Security Musings

Security Musings

Market Investment Strategies for Busy People

I have been investing for over 41 years, so at least I know a few things not to do. With this series I'd like to share my thoughts on market investment strategies, and I would welcome hearing about your personal investment experiences, so please write to

Other Related Articles in Market Investment Strategies for Busy People

A Fundamental Strategy for Investing

By Stephen Northcutt
Version 1.1

I've meant to do this for a long time, so let me give it a shot. Nobody died and left me smart about the stock market, but I have been investing for over 41 years, so at least I know a few things not to do.

Mr. Market is Efficient

The market is efficient. Only a little information about stocks, sectors or world events is not known to the traders on Wall Street with their fast networks, big computers and trading models. That means professional traders have already digested whatever information is available, and that information is almost certainly priced into the stock before we ever learn that information. Therefore, if you read about it in USA Today Money, you are five days too late to make that investment; if The Wall Street Journal, Barons, or Forbes, you are three days too late; if you get a real time alert, you are two days too late. It also means that one of the smartest bets you can make is a very broad based ETF that has a LOW management fee.

Terms and definitions: An ETF stands for Exchange Traded Fund. All that means is that it is a basket of related stocks. If you buy an individual equity, IBM for instance, if that company goes bankrupt, the value of your stock is near zero, since an ETF is a basket of different stocks with some underlying theme, even if one company in the ETF goes bankrupt the rest are still OK. The value of the ETF may be reduced, but should not reach zero. An ETF can be traded just like a stock using an online brokerage often at the same commission cost as a stock. This means you can trade them instantly, unlike a mutual fund which takes a day to trade in or out of. Very commonly an ETF is based on an index. Indices ( the plural of index) are simply an attempt to measure a section of the stock market. The market is huge and except for some very rare moments, some part of the market is going up while another is going down. Two of the most important concepts of investing are diversification and correlation. In our increasingly connected world, all investments, not just stocks are increasingly becoming correlated. Our best chance of staying sane and protecting our principal is to seek diversification.

Which of these indices should I use as a baseline?

Before you purchase a bunch of ETFs and equities, it probably makes sense to find a way to determine if you are doing well or poorly. One idea is to pick an index or two to serve as a benchmark. Here is the Wikipedia list, but we are going to recommend two that are commonly used to track performance. If you are largely investing in US stocks you might consider S&P 500 as a reference index, this is 500 large cap stocks traded in the USA. SPY is an ETF that will serve as a proxy for the S&P 500. You might only want one share of it in your portfolio, there are better investments, but that makes it easy to see how your other investments are doing. Another popular index is the MSCI All Country World Index and ACWI is an ETF that tries to track that index. Consider having at least one share of each in your portfolio to serve as references.

Micro trading

I have introduced some of my family to the Charles Schwab ETFs. There is nothing special about them; they are vanilla index-based ETFs, but there is currently no trading fee if you have a Charles Schwab account, and they have a low internal ETF management fee. This allows you to trade by an index which is exactly what you want to do (for starters). I would suggest buying into at least six of these: some domestic, some foreign, some value, some growth. And, just watch two things. One, they correlate far more often than not. If one of them goes up for 30 days, odds are very high the other five will be also going up. Two, to the extent they do not correlate (they are all going up, but one is going up faster than the others), just wait - a different one will be the poster child in six months. There is no one master strategy. In an efficient market, try to play the best index that you can. The chart below shows three low cost ETFs from Charles Schwab. All three are "Large Cap" companies with a market capitalization of $10 Billion or more. They are:

  • SCHX 750 largest US firms which comprise about 80% of the US market (by capitalization)
  • SCHG ETF has diversified exposure to large growth names such as Apple, Microsoft, Wal-Mart, PepsiCo
  • SCHV ETF has diversified exposure to large value names such as ExxonMobil, GE, Johnson & Johnson, Pfizer

What you should learn from the chart:
  • They correlate; when one goes up, they all go up, when one goes down, they all go down over enough time. The question is who goes up the most and down the least.
  • However, on a given day one may go down more than the others, that trend could even last a month or a quarter making that equity cheaper relative to the others.
  • When this chart was created one of them, SCHG was outperforming the other two. Does this mean you should put more money in SCHG? Well, if you did that, you would lose out slightly because in 2011, so far, SCHV has ever so slightly outperformed the other two.
three low cost ETFs from Charles Schwab

NOTE: January 14, 2011 of the five ETFs mentioned so far SCHV is still the best performer up 3.25% for the past 12 months, followed by SPY up 2.71%.

