand the cash flow and workflow of their particular business—especially if it's cyclical. Portrait photographers must plan ahead to run specials and do marketing in December to make up for doldrums in January and the first half of February. March through November they are normally very busy. Accountants may work seventy hours per week from February through April, and they may spend the rest of the year advising clients, developing business, and performing routine functions.
In any case, wealthy people understand the ebb and flow of their profession. They know if their accounts payable exceed their accounts receivable that a cash flow problem is upon them. They comprehend and have an intuitive feel for the cost structure of their enterprises, what they should be grossing, and they know what actions they should take at any moment to ensure viability of the business. Equally, a household that spends more than it earns is a potential disaster. Millionaires run their personal financial affairs with discipline. Wealthy people in America put their surplus funds to work. They set aside funds for emergencies, and they invest for the future. They manage their resources to maximize the enterprises they understand, where they are able to produce outcomes with some predictability and minimize exposure to risks that are unique to those enterprises.
Strategy Two: Pay Yourself First, Invest In Yourself First
Many budding entrepreneurs and professionals forget the advice, “Pay yourself first.” Seasoned entrepreneurs know there will always be an alligator to eat up the money, so they compensate themselves first, and they allocate cash to pay expenditure slater. Getting paid first is critical because time is truly money, and the faster they can get money working, the sooner they can give to charities, provide educational and cultural opportunities to children and loved ones, and support causes and candidates that promote solid values and ideals.
The first strategy covered re-investing in the enterprises that bring positive cash flow. In Strategy Two, paying yourself first keeps personal expenditures contained and allows for investment in yourself. Making time for outdoor recreation, exercise, traveling to new places, doing research into emerging trends, treating a nagging health problem, and going back to school, are all ways of investing in yourself, which ultimately increases your capacity to earn. Formal education toward an advanced degree or certification is almost always worthwhile in monetary and emotional returns. Many successful companies are led by CEOs who attended law school but chose not to practice law. They went to law school to learn how to get information, how to interpret data, how to ask the pertinent questions, and how to communicate the appropriate answers. Expanding your reasoning and thinking skills by going back to school can make you a shrewder investor and enrich your inner life.
Strategy Three: Follow The Leaders and Use Three Sound Investment Philosophies: The East-West strategy, the Modern Portfolio Theory, and Value Investing.
The East-West strategy is a balanced portfolio approach. Half the portfolio is in dividend earning utilities stocks and mature companies, and conservative interest earning investments such as municipal bonds, Treasury securities, and high-grade corporate bonds and altogether make up the East side. The other half of the portfolio is in growth stocks, foreign stocks, cyclical stocks, IPOs, and start-ups. The investor keeps the portfolio balanced by investing the incremental, smaller gains from the conservative group into the principal of the more aggressive (West) side, while taking the larger gains from aggressive securities and adding them to the principal of the conservative (East) side. Drawing two columns on a blank sheet of paper, while labeling one side East and the other side West then listing conservative investments on the left and aggressive investments on the right — now linking the columns with yin-yang arrows—produces an illustration of the model. It's a simple method for balanced, controlled portfolio growth.
The Modern Portfolio Theory, which is the basis of money management and hedge funds, is a little more abstruse. Without trying to oversimplify the details, hedge fund managers attempt to “buy” the market. They buy stocks from the companies in market sectors, and they hedge their bets, making short sales of companies that look overvalued within each sector. If only part of the sector moves, the funds benefit from the diversification of the entire sector, and potentially, the fund can still make money from the short sales of overvalued companies within the sector when those stock prices take a downturn. In effect, the Modern Portfolio Theory attempts to maximize gains and spread out risks over entire stock market sectors. It's based on complex mathematics, but hedge fund portfolio managers like Mark Yusko of Morgan Creek Capital Management in Chapel Hill, North Carolina have done very well for their customers. The buy-in for their investment services is $200 million. As of last year, Morgan Creek is affiliated with Julian Robertson of the Tiger Fund in efforts to produce a hedge fund with a buy-in of $5 million. Yusko and his team have many years of experience working with University of North Carolina, Duke University, and University of Notre Dame endowment funds. For investors able to afford hedge fund managers 'services, one to three percent of assets go to management as fees, plus net profits up to 20 percent may be shared with the advisers.
Benjamin Graham introduced value investing in his classic books Security Analysis and The Intelligent Investor. Warren Buffett declares the latter “the best book on investing ever written.” His investment holding company, Berkshire Hathaway, has done extremely well. Benjamin Graham's model for investing in stocks is a simple formula that includes earnings per share (EPS), five-year earnings growth estimate, average yield of high-grade corporate bonds in the current year, the current yield of AAA corporate bonds, and the price-to-earnings ratio(P/E) of a no-growth company (which Graham estimated to be 8.5). Although the model may be too rigid considering the volatility of today's stock market, it takes into account a company's fundamentals and the broader market conditions.
