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Saturday, April 28, 2012

Notes from the USA (Apr 2012) - a guest post

If you are like most small investors who have been in the investing game for some time, you probably have an unplanned and unwieldy portfolio of funds/stocks with a lot of losers and a few winners. Loss aversion may motivate you to hang on to the losers with the hope that they will somehow by some miracle turn into winners – or, at the very least, allow you to break even. The few winners are quickly disposed off at small profits lest they turn into losers as well.

How does one break out of this losing cycle of ‘cutting the flowers and watering the weeds’? Learning the rules of the game before playing it is a necessary pre-condition – but it isn’t sufficient. Not knowing the rules is courting disaster, but just knowing the rules won’t turn you into a good player. For success in your investments, you must be dispassionate and learn to be patient and disciplined. Easier said than done?

In this month’s guest post, KKP suggests how you can generate better returns by actively managing your investments with an asset allocation plan that takes some of the emotion and guesswork out of your investment decisions.


Active Management of Investments

Everyone knows that managing investments can be a complicated and overwhelming affair, and for many investors, entrusting the management of their portfolio to a broker or an advisor may seem like the smart thing to do. In the end, very few investors have found that to be as successful as per expectations. So, is it an issue with our expectations, or are these brokers and advisors in that position where they need to make money from doing a ‘job’, as opposed to generating high returns of the invested cash? I think that with the help of powerful new tools commonly available over the net (for free and fee), self-directed investors like you and me can invest more confidently and be better informed about actively managing our investments and can greatly improve our long-term financial well-being.

Entrusting portfolios to mutual funds might be the right thing to do for some investors, but even that route has not proven to be as good. Hence the invention of passive indexed portfolios which has commonly turned into ETFs (Exchange Traded Funds). This simply means that they are like mutual funds, but are traded all day, with total transparency to the investor. Transparency comes from the fact that they are following a predetermined mix of stocks or bonds created by one of the brokerage houses under the name of one of thousands of indices. Besides ETFs provide this simplicity generally at a lower cost of operation than Mutual Funds, hence the popularity.

When we become more informed, we get deeper into being an active investor. As we become more active, we can get deeper into picking a basket of stocks, a few ETFs, and finally some other asset classes. So, the more knowledge about investing and the financial markets that we gain (and it comes over time), the better it serves us and our families. Best part of all is that this passion will last a lifetime, and especially serve us well at a time in our lives when our kids have grown, and we have more time on our hands.

Every investor whether young or mature, rich or middle class, needs to have an investment plan that is documented to lead to financial success. Defining life’s goals, financial needs, current disposable assets, risk tolerances and knowing the benchmarks that we wish to beat is the key to going ‘independent’. This 360 degree plan is needed to determine which investments are best for us, and of course, the plan changes over time. After all, how can we accomplish our goals, if we don’t know what they are or how to get there?

Asset Allocation: Spreading investments across a variety of asset types that react differently (and this is critical) from each other in both bull and bear markets can give you good overall returns, year after year, while reducing the overall risk. Young investors miss out on this, as I missed out also, in my younger na├»ve days. Once ours goals, risk tolerance, and benchmarks (that we want to beat) are documented, it is time to decide/develop a portfolio with weights. The most important step then is to rebalance with ‘new’ ideas, but essentially keep the asset allocation percentage constant from year to year (apart from making overall changes every 5 years – more to come on this). Annual rebalancing works for most, but if you want to be active, then quarterly rebalancing is also OK. This will allow you to keep your overall portfolio oriented towards the long-term goals with which the asset weightings are aligned to your thinking. Also, it will avoid the emotional mood swings that we all go through when the markets are too far up or too far down.

Allocation changes every five years are necessary by taking your laptop / iPad / Tablet to a coffee shop and thinking this through with a ‘strategic mind-set’. Look at my previous post on ‘strategic thinking’. Once you get good at both strategic thinking, and evaluations of everything every 5 years, the Asset Allocations should match your age, need for funds, and also re-alignment with the then-current-goals. What if you were planning to do a huge upgrade on the housing front? What if the kids are now talking about going to a Private University instead of a Public University (delta between these in the US is approx $30,000 per year). Or what if the wedding of your son/daughter is coming up earlier than you planned. All of these are big events that don’t have a fixed date or expense amount. In addition, we are all aging. So, these changes need to be incorporated into your Asset Allocation, over time.

In summary, allocate your assets, keep some assets aside for ‘playing with the market’, and keep the discipline and faith in the longer term performance of the markets. Also, do not forget to have bonds, real estate, gold/silver/diamonds, rental-real-estate, FMP/FDs etc in your portfolio as a permanent aspect of your assets (change allocations only). For those who do not believe in investing in gold/silver/diamond, these assets can be worn to make you feel good. An FMP feels good inside the heart, but a gold pendant with a 1 carat diamond looks good right outside the heart on your wife!


KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

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How to reallocate your assets

1 comment:

Anonymous said...

normally people buy gold, stocks etc on Akshaya Tritiya (which happened recently). I finally gathered took sense and gave myself a gift and the day my auspices by getting rid of all my loss makers. talk of spring cleaning! Good post.