It is less a question of what and more a question of how

At the time of this update, January 14, 2011 , a share of SCHX last closed for 30.66. Let's say you want to add a share to your portfolio. If you had to pay the commission to the online broker it would be somewhere between 5 and 9 dollars for any of the online brokers I have looked into, that is somewhere between 16 and 29%. So the share actually costs you somewhere between 35.66 and 39.66 and when you sell you have another commission and sometimes a fee on top of that. Unless you are buying 100 or more shares at a time the commissions can eat you alive. As a general rule, try to keep your commissions to no more than 1% of your investment, half a percent when buying, half a percent when selling. This is why looking for brokers that have no commission ETF trades is a really good idea!

What if you are looking at two ETFs that follow the same index and one out performs the other. How is that possible? There are a number of factors. A lot of this lesson is about how to trade to get the best bang from your hard earned buck. If you are patient building your portfolio, there are ways that you can get the ETFs for five, or even ten or more percent cheaper than someone that buys them all at once with a market order.

You do not understand; I am busy

Oh, but I do! That said, I doubt you would want to trade your busy card for mine. Since we are busy, we need to leverage the efficient market and the beautiful thing is that we can. It is called the Pareto principle, the 80/20 rule, and can be stated in many ways. One Pareto observation is that it is possible to achieve 80 percent of potential investment gains with 20 percent of the time and effort. We need a disciplined methodology that lets us achieve a bit more than 80 percent of potential gain with as close to 20 percent of time investment as possible.

Three Keys

There are many strategies, with ours there are three keys to help you be efficient with both your time and money. Investing by low cost, commission free index ETFs is the first key. Think about it. If you invest in a number of obscure individual equities, say: MRCY, JNJ, KELYA, JNPR, SNY, MELI, AFAM, they may all be great companies - in fact, at the time of this writing, they are. However, after you own them, you get busy and X, Y, Z happens, and suddenly, they are not as good of a deal. Now what? It has been 30 days since you visited your account and one of these lovely equities is now down by 50%. That could happen with ETFs as well, but because they are broadly based, they tend to fall a little less than some equities though they may also rise less and slower. Since we do not have armies of analysts and computers that never sleep monitoring our investments this is a little safer.

You can be an active investor even if you do not move beyond index and specialized ETFs. Take a minute to check out this incredible resource, If you go to their ETF page, they have a browser that allows you to compare and contrast hundreds of ETFs by type. For instance, I might want to achieve some diversification based on the size of companies. A common categorization is "small cap, mid cap, large cap". Cap is short for market capitalization, the amount of money the outstanding shares of stock are worth. More or less, small cap is 300 Million to 2 Billion, mid, 2 - 10 billion, large above 10. Why do you care? Well if you look at the ETFs that I selected from, RZV - small cap value, CZA - mid cap value, CVY - large cap value, you can easily see that RZV is more volatile. It had lower lows and higher highs in a this three month period.

The second key is to recycle your trading ideas. In lesson two, The Search for Core Holdings, we will talk more about that. Go to the store, buy one of those cheap composition books, or even better (since this is real money we are talking about), invest in a Moleskine Legendary notebook. Create a table of contents. Give every equity you want to follow at least four pages. Make observations and predictions. Establish a thesis: "I believe this equity will go up (down) because...", then list as many reasons as possible, and see what happens. As you mature as an investor and move from index based ETFs to also add individual equities to your portfolio, you will want to establish a position in eight to twelve companies that you understand. As you grow even more, you may have small positions in candidates that may one day become core holdings.

The third key is to have an online portfolio, or even several. A great place to start is Google Finance, but if you prefer a different web site, more power to you. The idea though is to have one place where you can look at ETFs and individual equities you are interested in to see how they are doing at a glance. Although I set time aside during the year for deep study, week to week, I try not to spend more than fifteen minutes in the evening, Sunday through Thursday, looking at the market. I know what I am interested in. I have my portfolio showing on Google Finance, I bring up the online broker basket* that I have allocated some money to and I start making my decisions. Even though I am busy and need to go fast, I often make my decisions one night, sleep on them, come back the next night and if it still makes sense, execute the trade.

Past performance does not lock in future gain

One beautiful thing about an online portfolio with stocks you are watching that are candidates for your real money portfolio is you have a chance to compare your thesis against your benchmarks: SPY and ACWI and any other index you decide to use. After all, if it does not look like your candidate can beat your benchmark indices, it might be better to add additional benchmark shares or to wait and develop a new thesis. There are a couple gotchas here to be aware of. What is hot today, may well not be hot tomorrow. One year, emerging markets might be the hot thing, then they cool off and on and on it goes. I use Google Finance a lot when doing research and when I can, I like to use a five year view and then the shorter views, including the past five days to choose the limit price. However, many ETFs are not five years old, so you have less history. If they are based on an index, you can often research how the index has done. If it is a specialty ETF, that is a lot harder. There are three numbers that you want to develop, percent allocation how much of your total portfolio do you intend to invest in this equity even if it takes months to get there, buy around not what the current price is, what should you be paying, and target, what do I expect to make at some named point in the future. Please do not invest your money past your baseline index funds until you understand what these numbers are.

