Markets Roll- Show coming. Read market update- January 15, 2016

Money Matters Airs next Thursday at noon PST January 21st, 2016

Marc's Notes,

Markets roll, Money Matters airs next Thursday. Read below and consider your options.

Feel Free to call me or email me with your questions about this market.

(530) 559-1214 Email: mcuniberti@cambridgesecure.com

Building a portfolio for investors can be a daunting task. Many portfolios I see use what I call a “shotgun” approach.

What I call shotgun portfolios are built on a variety of mutual funds which may include large cap (large companies)  mid cap (midsize companies) , small cap (small companies) , emerging markets, global stocks, municipal bond funds, corporate bond funds, high yield income funds (usually comprised of a variety of junk bonds) and even individual stocks. I also might see sector funds (certain industries), mortgage REITs (real estate investments trusts), business development companies (BDC’s) and even Treasury debt and a variety of other debt instruments.

The common thread among this shotgun approach is to buy some of everything with the belief is your “covered”, or in plain English “diversified”.

I often find this approach grossly inadequate for today’s markets but this is my opinion only.

Rarely if ever do we see all assets classes move in concert.  Every day I see red and green on my board, meaning certain market areas will go up while others go down and some will even remain where they are on any given day.

That being said, holding a shotgun portfolio may have a tendency to be profit neutral, meaning it may be going nowhere fast, a complaint I hear often.

Going nowhere may be desirable in down markets but in up markets can be frustrating.

There are different strategies and many theories on how to build a successful portfolio and it may not include just buying a chunk of every asset class.

Select a period in time and there will always be sectors that are hot and some that are not, some that have had tremendous runs and some that have been hammered mercilessly.

The trick is of course when do you buy into a sector, hold a sector or outright sell it?

Although no one holds the proverbial key to guaranteed success, active involvement in selecting certain sectors and avoiding others may have its advantages.

Selling sectors whose run could be over might avoid losses. Buying beat up sectors (known as value investing) looks to capitalize on assets that could be regarded as “on sale”.

Avoiding assets that are sensitive to interest rates (fixed income such as bonds, preferred stocks and even utilities) might be considered when interest rates are expected to rise.

If world markets are reeling, the US market may attract “flight to safety” capital in lieu of emerging markets which tend to sell off more violently during global upsets.

If markets look to run however, emerging markets may amplify a move, allowing more profits to investors placed there.

In inflationary environments, precious metals and commodities may rise and during deflationary times, cash and cash equivalents hold value while most other asset classes may deflate.

For conservative investors, higher cash percentages might sooth anxious nerves and younger investors may want to take on more risk in high growth areas.High cash positions may also be warranted in uncertain times for all investors. High cash not only preserves portfolio balances, it’s also dry powder one can use to buy more of an asset after a crash when prices are lower.

Retirement accounts have compounded growth from assets that pay out cash because of their tax structure (avoiding the yearly tax that non IRA accounts may pay) while non retirement accounts may look to hold some tax free assets such as certain municipal bonds. Avoiding income tax on tax exempt assets essentially gives investors a higher net return if the asset is tax free or taxed at a lower rate.

Dividend paying stocks and funds pay an investor income while they hold the security in lieu of assets that yield nothing. In flat markets, these payments can bring smiles to the faces of investors while others wait for markets to rise with assets that pay nothing.

Target funds aim to maximize time frames with a moving mix of stocks and fixed income holdings. This means investors select a definitive time period to target maturity in which the fund then slowly goes from risk assets to lower risk assets as the target date approaches.

Target funds are popular in college accounts, where the age of child is known as is the projected date of college enrollment. The thinking is when a child is younger, the account can hold more stocks which might grow over time, but as the college date approaches, stock are slowly replaced with a higher percentage of fixed income assets such as bonds and preferred stocks which traditionally are less volatile.

There are many considerations which depend on the factors of the investor and of the market in general. Avoiding the typical “Shotgun” approach to investing could be compared to the mistake that one size fits all. Each market is different as is each investor. That being said, instead of a blasting away with shotgun, perhaps a better approach would be a carefully selected advisor with a good aim.

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An interesting read from Cabot Investing Advice from cabot.net

Buffett Said it Best

Warren Buffett (while not a growth stock aficionado) once said there were only two rules to follow with your investments:

Rule #1: Don’t lose money.

Rule #2: Don’t forget Rule #1.

