14 Rules for keeping your Head in a Troubled Market

It's days like these, when the market is showing so much weakness, that I like to revisit some sage investing advice. The following rules are based on the writings of Robert Menschel, a 50+ year veteran of Wall Street and author of Markets, Mobs & Mayhem: How to Profit From the Madness of Crowds These rules can help you keep your head when everyone else is losing theirs.

I especially like to re-read #2 – the stock market always comes back. I have seen it rebound several times in the last 20 years and am expecting it to do that again. I also have been taking note of some very interesting potential buys. It's for times like these that I have stashed cash on the side to take advantge of the sale price of stocks like BRKB and AAPL.

1. Remember that at the time of extreme fear in the marketplace, when all the excess has been wrung out, great buys are all over the place.


2. Remember, too, that the stock market always comes back, no matter how shocking the events that drive it down. Within three years of the December 7, 1941, attack on Pearl Harbor, of John Kennedy's assassination, and of the 1993 World Trade Center bombing, the market was up anywhere from 21 percent to 81 percent.


3. Define the sandbox you want to play in. Invest in growth-value companies that have records of consistent sales and earnings performance, management committed to a defined strategy, and with strong franchises that are highly focused. Only buy these stocks at sensible multiples and don’t add new companies unless you are willing to sell the weakest.


4. Have a buy strategy and stick with that. Buy in to a stock in steps, instead of at one price. Once the stock price is within range, begin with an initial buy in of 25% of the total desired holding. Then add increments of 25% to reach 100% of your total buy.


5. Stick with what you know. Invest in companies that create products and services that you can personally field-test day in and day out.


6. Stick with who you are. Be aware of your own risk tolerance. Understand that what is considered too risky by one might be too cautious for another. When your risk tolerance and portfolio are not aligned, bad decisions can follow.


7. And stick with companies that know what they are, too. Invest only in companies that stay focused on their core competency and have a strong franchise. Menschel also recommends avoiding technology companies because industry changes are so rapid that most of them turn into commodity businesses with no lasting franchise.


8. Always do due diligence. Invest your money only after thorough study. It's the mistakes that kill your investment performance. Evaluate the downside risk as much as the reward side, and you'll never have to be brilliant.


9. Never make a buy or a sell decision in your broker's office. Brokers are too close to the roar and the feeding frenzy of the crowd. Take time to make your decisions.


10. Buy for the long term. If you were to die tomorrow, would this be a stock you would want your heirs to hold? It sounds morbid, but it is not a bad test to apply. Stocks should be for the ages, even if we won't survive them.


11. Accept a little boredom in your life. Greedy management bent on making overpriced acquisitions gets the headlines, but good companies with superior management teams and a culture of teamwork, turning out good, usable, affordable products, make money. Look for companies selling at a reasonable multiple, generally no more than 50 or 60 percent greater than the rate of growth in earnings.


12. The faster a stock has a run up in value, the faster it is likely to run down. Almost no company can safely grow earnings faster than 15 to 20 percent a year without attracting fierce competition.


13. It's the small things, not the big ones, that count. In baseball, homerun hitters get all the attention. Investing is simpler: Hit for average, swing for singles, not the fences. This race is ultimately to the sure, not the swift; the tortoises, not the hares.


14. And finally, Never forget the miracle of compounding. A modest 8% rate of return will double your initial investment in 9 years and nearly triple in 14 years.
    

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Getting a handle on Stock Market Volatility

Ever gone golfing with a friend and then after a few bad shots watch them explode? I have seen people throw golf clubs, knock over golf bags, throw down hats, and kick the cart after an undesirable shot. I have wanted to do the same thing at times! But, then I remind myself that I am out there to have a good time. I am not a professional golfer and I don’t play the game well enough to get that upset about a poor shot.