How much money, what kind of money should I invest

We call it the five year rule and while it has many sources, it is most famously attributed to a sad chapter in larger-than-life investor Jim Cramer's life. I will not go into the details, but here is the famous statement that, despite the ridicule it brought to Cramer, is actually very wise if applied correctly, "Whatever money you may need for the next five years, please take it out of the stock market right now, this week. I do not believe that you should risk those assets in the stock market right now." I suppose a lot of people got hurt taking their money out near the market bottom and we should never make investment decisions in a spirit of panic, however we can learn from this event. So, let us make that our rule. If we take money and invest it in the market, we should be prepared to let that money sit for at least five years. That way, when the market drops, and it will, we leave the equity alone knowing that, so far, it has also come back up. A good investor welcomes a drop in the market as a buying opportunity.

When the Market is UP, Everyone is Smart

Surely we can agree that some equities perform better than others for a season, but the overwhelming majority correlate to each other. So, when the market is up it usually does not matter which broad based ETF you buy, you will make money. As of May 29, 2011 we had a long positive run following the great recession, the broad based ETFs I have been talking about are up 20% for a one year period and 6.5% for 2011. That is great! But if you look at the market for a long period of time, say five years, after going up a certain period of time, the market goes down. The chart below shows three famous indexes, at least in the USA: Dow Jones, S&P 500, and NASDAQ. An index is a whole bunch of stocks grouped together so you can see how they perform as a group. Many broad based ETFs are tied to an index.

What you should learn from the chart:
  • The indexes, large groups of stocks, also correlate. By now you are probably thinking OK, I want to find something that does not correlate, and that is an interesting thought.
  • The magnitude of both the ups and downs varies greatly, big ups, little downs, big downs, little ups; it is a mixed bag.

3 Indexes over 5 years

Sadly, what we learn is that this system tends to make regular people like you and me, poor. The market drops down; we lose our nerve and pull out of the market, thereby locking in our losses. The market goes up; we wait and wait because we got burned before, then near the end of the up cycle we don't want to lose out on the returns, so we buy when equities are expensive. Then, they go down; we lose money, jump back out of the market and lock in our losses. Surely, there is a better way and, in fact, there is.

When the Market is UP, it may be time to sell some of your stake and re-invest in safer alternatives

Conditions change, so you have to do all your own thinking, but in May 2011, the market was up and bonds were fairly down. Bonds and CDs tend to be safer than equities, but they often do not reward as much in the good times. I like CDs because there are two safety nets; first the bank has to fail and, second, FDIC would have to fail (and if that happens, I have bigger problems than my lost investment.) However, because it is such a safe investment, a CD tends to have a low interest rate most of the time. However, if I invest a thousand dollars in equities and earn 20 percent on that investment in an "up" market and then move it to a CD at two percent, I can think of my interest as an average of 20% and 2% and I have a much better and safer deal. Pssst: be sure and hold that equity for at least a year to avoid a potential 35% capital gains tax. Speaking of tax, if you invest with discipline, you will start to earn money. And the various governments will want to tax you on that money. You will have to do your homework, but in many states they do not tax money earned on municipal bonds from that state. Not being taxed can make a 4% return sound a lot better.
UPDATE: June 18, 2012, this strategy has really been working out for me. Since I have started doing this, there have still been no decent returns anywhere outside the stock market and I believe the market is even riskier than it was a year ago. Let's break this strategy down:
  • We average into the market, making some investment at least once a month with money budgeted for that purpose
  • We are patient, except for times the market is screaming upwards, we we try to buy with limit orders
  • We begin with broad ETFs, because they should not go bankrupt; we favor ETFs that pay dividends
  • When we buy individual equities, we realize we are investing in a company, we have a thesis and we have a way to know things about that company
  • The majority of our investments are for the long haul, statistics clearly show the more we buy and sell, the less likely we will grow our portfolio
  • Not every equity will be a 30% return in the short term, but from time to time we look at an equity that we bought and did well, sell it as profit taking, and invest the principal and the profit in a safer alternative like a Municipal Bond or a CD. We do this because we know we should have a diversified portfolio and no same person would buy a multi-year CD at 2% interest at a time when there are potential inflationary pressures two or three years in the future. However, if we made 30% profit and use that money to buy the safer investment, we are protected from inflation.