Of course, Buffett was talking about taking the risk out of your investments by investing in undervalued situations. But his point is well made. If you subject your portfolio to the risk of large losses, it’s tough for you to accumulate lots of wealth over time.

Why is Cutting Losses Short So Important?

This is a question we get quite often in one form or another. After all, if a stock drops 15%, 20% or 25% from you initial purchase price, isn’t it simply a better buy at these lower prices? And if the company’s fundamentals (which you researched before buying the stock) are intact, why would someone actually sell just because the stock temporarily falls?

Well, there are two major reasons why cutting losses short is the right thing to do.

1. It’s a fact that all big losses start out as small losses. Sounds simple, right? It is! By cutting a loss short, No single stock will hand you a devastating loss and severely damage your overall portfolio. This is especially important when dealing with aggressive growth stocks, which can dive bomb significantly lower over a period of only a few weeks. It’s particularly important for those investors who tend to focus (as we advise) on a relatively limited number of stocks (say, 8 to 12). If you only own 10 stocks and one of them gives you a 50% loss, that means your overall portfolio just fell 5%. Not good!

Here’s another way to view the damage a big loss can inflict on your portfolio. It’s the Profit Curve’s evil twin, the Loss Curve. This graphic displays the percentage gain you must garner from a stock just to make up the amount you lost.

For example, let’s say you sell at stock for a 10% loss. To make up that low, your next purchase need only advance a little over 11%. Not bad. For a 20% loss, the next stock must show you a 25% profit. Also doable.

But notice how the curve accelerates to the downside as your losses grow bigger. (It’s like the magic of compounded growth with the Profit Curve, except it’s working in exactly the opposite fashion.) If you lose 50% in a stock, you need to find a stock that doubles, just to break even! For a 60% loss, the gain needed to break even is 150%. For a 75% loss, the figure is 300%. And so on.

Clearly, if you allow just one or two of your stocks to hand you severe losses, your entire portfolio can be damaged for months to come, if not longer. There’s a saying in the market, “The first loss is the best loss.”

2. The second reason for selling after a stock goes against you is because sometimes the stock is actually telling you something by dropping. Specifically, if you buy a stock that’s a little off its high, then watch is fall, say, 20%, you should ask yourself why the stock fell. Did a market correction pull it down? Or did the stock fall on its own? Or was its industry group weak?

A correction in a stock, especially when the market appears to be in fine shape, can actually be forecasting trouble. It means investors are selling the stock much more that the rest of the market. And that sometimes implies that bad news is forthcoming.

In addition, after a stock corrects, a certain amount of overhead (i.e., resistance, which exists because people who own the stock at higher prices are often willing to sell once the stock rallies back near their buy price) is created on the chart. That can stall the stock’s next advance, even while other stocks are roaring to one new high after another.

How to Develop Your Own Loss-Cutting Rule

The Cabot Market Letter uses a loss limit of 10% to 20%. That is, if any stock closes out a day giving us a loss of 20%, we’ll sell the next day. Note that we wait for a loss to materialize at the close of the day. Intraday volatility these days is huge, and sometimes a 20% loss during the day can shrink below that level by the close.

But 10% to 20% isn’t necessarily the right limit for you. So what is? It depends on your personal risk tolerance, the type of stocks you’re buying and the size of your initial position (in dollar terms).

We wouldn’t advise any loss limit exceeding 20%, however. A loss greater than 20% brings you too far down the Loss Curve. We’ve found the 10% to 20% limit to work well, so you may want to start with that and see how it works.

Consider these three factors: your risk tolerance, the types of stocks you focus on, and the relative size of your initial position. And once you’ve decided on your loss limit, stick to it! We know that cutting losses short is the rule that investors follow the least. After researching a company’s fundamentals, analyzing a chart to see if the stock is under accumulation and actually making the purchase, investors are understandably hesitant to simply dump their shares a few weeks later, for any reason.

Even worse, some investors will cut their losses short only to see the stock thumb its nose at them and work its way higher. Eventually, though, those investors who don’t cut their losses short are doomed to own a couple of stocks that literally fall off a cliff. And that’s not what you want!

Thus, we can sum up this entire lesson in one sentence: Cut your losses short! 

(FROM CABOT INVESTING AND REPRINTED FROM THEIR WEBSITE)

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Keep tuned to Money Matters and again, if you need to discuss utilizing our services instead of what you are doing now, feel free to contact me. I will sit down with you and we can talk.