To earn the right to get that mad, you have got to become disciplined enough to become a good golfer. If you are not that good at a game, then there is no reason to get irate. Instead, relax and have a good time. That is the message from motivational speaker, Bryan Dodge. He asks the question why get so upset, when you are not that good?

That’s easier said than done. We all want to improve our skills and when we fail or make a bad shot, its upsetting. Its upsetting because we are impatient. We want to get better now, not next week or next month. Nobody wants to be just average, especially when we have tried to improve our game. Similarly, its frustrating in times like now, when the stock market declines are erasing large chunks of our hard earned money. You and I have been trying to improve our financial situation, gaining investment knowledge, reading PF books and blogs, building an allocation plan and then the DJIA drops 4% right out of the 2008 gate.

Got Discipline?
Just like the golfer, you have got to be disciplined to become a better investor and build a retirement portfolio. It's easy to become impatient. But its very important to keep working towards your goals, even in stock market turmoil like we are seeing in the beginning of this year. If you have an asset allocation plan - stick with it. Keep investing using dollar cost averaging or value averaging at these lower prices and eventually things will turn around. We all know the key to successful investing is to “buy low, sell high”. Well, this is the time to “buy low”. Do you have the courage and the patience to be a successful investor? We are fixin’ to find out, aren’t we?

Free Portfolio Analysis by Vanguard

Vanguard offers a portfolio evaluation tool called Portfolio Watch, as part of its Voyager select services. The analysis compares your stock and mutual fund investments with overall market weightings in terms of capitalization, style, and industry sector. The concept is that the more your holdings vary from the market bench marks, the greater the probability that your returns will differ, higher or lower, from the market.

The exam included an evaluation of overall market risk, mutual fund costs, tax efficiency and concluded with steps or recommendations to update and fine tune my investment strategy.

Before we get to the analysis, let’s take a look at my portfolio asset allocation. I call it the CoffeeHouse Portfolio with a Double Espresso Shot. The allocations for each holding are shown in the following table. The dollar amount of the asset is divided by the total dollar amount of the portfolio to arrive at the “weighting” for each fund or stock in the portfolio.

The Fixed Income asset type is a money market account. The 40% allocation to Large CAP stocks has been broken down into three subcategories: Health care fund, defense contractor stocks and technology stocks. So, health care is actually 28% (0.7*40) of my holdings, defense is 10% and technology 2%.


















Cautions
Throughout the analysis VG provided advice, tips and made note of a few cautions. VG states that these cautions are areas where my portfolio differs from the broad market target. I have listed each of the four cautions below. I have also summarized my assessment and what my plan of action is concerning these cautions.

Bond allocation is low
I have never been comfortable settling for the significantly lower returns of bonds. In Bogle’s book, Bogle on Mutual Funds, he talks of bonds returning 7% and equities 8%. This was back in the 90’s - I would like to find a quality bond at that rate, today. Bonds are not risk free and have much less upside than stocks.

Certainly as one moves into retirement it is prudent to add more fixed income assets to reduce risk and smooth out the market ride. I have been accumulating cash in a Money Market account as MMs have outperformed bonds in the last few years with minimal additional risk. I plan to direct that cash towards the purchase of TIPS and Municipal bonds in the near-term future.

Hold Less than 5% in company stock
VG recommends not holding over 5% in any one stock. This is sensible advice given the volatility of individual stocks. I have not made this change because the stock that I hold at 10% is a non-cyclical, defensive stock that should do well in volatile markets and recessions. I am well aware of the Enron debacle, but I think every situation needs to be evaluated in it's own light.

Increase Emerging market holdings
Given the capital and liquidity issues that are occurring in the US (see financial mortgage meltdown), I am hesitant to invest in new developing countries that may require extensive amounts of capital for business development. I prefer to invest in developed international markets which have less risk. Additionally, Emerging markets have had a significant run-up in performance lately and are not a good value buy at this time, anyway. This is a sector that I have researched, but never felt compelled to pull the trigger.