When the Market is DOWN, it is time to buy

This one is hard, so don't throw a bunch of your money at this pearl of wisdom until you truly understand it. But when the market is going up, your basic strategy is to let it go up, make money, feel smart, life is good, hugs for everyone. But also start accumulating a bit of cash. And research, research, research. We will have tips on how to do that, but this is the basic game plan. Now, there are big dips and little dips. Spend a little money during the little dips. When the big dips happen, that is the time to seriously invest. After all, if it really is the next Great Depression, that money you are concerned about losing probably won't do you much good anyway.

Everything we know is wrong

That is not exactly true, but it is close to true. Much of what we are told, or have read, about the stock market is false. Investing based on false information means losing money unless we are just plain lucky. Because so much of what we read on blogs and financial magazines is pure opinion, small investors get creamed all the time. Let me give you two examples I learned from reading a book by the famous investor, Ken Fisher:

a. Myth: Never invest in a stock with a high P/E. Most investors draw the line at 18. Reality, Apple right this minute is 16.08 so they might be getting close to this famous metric. They dominate 90% of the tablet/pad market and that is a fast-growing segment. If they keep firing on all cylinders and continue to gain share with the iPhone and prevent loss of market share with the iPad, they may cross a P/E of 18 which is a very good thing for anyone that holds their stock. After all, if you bought Apple at $150 and at some future date it is selling at $400, does a P/E of 19 ruin your day?

b. Myth: If oil prices go up, stocks go down. Oh really? It turns out there is about a 2% correlation between the two events; it is a little higher if you invest directly in the Japanese stock exchange because they are far more dependent on imported energy, but we are a long, long way from discussing investing in foreign exchanges and currencies.

This is why we start with very broadbased ETFs. Most of the people that want to give us advice (not free), do not know what they are talking about. I had to learn this the hard way; you don't.

There is exactly one way to beat the efficient market

The only time to invest in an individual equity (AAPL, IBM, etc.) or asset class (Canada, commodities), is if you know, or intend to learn, something that every trader on Wall Street does not know. Any time we consider a purchase we need to believe it can help our portfolio beat our baseline indexes such as S&P 500 and the MSCI World Index. It is less about picking random asset classes and more about allow myself to be slightly overweight in a particular class or country that I think has a good chance of beating the baseline index. Here is an example. I believe I have information the traders do not seem to have about Canada. When we went to Jamaica, most of the people at the resort were from Canada. When we went to Curacao, same thing. When we went to Palm Springs, so many Canadians are buying property in this lovely warm area, they have billboards for Canadian real estate vendors. They have almost no debt as a nation and an entrepreneurial spirit. I have Google alerts for Canada and they come into my inbox every day. Long and short of it is, I think, that the MSCI index is underweight on Canada. So, I hold some additional investments on Canada, CNDA and EWC, broad indexes, FXC, a currency play, and TD and RY, two of the five major banks. Not a huge amount of money, but trying to improve the return of all my investment over just the MSCI index. Now what was true in 2010 and 2011 may not be true in 2014, so I have Google Alerts on various Canadian terms and try to hit the Financial Post from time to time.
UPDATE: January 14, 2012. Ouch! After years of following Canadian news and equities I learned I have to tweak my thesis. Yes, Canada is a well run country, they manage debt, they export and they have natural resources, but their economy is tied to the US economy and if growth in the US is slow or negative, it impacts their stocks more than I would have guessed. So, I am still learning how to invest in my neighbor to the North.

Unless you are spending most of your working day tracking investments, I would have a limit of 8 - 12 stocks to hold as individual equities. Eight is a magic number because you are almost as diversified as an index with only eight equities as long as they are in different sectors (tech, health care, etc.). If that does not seem correct to you then below is a chart to reinforce this.

Netflix as a case study; at the time I first wrote this document, Netflix was beating the market in a big way, but in May 2010, it was probably very late to jump on that bandwagon even if you couldn't see their famous customer bashing email coming. However, if you picked up on Netflix in the early days, you could have really cashed in. It is always much easier in hind sight, but if you were following Netflix closely what should you have been able to know? No really new innovation, their contract negotiations with Starz ( 17 cable channels of content) broke down it was a sign their days of meteoric growth were coming to an end. However, please note how closely the other seven equities correlate. Eight equities will give you an amazing amount of breadth and you can still know how they are doing in your very busy life.

What you should learn from the chart:
  • I took eight of the most unrelated US Based equities that I could think of. Seven of the eight are highly correlated.
  • If we can find the quality equity that outperforms the general market and escapes correlation, we have an opportunity to make serious money, especially if we find it early in its run.

