Look outside public markets for true diversification

From a post on diversifying from The Humbe Dollar, based on Harry Markowitz’s 1952 research paper on the subject.

For instance, he explained that the number of stocks you hold is far less important than the number of types of stocks you own. A portfolio of 60 stocks might appear to be diversified. But if all 60 are technology stocks, there is still quite a bit of risk. Today, this might seem like commonsense, but at the time it was a major revelation.

Markowitz ultimately won a Nobel Prize for his work, and there’s no question it was brilliant. Today, however, there’s even more you can do to manage risk in your financial life. Here are five ideas to help you think more comprehensively about diversification:

Diversify your tax rates
Diversify your investment products
Diversify your financial relationships
Diversify the timing of your purchases.
Diversify the timing of your sales.

While this post at the Humble Dollar focuses on public market investments, diversifying can be taken much further. With easier access to alternative investments, it’s easier than ever to diversify among a large number of investment products. The trick is doing so feasibly and with proper risk management.

via Five Ways to Diversify – HumbleDollar at HumbleDollar

Thinking of investing as a game

Graham Duncan on thinking about investing as playing a game:

One of the most important things I’ve learned in that process is what separates the great investors from the rest. The great ones view investing as a game, and they know exactly what game they’re playing. It brings to mind an observation from the philosopher Kwame Anthony Appiah: “In life the challenge is not so much to figure out how best to play the game; the challenge is to figure out what game you’re playing.”

One way to relocate your locus of control is to frame investing (and even life more generally) as a game. This allows you to experience luck as luck, to separate the hand you drew from the playing of that hand.

He describes five levels of the game for investors, though it seems more generally applicable:

1. Apprentice — learning the game

2. Expert — mastering the game you were taught

3. Professional — making the game you were taught fit your own strengths and weaknesses

4. Master — changing the game you play as part of your own self-expression and operating at scale

5. Steward — becoming part of the playing field itself and mentoring the next generation

 

Read the full post at The Playing Field on Medium.

Dollar cost averaging with stop loss orders?

More on stop loss orders, which are called The Most Important Trading Tactic in this article from The Balance. The idea of stop-losses is great. In practice, I’m less convinced.

The optimal degree of the stop-loss price is different for every investor, and sometimes may be as low as a few percent. For others the level could be as great as 30 percent, sometimes even larger. For example, some investors may set their stop-loss price at 70 cents for shares which were bought at $1. Whatever level each person chooses represents their total downside risk.

An effective strategy to protect against downside, and preserve potential gains, is to use multiple stop-loss prices.  For example, you may commit to selling a portion of the shares at one price, then another part at an even lower level.  Using our example once more, when the shares hit $2.85, you may have established a mental stop-loss at $2.50 for one-third of the shares, then another at $2.00 for the remaining two-thirds.

Tips for successfully using stop loss orders

A few highlights from the post 10 Great Tips For Using Stop Loss Orders Successfully at StockTrader.com.

1. Never use stop loss orders for active trading. For investors that watch their screens all day and are involved in day trading a stop loss order serves little purpose.

4. For the original placement always give the stock atleast 5% of space to avoid market maker abuse. If the stock is trading at $100, a stop loss should be no higher than $95 initially as intraday price swings may cause the order to trigger prematurely

9. Set the trigger price at common price increments. Prices like $100 or $60.50 are far more common to be traded at than $123.47. By placing the trigger price at a common increment there is a smaller chance of the stock “trading through” the order trigger.

Stop limits kicked in on nearly my entire portfolio this week as the market has dropped relatively significantly across the board. A few stocks have popped back above my selling positions, though overall it’s saved me from a lot of losses. I’m still unsure if this is the best practice moving forward, since some gains were lost and some items sold at “flash crash” type prices, possibly engineered by Wall Street in some way.

Paying for performance

Matt Levine on charging higher fees for increased performance. It’s not looked upon well, which doesn’t make sense.

One mental model you might have is: Shouldn’t the active managers’ share of the pie be reduced by competition? If Fund X outperforms by 60 basis points but takes 44 for itself, shouldn’t Fund Y swoop in and offer to outperform by 60 basis points but take only 30 for itself? Just asking the question makes it obvious that the answer is no. Sure, right, if lots of active managers could predictably outperform, then they might compete with each other on price. But as long as reliable outperformance is rare, investors should rationally prefer to pay a lot for outperformance rather than to pay less for underperformance.

Full post Is Paying for Performance Bad? at Bloomberg.com

The first rule to catching a bottom? Don’t try to catch a bottom

Michael Batnick, on attempting to catch a bottom, in a post from last July:

Nobody can actually buy low and sell high. Not consistently anyway. Successful traders typically buy high and sell higher, and successful investors buy low and sell rarely. But if you are tempted to catch bottoms, to be the investor who can recognize treasure where others find trash, there are some broad rules that I suggest you follow.

The first rule to catching a bottom? Don’t try to catch a bottom.

The first rule of catching a bottom is don’t try to catch a bottom. It’s one of the hardest things to do in all of investing. Macy’s has experienced three separate 30% rallies on its way to a 70% decline. None of them stuck. Quick traders made money. Bottom-fishing investors got filleted.

Here’s one way to do so:

Rule #4: Wait for a longer-term moving average to stabilize. Macy’s twelve-month moving-average, for example, is still crashing. If you wait for a long-term moving average to stabilize, you won’t buy at the bottom, but better safe than sorry. Falling knives are guilty until proven innocent.

Good reminders when instincts are telling you differently. Read his full post Ten Rules For Catching A Bottom at The Irrelevant Investor.

Being too cautious can be costly in investing

Ben Carlson on the false narrative of all-time highs resulting in a crash. There’s a lot of talk about the market being ready for a correction simply because things are going well.

Here, Carlson quotes a myth from his own book, publishedin 2013:

Of course, stocks can fall from all-time highs, but hitting an all-time high isn’t necessarily the trigger that causes them to fall. Since 1950, there have been over 1,100 all-time highs reached on the S&P 500. That’s good enough for almost 7 percent of all trading days or roughly one out of every 15 days that the market is open. Here is the breakdown by decade that shows how often the S&P 500 hits a new high level:

He then goes on to give some numbers on what’s happened since then:

Since new highs were hit in 2013 there have been 201 new ATHs in total. This year alone there have already been 13 new all-time highs on the S&P 500, the same number that was seen in the entire decade of the 2000s. It’s not even the end of January.

Stocks are already up almost 8% this year and that’s after 9 straight years of gains (with 7 of those annual returns in double-digit territory). It’s been almost 20 months since we saw a 5% correction.

A good reminder that being cautious can be costly too. Rad his post All-Time Highs, Risk & Consequences at A Welath of Common Sense.

Stick to familiar companies

Good reminder from Howard Lindzon to stick to what you know when it comes to investing. Buffett stresses this in his investment philosophy as well.

Valeant never interested me on the way up. Pharmaceuticals and biotechs are too complicated for me to understand. Wall Street and greedy executives take advantage of these complications.

via Dirty Money and Pharmapalooza at Howard Lindzon