Keeping Your Portfolio Out of the Critical Care Unit

9 November, 2015

'Buy and hold' - we have heard this axiom as the only solution to successful investing for decades, and it has gradually gained wide acceptance by the investment industry, the media, and investors. It was meant to keep investors from constantly trying to time the market and avoid large losses. Psychological biases, which afflict all individuals, including professionals, stir emotional responses to market fluctuations. To avoid these emotional instincts, investors are told to simply, invest their money whenever it is available and then ignore the news.

However, 'buy and hold' is a simplistic concept that doesn't truly explain the investment process of professionally managed money. As such, do-it-yourself investors, think that this strategy applies to all of their investment decisions. This results in people sometimes buying bad stocks and holding them into perpetuity without consideration for how that company's fortunes are changing. Or buying an ETF to replicate a stock index and assuming over the long-term, that the market always moves upward. History shows that stocks have repeatedly entered prolonged 'secular' bear markets where they can drift sideways for decades.

Nothing in life is permanent. There's an ebb-and-flow to the movement of capital, and evolution in technology and science which affects the fortunes of all businesses. It results in large and established companies eventually dissolving into the past (seen any typewriters lately?), and the creation of new dynamic companies.

Governments have also taken to increased intervention in capital markets which causes distortions in interest rates. In turn, these interest rate distortions affect prices for housing, bonds, and businesses in various economic sectors. It also results in capital flowing geographically from one country to another. To add to this complexity there are seasonal tendencies in stock prices due to the patterns of consumption of certain products and services. In short, the movement of capital never ceases.

This perpetual capital movement requires the active monitoring of one's investment portfolio on a regular, and systematic basis, in order to make periodic adjustments, which sometimes can be quite dramatic.

In addition, as we all know, capital markets sometimes experience a change in their primary trend which results in violent downward movement of prices - a.k.a. a 'Bear Market'. A profitable and well-managed portfolio will have a defined process for identifying a change in the primary trend, and making appropriate adjustments to its internal components. These are the times that, as an investor, you must switch from an 'offensive posture' to a 'defensive posture'. This means reducing your exposure to the stock market as a whole until the trend eventually changes again. A reduction not of just 5% but perhaps by a third, or by half, or more.

The 'buy and hold' axiom therefore does not adequately explain what is involved in the investment process. A process which passes through various economic conditions and stages, that warrant ongoing adjustments to ensure successful, long-term, investment performance. Buy and hold means different things to different people. It might mean, 'invest your money with a professional and leave it alone' or 'buy your favourite stock and keep it forever'.

However, achieving your investment objectives requires a more thorough understanding of the investment process. A process which should have a system for making ongoing adjustments to a portfolio's components, which are not simply bought and held forever. What nearly 30 years of experience, and a study of economics and market history has demonstrated to me, is that those who self-manage their investments are not equipped to fight their own psychological biases which will result in lower returns. It has also proven that the investment industry, as a whole, does not consider changes in trend or seasonal patterns, when making portfolio adjustments.

Avoiding the critical care unit for your money requires, objectivity, emotional detachment, critical thinking, and most importantly, innovation in investment strategies, not simplistic catch-phrases.
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Written by: John Soutsos

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