Hold Growth and Value stocks in similar proportions
VG recommends a portfolio with equal weight in growth funds and value funds. This is an area that I have been working on to get to at least a 2:1 ratio (Growth equals 2 X Value). I will continue to add new funds to the value side of this as I move into retirement phase. In addition, I am interested in increasing my holdings in Berkshire Hathaway stock – which I consider to be a large cap value stock.

Overall take
The analysis and charts are organized and informative. The advice is straightforward and easy to understand. I especially liked the “xray” ability that VG used to dissect some of my fund holdings. For instance, one fund has a 15/85 split between international and domestic holdings. The tool actually split the fund by the appropriate amount into each of the two sectors, so that my total portfolio allocation reflected this split.

The analysis confirmed my suspicions about some of the shortcomings of my asset allocation strategy. The second opinion was helpful and motivational. After reading through the analysis a couple of times, I have been encouraged to make some changes to my bond and value fund allocations.

Value Investing - seldom popular, always prudent

The first PF books that I ever read advocated a form of value investing. For instance, Peter Lynch’s Beating the Street, and the Beardstown Ladies common-sense investment guide expounded on the importance of due diligence. Doing your homework to find undervalued stocks and then buying and holding until everyone else got wise and bid up the price to a more reasonable valuation. Sounds easy. And if you have patience and courage, it is easy. It takes courage to buy a stock that no one else wants. It takes patience to wait for the market to figure out that stock XYZ is undervalued. Since I was new to investing, I thought this was the way everyone did it. LOL.

First Stock Purchase
I followed the advice and did my research. I had some brands that I liked and that I thought had some potential. From there I actually went to the library and checked out the Value Line. The Value Line’s Investment Survey provides an analysis of the company’s annual report giving an assessment of a company’s health and future prospects. Value line provided all of the ratios and financial data that I needed. I looked for such things as industry ranking, debt to asset ratio, price to earnings, management quality, etc. Finally, I had narrowed my stocks down to one – Apple computer. Apple was not in favor in the early 90’s, in fact, it was in distress. The perfect value play. I bought shares and held.

Value in Index Funds
I also looked for value plays in Mutual funds. I wanted low cost, broad based market funds. Since, I abhor fees and “no value added” expenses, I bought Index funds. My first selection was Vanguard’s S&P 500 Index followed by a couple more Small Cap Indexes and a Real Estate Investment Trust index.

The Dot Com Disaster
It was truly amazing. I got pulled in to fast and easy money. Why do all that work (due diligence) and then wait and wait? Instead, buy on momentum, jump on a stock when it's on it's way up, technical analysis is the mantra now. Yes, I made money, lots of money. Those were heady times – everybody was getting great returns – we had become stock picking genius’s and Warren Buffet and value investing was washed up. I was drawn into the crowd that kept saying that this was the “new economy”. All of that previous stock market history was meaningless. The favorite topic at the water cooler was the next hot stock………. And then I gave back a lot of money. For some reason, I am not sure, maybe it was sentimental, or just simple inertia, but I still held my Apple stock. My value play kept on.

Full Circle
The pain still lingers. That’s a good thing. I don’t want to ever forget the lessons from the dot com era. I cleaned out my stock portfolio. I sold off losers to offset capital gains from my Index funds. Then started reading value investment guides again, like The Intelligent Investor and Bogle on Mutual Funds. I have come back, full circle to value investing. I was fortunate, I only dabbled in dot com madness while maintaining my core index funds and of course my favorite value play: Apple. I am aware of a few co-workers and friends that poured everything they had into the skyrocketing market. And when it dropped, many assumed it was just a dip and used options to buy even more with borrowed money. That is a very painful lesson.

It will happen again and again
Don’t be fooled. After the 2000-2002 market dive, most of us were fearful of the market. We didn’t trust it with new investment dollars. So instead of buying into the market when it was cheaper, the crowd looked for a “new” type of investment. And the housing market took off…