8 Equities that almost correlate

I ONLY invest at the core holding level in companies whose products I know. I do business with them, but in addition, I make sure to set Google alerts for them and read about them as often as possible. Try to make sure you know more about those companies you have individual stocks in than the traders on Wall Street. That said, I would also check them against basic trader research. Most online brokers have analyst research. If you buy a troubled company, you will lose money most of the time unless you get the stock at a very good price. If I buy a stock because it has an “A” and it gets downgraded to a “C”, consider selling it that day; perhaps you remember the song "Too many fish in the sea". There are plenty of other, higher quality equities. Later we can talk about the fundamentals, but for now, use the professional's evaluation with their market intelligence and sophisticated trading models. Add into your analysis what you know that they do not know, then your decisions will normally fall into four possible buckets:
  • Buy market price, only a good idea when the market is in a general uptrend ( most stocks are going up )
  • Buy limit price (recommended; do this a lot)
  • Buy around (anywhere in this range works with your analysis)
  • Pass (may be a great equity, but the price is wrong or it is wrong for my investment style).

Patience and Methodology

If you are truly an investor, you are patient and you have at least one methodology or approach. Patience is not my strong suit. I realize that one of my best opportunities to increase my opportunity to make money is during a down market. Equities become cheaper. Sometimes you can get great stocks at prices that were only possible three years ago. Make sure to have the right rising market mindset. When the market is rising, we are earning money, therefore we are smart and happy. However, if the market has been rising for a long time it takes more work to intelligently invest more money. At some point it may make sense to start letting some money sit on the sidelines waiting for a golden opportunity. Or perhaps, it is even wiser to sell some stocks at a profit to lock in a bond. Whichever choice you make, it will come, the stock market trader's computer models almost guarantee that.

Bonds as example of what we mean by patience

There is a rule of thumb that an investor should subtract their age from 100 and that is the percent that should be in bonds. It is a stupid rule, but clearly bonds have some advantages. US Government bonds are considered incredibly safe. However, in recent years they have not returned any increase in money, they are simply away to protect principal (the amount you invested in them). Municipal bonds can have the advantage of lowering your takes, so they should be considered as your portfolio grows. I had a day off scheduled recently and part of what I was planning on doing was selecting a couple bonds. There were some municipal bonds on the secondary market with coupon of face values of 5%. However, you are buying them on the secondary market, they are previously owned.
Today is January 13, 2012 and 2011 was a tumultuous year for stocks. This makes bonds more attractive, in addition, interest rates are very low which also makes bonds attractive. So, when I went to an online broker, I could not find any really good deals. Basically, I would be locking in chunks of money close to $6,000 in current conditions for three to five years for one per cent actual interest and despite what they tell you, there is some risk in municipal bonds.
TIP: Type "yield to maturity" bond calculator into Google so that you have a tool that can help you calculate the actual yield of a bond on the secondary market

My bonds thesis for 2012

So, while a lot more of my portfolio should be in bonds than my current allocation, I am willing to be VERY patient. I have a 20% rule for non-core equities. I am not strict on the 20%, it could be 18% and it could be 25%, but somewhere in that range, if a non-core equity gets that high, I am going to consider profit taking. There are a couple factors to consider, if I have not held the stock for a year, I will have to pay capital gains and I try to avoid that. However, if I can sell a few equities that I have held for a year or more and invest that money in a bond, it seems like a good idea. Eventually, there will be a season where the market is up and interest rates will be rising. That will be a time to take the buying of bonds far more seriously because they will be at a favorable price.

What about bond funds (ETFs and Mutual Funds)?

They scare me; a lot. They are a way that you can invest in a collection of bonds and not have to plop down $5k chunks of money. In a down, or choppy market such as last year (2011) they went up some. However, when stocks go up, they tend to go down. When they go up, they go up slowly, but when they go down, they can go down VERY fast. I do use them in down markets, but try to avoid mutual funds and select ETFs when possible; if I have to get out, I need to be able to get out fast.'s ETF browser yields the following high yield (i.e. risky) bond ETFs: PHB, JNK, HYG and for municipals: HYD abd HYMB.