Strategy Four: Look For Securities at Sale Prices
Whether bonds, options, or stocks, it's smart to look at the technical charts, and the sales and earnings reports to determine if the stock might be in a “pocket” or window of buying opportunity. Phil Town, author of Rule #1 and commentator on CNBC's The Millionaire Inside, advises people to buy stocks on sale—meaning, think like a business owner and buy a company that's understandable when it's price is half what it should be, then sell it when the stock price reaches the estimated target. September and January may be great months to use contrarian tactics to find undervalued securities. If a company is cyclical, an investor can watch the stock's price chart through any of the online brokerages, Reuters.com, or even Yahoo! Finance. William J. O'Neil, publisher of Investor's Business Daily, recommends buying stocks with solid company fundamentals and a technical chart that forms a discernible cup-and-saucer pattern, which might signal an upward breakout for the stock.
Strategy Five: Diversify
“Never have all your eggs in one basket.” The old proverb is a good rule. The Modern Portfolio Theory tells managers to buy the market and spread out risk systematically. If an investor knows a particular industry and market, then their tolerance for risk is much higher than the novice investor whose experience is limited to mutual funds and annuities. According to Paul Hawken, author of the Next Economy and Growing A Business, entrepreneurs are not risk-takers. They minimize their exposure to risk with knowledge and appropriate action. Investors with specialized knowledge and insight might minimize their risk and maximize their profits by investing solely in an industry they comprehend. Others may need to create diversification by investing in solid companies using the Benjamin Graham value method. In 1999, Warren Buffett addressed the students of the University of North Carolina Kenan-Flagler School of Business and explained that he liked to buy companies that were simple and solid. At that appearance, Buffett explained how he used Benjamin Graham's model for investing in large blocks of Coca-Cola and a substantial part of Gillette. As evident in the success of Berkshire Hathaway, he owns stock in many companies that were undervalued at some point, providing diversity and lowered overall risk. In 2007, David Bach, another commentator on the CNBC special The Millionaire Inside and the author of several practical investment books, recommends a diversification strategy of one-third of assets in real estate, one-third in stocks, and one-third in guaranteed returns.
Strategy Six: Never Deviate From a System That Works
Many people understand the theory of value investing as outlined by Benjamin Graham and put into practice by Warren Buffett, but very few investors understand the concept of protecting investments from downturns and the concept of taking profits. Investors born during The Great Depression often buy and hold, and they keep holding. Investors should never become emotionally attached to a stock. If the stock price has exceeded Wall Street estimates, and the investor can at least sell a portion of the shares, they should follow through and take some profit. Some investors who want to maintain a foundation of consistently good stocks in their portfolios will sell off only enough shares to pay for the original purchase of stock. Preferred shares and dividend-paying stocks (often times mature companies such as utilities) make good portfolio foundations when it comes time for Baby Boomers and children of The Great Depression to diversify. Markets are so volatile due to institutional and automated trading that investors should always have stop, stop-loss, limit, and stop-limit orders in place. Most brokerages keep a good-until-canceled order (GTC) for sell-limits and buy-limits for ninety days. Keeping such orders in effect with the brokerage serves three purposes: a) Downside protection from a loss greater than the investor-specified limit, b) The opportunity to take a profit in a stock that has reached its target without the hassle of watching a computer screen all day, and c) The chance to utilize cash reserves for investment in new stocks without waiting for a stockbroker's phone call to time a purchase. A disciplined strategy for getting out of an investment position is just as critical as an investment purchasing algorithm.
Strategy Seven: Pass It On
Raymond A. Moody wrote a short, anecdotal book about the experiences of people who have been revived after being declared dead called Life After Life. The individual stories differed in regards to the transition made into the afterlife, but there was a common thread in the experiences of the deceased-revived. The respondents were questioned on two subjects—either by impression to the mind or by direct interrogation from benevolent souls. How well did you live? And how well did you love? Successful professionals and entrepreneurs live well. They are net producers in the socioeconomic fabric of America. The wealthy have grand opportunities to work hard and play hard. The affluent can indulge their tastes for the haute-luxe life, live well, and reward themselves. They have the power to create opportunity and confidence within their own families through the use of family partnerships, revocable and irrevocable trusts, 529educational programs, Uniform Gifts to Minors accounts, and family foundations—in effect passing on the love. Legacy gifts to educational institutions and planned donations to hospital and research foundations have been increasing the quality of life for generations, since the beginning of the United States of America. The time is now to get proper advice from CPAs, estate planners, and attorneys. An updated will is always a good investment of time and money, and insurance needs should be reviewed frequently. It takes work and stewardship to accumulate wealth. It takes structure, strategy, and planning to keep an estate out of probate court.
With some evaluation of strategies and implementation of portfolio safeguards and diversification, January can be a profitable month. Just as an artist must begin with a clear image of the final painting in mind, investors must decide their goals, must visualize the end result very clearly, and must create the game plan to accomplish the vision. Producing a substantial income, spending less than personal earnings, investing in enterprises that are comprehensible and have positive cash flow, paying and investing in oneself first, looking for bargain investments, consistently working an investment strategy that creates diversification over time, and passing on the wealth to do more good in the world are solid strategies for investment management at this time of year. Indeed, January could be a particularly great month.
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