Submitted by Steve Selengut
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Investment Performance Evaluation Re-Evaluated: Part One (April 2009)
It matters not what lines, numbers, indices, or gurus you worship, you just can't know for certain where the stock market is going or when it will change direction. Too much investor time and analytical effort is wasted trying to predict course corrections--- even more is squandered comparing portfolio market values with a handful of unrelated indices and averages.
Annually, quarterly, even monthly, investors scrutinize their performance, formulate coulda's and shoulda's, and determine what new gimmick to try during the next evaluation period. My short-term performance vision is different. I see a bunch of Wall Street fat cats, ROTF-LOL, while investors beat themselves senseless over what to change, sell, buy, re-allocate, or adjust to make their portfolios behave better.
Why has performance evaluation become so important short-term? What happened to long-term planning toward specific personal goals? When did it become vogue to think of investment portfolios as sprinters in a race with a nebulous array of indices and averages? Why are the masters of the universe rolling on the floor in laughter?
--- Because an unhappy investor is Wall Street's best friend.
By emphasizing short-term results and creating a cutthroat competitive environment, the wizards guarantee that the majority of investors will be unhappy about something, most of the time. In the process, they create an insatiable demand for an endless array of product panaceas and trendy speculations that regulators fall bubble-years behind in supervising.
--- Your portfolio needs to be uniquely your own, and in line with some form of realistic investment plan.
I contend that a portfolio of individual securities rather than a shopping cart full of one-size-fits-all consumer products is much easier to understand and to manage. You do need to focus on two longer-range objectives, however: growing your productive working capital, and increasing your base income. Neither number is directly related to any of the market averages, interest rate expectations, or the calendar year.
A focused approach protects investors from their too normal reactions to short-term, anxiety-causing events and trends, while facilitating objective based performance analysis that is less frantic, less competitive, and more constructive than conventional methods. Unlike most techniques, it recognizes the importance of income generation as a long-term growth enhancer.
The terms "working capital" and "base income" are tenets of The Working Capital Model (WCM). The former is simply the total cost basis of the securities and cash in the portfolio, while the latter refers to the total dividend and interest production of the portfolio. The discussion below is based on the complete WCM methodology.
If we reconcile in our minds that we can't predict the future (or change the past), we can move through the uncertainty more productively. We can simplify portfolio performance evaluation by using information that we don't have to speculate about, and which is related to our own personal investment program.
Let's develop an all-you-need-to-know chart that will help you manage your way to investment security (goal achievement) in a low failure rate, unemotional, environment. The chart has five data lines, and your portfolio management objective will be to keep three of them moving upward through time.
Please refer to the chart in Chapter 7 of "The Brainwashing of the American Investor: The Book that Wall Street does not want YOU to Read", and on-line here (http://sancoservices.com/Sanco/WorkingCapitalLineDance.htm).
The Working Capital Line: The total portfolio working capital should grow at an average annual rate between 5% and 12% plus, depending on your asset allocation and current interest rates. Higher equity allocations should produce greater growth over the course of a complete market cycle. Note that this major-focus line is absolutely not a measure of market value.
In fact, the market value line is expected always to track south of working capital. If market value breaks through, it means there are unrealized capital gains in the portfolio--- you'll want to avoid that scenario. This line is increased by dividends, interest, deposits, and realized capital gains and decreased by withdrawals and realized capital losses.
The WCM is an investment-grade-only methodology, and it includes techniques that cull downgraded or non-productive securities from portfolios at pre-defined times during the market cycle. Thus, high cost basis junk doesn't inappropriately impact the long-term slope of the working capital line. Similarly, the WCM attempts to keep tax code based decisions out of the process. For example:
Offsetting capital gains with losses on good quality companies becomes suspect because it results in a larger deduction from working capital than the tax payment itself. Similarly, avoiding securities that pay dividends, and/or paying flat-fee commissions in advance, reduces the income compounding effect that the WCM attempts to nourish.
A declining working capital line can be very informative. If you are experiencing too many capital losses, it's a sure sign that you selection criteria are too speculative; you aren't diversifying properly (or in 2008 and 2009) that you were victimized by misguided federal government intervention both before and during the financial crisis.
Excessive withdrawal activity, for whatever reason, reduces more than just working capital. It also reduces current base income and stunts the future growth rate of both numbers. Long-term portfolio and income growth demand control of expenses at a level below base income.
Hmmm--- I wonder if that would work in Washington?
Every December, with visions of sugarplums dancing in their heads, investors begin to scrutinize their performance, formulate coulda's and shoulda's, and determine what to try next year. It's an annual, masochistic, rite of passage that produces Wall Street's favorite people --- unhappy investors.
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Steve Selengut is registered as an investment adviser representative. His assessments and opinions are purely his own. None of the information presented here should be construed as an endorsement of any business entity; the information is only intended to be educational and thought provoking.
Risk Management: Income, 401k, and IRA Programs
Take a free tour of a professional investment managers' private SEP IRA program during ten years surrounding the financial crisis:
In developing the investment plan, personal financial goals, objectives, time frames, and future income requirements should all be considered. A first step would be to assure that small portfolios (under $50,000) are at least 50% income focused.
At the $100,000 level, between 30% and 40% income focused is fine, but above age 50, the income focus allocation needs to be no less than 40%... and it could increase in 10% increments every five years.
The "Income Bucket" of the Asset Allocation is itself a portfolio risk minimization tool, and when combined with an "Equity Bucket" that includes only IGVSI companies, it becomes a very powerful risk regulator over the life of the portfolio.
Other Risk Minimizers include: "Working Capital Model" based Asset Allocation, fundamental quality based selection criteria, diversification and income production rules, and profit taking guidelines for all securities,
Dealing with changes in the Investment Environment productively involves a market/interest rate/economic cycle appreciation, as has evolved in the Market Cycle Investment Management (MCIM) methodology. Investors must formulate realistic expectations about investment securities--- by class and by type. This will help them deal more effectively with short term events, disruptions and dislocations.
Over the past twenty years, the market has transitioned into a "passive", more products than ever before, environment on the equity side... while income purpose investing has actually become much easier in the right vehicles. MCIM relies on income closed end funds to power our programs.
To illustrate just how powerful the combination of highest quality equities plus long term closed end funds has been during this time... we have provided an audio PowerPoint that illustrates the development of a Self Directed IRA portfolio from 2004 through 2014.
Throughout the years surrounding the "Financial Crisis", Annual income nearly tripled from $8,400 to $23,400 and Working Capital grew 80% $198,000 to $356,000.
Total income is 6.5% of capital and more than covers the RMD.
Managing income purpose securities requires price volatility understanding and disciplined income reinvestment protocals. "Total realized return" (emphasis on the realized) and compound earnings growth are the key elements. All forms of income secuities are liquid when dealt with in Closed End Funds.
|Please read this disclaimer:|
Steve Selengut is registered as an investment advisor representative. His assessments and opinions are purely his own and do not represent the views of any other entity. None of his commentary is or should be considered either investment advice or a solicitation of business. Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be or should be construed as an endorsement of any entity or organization. The reader should not assume that any strategies, or investments mentioned are any more than illustrations --- they are never recommendations, and others will most certainly disagree with the thoughts presented in the article.