Market timing

Books, blogs and seminars on investing all try to reinforce the fact that you can't time the market. That is, you cannot accurately pick the top or the bottom. Worse, the Wall Street computers never sleep or go on vacation so if they market starts to change they can react instantly; we can't. The expression traders use is: "Never catch a falling knife". While great advice in the kitchen, if you have done your homework and you know it is a good company, pick it up if it drops. In early 2000, Proctor and Gamble missed earnings and P&G's stock price fell from $59.18 to $26.5 in the course of eight weeks. Today it is 65.81, but not only did it recover its price and then some, but it pays dividends four times per year. Now to be sure, if you did not know the company's fundamentals and you picked it right after a massive pay decrease you could very well ride it to the bottom. None the less, it stands to reason that if the market is down, there are buying opportunities, but you are going to see a lot of red ink which can be unnerving. The biggest suggestion is to avoid buying your entire position in an equity all at one time. On September 12, 2011, for over a year the

The press has been talking about default of sovereign debt in Europe for over a year. My thesis, in June 2011, was that Germany, a powerhouse economy would get hammered, but would recover and shine. An easy way to play that is the ETF EWG. However, I buy it a little at a time. I can't time the market, I have no idea when the bottom will happen. I found an online broker that will allow me to purchase EWG with no trade fee so long as you hold it for more than 30 days and I plan to hold it till at least 2015. I buy five shares or so at a time. And I can set limits so that even if I am working or sleeping, if a certain condition is met the trade happens. This does not let me level the playing field with the Wall Street efficient market computers, but it keeps me from being swept off the game board. Yes, at this point, January 14, 2012 EWG is still in the red, still dropping, the online broker I use reports that I have a 20% loss, which hurts my trading ego, but that also means it is cheaper to buy more. My thesis has not changed, no matter how much reading I do, it appears the German economy is sound. Even if the Euro tanks, a worst case scenario, my thesis is that Germany will come out of the mess OK. Please lock in the point about market timing, it has been three months, we still have not apparently hit bottom in Germany with EWG, but I remain optimistic we will.
January 14, 2012 update. We are still falling. Even so, I just added to my position and it was considerably more than five shares for the month of January 2012. EWG is now at 19.61 which is insanely low. I set the trade up in two parts, a market order to ensure I have a larger position in EWG and a larger limit order for 18.75. I doubt we will hit 18.75, but in November, there was a drop to 18.14 followed by a rapid rise. Gosh, it would be nice to add to the position at a discount followed by a rise. Man has to have dreams!
June 18, 2012 update. EWG was last at 19.88, the elections in Greece were today. We now know we hit a bottom in and around September at about 17.52. If you were the hearty soul that bought in at that point, you have an entirely different perspective than most investors. If things go crazy in the next couple of weeks and EWG drops like a rock, I will add a modest amount to my already overweight position.

How to trade stocks when the market is rising

When stocks have been generally rising for a long time we have several strategies:
  • Buy using tiny limit prices: the stock may be selling for $1.00, but if we set $.96 as our limit, our purchase will only go through if the stock's price drops to $.96. This works best when we see the equity is bouncing around. We set up limit purchases in advance. This is where patience comes in. The problem with limits in a generally rising market is that we may well choose equities and price targets that never intersect. This ties up our cash waiting for the deal that may never happen. Lucky for us, we are patient, because we have decided to trade or at least research trades almost every week of the year.
  • Wait till a drop happens, make the decisions in real time: we have been doing our research all along, there are no major decisions about which sector, which equity, at what price - we know these things, we are simply looking for the best bargains. This is a great use of a market trade.
  • Set up a market trade if you think the equity is going to go up. I really screwed up last week; there is an ETF, I think is important to hold even if the analysts do not like it. It was trading just above 60, so I set a limit for 59.50, but forgot to set a reminder. In just ten days it is now trading above 70 and I felt very dumb having to pay ten dollars more than I should have.
  • Our strategy, after a long "up" market trend, is to start putting some money on the sidelines to pounce on favorable opportunities by selling some of the equities to raise money to invest in bonds and other asset classes that may be a bit cheaper.
The good news is that the big boys use computer generated models. Sometimes there is no human in the loop. Since the Flash Crash, most of these computer models have been a little more careful about deep discounting, but if you watch a typical trading day, you realize between 1 and 2% is commonly on the table, and in a down market, far more. The crazy thing about these computer models is that anything can set them off. The Queen of England sneezes and some computer model responds by selling ten thousand shares of some equity causing it to drop 5% in five minutes. If you have a limit order waiting, you can benefit from this.

Let's use Ford as an example. At this exact second October 5, 2011 Ford (F) is trading for 10.05. It had been too expensive, in fact may still be. Ford has too much debt; and, the recovery hasn't been that strong and new cars cost serious money. Also, all the stock advisory services are saying "buy GM". All of these things could potentially push the price of Ford stock down. My first inclination was set a limit for 9.80. My thesis is that Ford is a good stock at the right price; I like Fords, I own a Ford F150 and a Mustang GT 5.0 (and once you own a Mustang, you will realize there are a lot of Mustangs on the road.) I have dealt with Ford dealerships for thirty years. And, the Japanese car dealers are still unable to produce at pre-tsunami levels. If I can get Ford stock at a decent price and hold it for a year, I might make a small amount of money. I can't tie my money up forever with this limit, but if they are at 10.05 and the limit is 9.8, that has a very good chance of hitting. But is 9.8 the right price? That debt has to be serviced and that will pull from profits. All of this is an illustration that the markets are efficient.

But maybe make a bolder play. Ford has a high beta (2.37), which means that if the market drops 2%, Ford is likely to drop more than 4%. 9.8, which is below their 52 week low is likely to work. Investors must be patient.
NOTE: In the time it took me to write this paragraph, Ford when up .06 (six cents), so that 9.8 probably will not hit today. NOTE: it is now January 14, 2012, I ended up missing this by three cents, the low on Oct 5 was 9.83. Today it is trading at 12.04, but it is a long way to October 5, 2012 and I think I am glad I missed this one. Though I make exceptions, I rarely invest in a company with a debt to asset ratio greater than 20 and Ford is 63.14 today.

What about Mutual Funds and Investment Counselors

Do what you need to do, but I have only had two equities totally fail me in 40 years, I have had dozens of Morningstar five-star mutual funds underperform the market. Full disclosure though, I do hold a few mutual funds. They include in January 14, 2012:
  • DODWX, down almost 12% in the past year
  • MAPTX, down 12.7% in the past year, though I am still up since I have held it a long time
  • FREAX, up 5.65% for a year
  • FMIEX, down 3.7% in the year
Gosh, I just depressed myself looking at these. I had not realized it was this bad, because my online broker shows them as up, since I bought them a long time ago. I am certainly not recommending them to you at this time. I would suggest you wait a while before jumping into mutual funds and, to be honest, I think ETFs may largely supplant these as investment vehicles. To repeat, when computer models start selling things drop very rapidly and you cannot get out of a mutual fund until the next day.

Investment counselors get one percent (or whatever) off the top of your money. Then they go invest it in a mutual fund which they tell you is a special, exclusive mutual fund. When the market is up 20%, they will be up 15%. When the market is down, they will be down, but they will still be consuming a one percent management fee, so you have a solid guarantee of being down more than the market. If you can't invest ten to fifteen minutes of time Sunday through Thursday evenings, investment counselors may be a necessary evil unless you are willing to give some low cost index based ETFs a try.

My brain is my bank account's enemy

This is a tough one. We need to fully understand that our minds will play tricks on us. It is VERY easy for investing in the market to be like gambling. Every gambler remembers the weekend they were up $2,000.00, but they somehow forget the nine weekends they lost money. Many people invest by instinct, they look at one or two pieces of data and put their good money down in one shot. Invest with your head, not your heart, not by instinct. I usually do my research on one day, look at my research the next and if what I wrote down still makes sense, I make the trade. And not to hit a point too hard, but, use limit buys often. Does not always work, sometimes the equity keeps going up. Too bad, so sad. I keep my research in a notebook, stocks go up, stocks go down, I will have another chance. I am on my second research notebook for 2011, I filled the first one up. In our next lesson I will share what I do with the notebook. There is nothing wrong with researching more stocks than one can afford to buy. When I was 14, I used to take the Sunday paper and track a paper portfolio. Now we can track the stocks we are interested in using Google, the Motley Fool or a host of other websites.

With my notebook, I will go back to stocks that I researched two years ago, and chose not to buy, or bought and then sold. I will rerun the research. If they were worth considering two years ago, they were companies that I knew something about that perhaps not everyone on Wall Street does. Let me give you one example, Wal-Mart. Hunter would be quick to tell you that when I am on the mainland, I do most of my food shopping at Wal-Mart. They have good stuff at fair prices and I love the way they are starting to cater to the Latin market. I adore spicy food! I know the Wal-Mart on Kauai, in Richmond and the Wal-Mart in Seattle, and there is always foot traffic. When I was in San Antonio, I went to a Wal-Mart at 8:30 P.M. and it was packed, there were buses outside. Somebody told me it was payday in Mexico and they come to Wal-Mart, cash their checks, shop, get back on the bus and head South on Highway 35. In the past, Wal-Mart has not been a core stock for me, not one that I hold a lot of, but I have held Wal-Mart for ten years. It pays dividends, they came through the recession. It is growing internationally. It certainly deserves a few pages in my research notebook.

June 6, 2011 Wal-Mart at $54.70 per share. That is way too high, you would have been likely to lose money. The web site below currently sets $52 as the target buy price. However, if we are patient, there will be a bit of bad financial news and all those computer models will jump in. With practice, you can grab your research notebook, look at the portfolio you have already set up on Google Finance, and pull the trigger on the best buy available to you.
September 12, 2011 update. 51.82, if you have not been in a Wal-Mart lately, you should make a point of it. They are really challenging the perception widely reported in the press that they are not the lowest price. If this whole Greek mess causes them to drop, I am going to add to that position. They are still not a core stock for me, but I am headed in that direction. Adding to my position, note this is about the buy around price.
January 14, 2012 update. They are at 59.54 and have been flat for the past fifteen days or so, they are still trying to get USA same store traffic to rise. I do not really expect Wal-Mart Express to be a game changer but who knows, perhaps if they widen the aisles a bit. Wal-Mart did layaway for Christmas, really trying to emphasize low prices. They are still growing internationally. If they could get a large share of the online market ( fastest growing retail segment ) they have a solid growth trajectory. I just went to and it was slow loading. Apparently they do not invest in an Akamai cache page to serve Kauai. The salt air is killing our office printer.'s best HP all in one is the 6500 Plus for $149.84, I will try using them and see how well it works. Clicked on the add to cart, nothing appeared to happen, did it again, same result, third time it said added to cart. When I went to check out there where three printers in my cart, but that was easily fixed. Then they did not seem to be able to understand I wanted to pick up the printer from the Kauai Wal-Mart, they seemed to think I needed to get it from Pearl City on Oahu. I am not going to add to my position at this time, no progress towards Wal-Mart being a core holding. I realize it is easy to read this and think I am making investment decisions on one experience. Not so. For the past three years, I have had a Google Alert send an email with whatever Google felt was important about Wal-Mart into my inbox once a week and I invest time to read it.
April 24, 2012 update. Wal-Mart has gotten in trouble, something about bribery. The majority of my WMT holding were in my Es basket; the rules of that basket are to follow the instructions of the Motley Fool Million Dollar Portfolio which issued a trade alert. Wonderful thing is I was up 9%, I used both profit and principle to purchase a 7 yr CD at 2.25%. Wal-Mart closed today at 57.77. The My Dividends site still has the buy around at 52.00. Maybe set a deep limit on my dividend basket and see if it hits.

Bottom line: my brain is my enemy. It just wants to make a decision and be done with it. If the decision works I must be smart; but this path leads to financial ruin. If I make knee jerk decisions I am a gambler, not an investor. To be an investor, I need a process. At regular intervals I need to revalidate my research. I need to avoid blindly believing what my online broker software says about my equities . . . especially if I buy them over time as cheaply as possible, not just using limit orders, but keeping an eye out for commission free trades. My research notebook has tables. I write the price down myself at X date and Y date. It has taken me over 40 years to establish the equity positions I have, I am NOT going to make some massive decision tonight.

Our mantra must be: we research, we document, we make haste slowly, we are patient, even when we are talking about cycles that last a decade or more, like the current situation with bonds, we are patient.

Action Plan and Budget

  1. Get a brand new notebook, a one dollar composition book or a ten dollar Moleskine. Dedicate it to investing. Create a table of contents. Have a section for ETFs. Plan on holding at least a dozen ETFs and I would budget space for twenty. Give each one at least four pages. If you have an emerging market ETF such as SCHE, take the time to read its prospectus (which sadly does not say much), and its portfolio (much better). Note the regions of the world it trades in, the sectors and, most important, the equities it has the largest investment in. Right now this seems like a lot of work for one share and it is, but if you keep investing, soon you will have two shares and then ten, and one day will consider a second emerging market ETF that is more focused because you have a thesis that a particular region or sector will return greater gains than the overall index. Knowing what you have already makes it possible to invest wisely. UPDATE December 3, 2012, I have started to put my trading notebook online to model how to use one.
  2. Start an online brokerage account. They all have advantages and disadvantages. If you are married, do you want it to be a joint account? If you have a trust, you will need your trust paperwork and there is usually a separate form to fill out and you will need to be patient, many online brokers have a hard time with trust accounts.
  3. Fund the account. As long as you meet their minimum, you have access to the tools and research in all the accounts that I investigated.
  4. Get your two baseline index ETFs, SPY and ACWI
  5. Use limit orders at least half the time. However, balance that and don't get greedy all the time or your money will stay on the sidelines. Try for 1 or 2% cheaper than the market, it is great practice. Every once in a while, set a limit for 5% or high drop; again, it is all practice. Use the ten to fifteen minutes per day Sunday - Thursday to leverage your money.
  6. Get familiar with correlation, see how your ETFs rise and fall together, that is going to matter a lot as we move forward.
  7. Create two portfolios using Google Finance or your favorite online tool. One for the ETFs you just bought, a second for whatever you think you might want to buy later.
  8. Look for the ETF that is performing slightly better than its cousins Or, if you are fairly sure your set of ETFs correlates over time, buy the one that is down the most for the month.

Looking ahead

In lesson two we are going to start talking about individual equities.