One of the many benefits that accrue from writing Invest-notes is spending time every week thinking about the economy and its impact on my personal finances. This, in turn, creates a paper trail of my thoughts, documenting the evolution of how and why I make investing decisions. The hope is that this exercise provides demonstrable proof of improved performance. So I share the following observation as a reminder of how much my thinking has changed and not as a criticism of another person on a similar journey.
Following a news link from a stock back on my watchlist (NLY) led me to a Motley Fool article. Long story made short, last summer an investor-blogger bought a $10,000 portfolio of ten high yielding stocks and this post was an update of how his portfolio was faring. He was using SPY (an exchange traded fund that tracks the S&P 500 index) as a benchmark, and at this juncture his portfolio had delivered a bit less than one percent while the S&P was up a bit more than 4%. These figures include the value of dividends, which is essentially the point of his experiment. Though he didn’t include this information, I calculated that his portfolio has an average yield of 6.9% compared to about 2.5% for the S&P. Even in a down market, he should be able to outperform the S&P.
The déjà-vu hit me when I read the following: “Given the massive move down in shares of Frontier over the last few months, I’m strongly considering reinvesting the money there.” The ‘massive move’ he mentions was a 45% drop in the stock price. The money he plans to reinvest are the dividend payouts he’s received so far. And this comment was sandwiched between two other lines. First, “But I’m confident in the long-run nature of this portfolio, and I fully expect it to outperform. If we see a downward move in the S&P, we’ll quickly gain the upper hand again, I think.” And, “Without its truly horrific performance — down nearly 50% since late June — the portfolio would be clearly better than the market.”
Now, for his portfolio to just break even the stock he’s ridden down has to double in price. If he’d had an exit strategy – I typically use a 20% decline as a trigger to sell a stock gone bad – he would now be ahead of the S&P and in a position to reinvest the sale proceeds and the dividends in one, or all, of the four stocks in his portfolio that are trending up. Further, assuming that it will take a market move (and I am unclear why a down move is desirable) for this portfolio to perform means there really isn’t an investment strategy beyond hope.
I have made this mistake – to chase the losers instead of the winners. I have made this mistake – to assume a market move is forthcoming and will save my ass. I have made this mistake – believing the long term will make my decisions good ones. Thankfully, I’ve learned to buy stocks on the way up and cut my losses when it is obvious my assumptions have been trumped by Mr. Market.
Oh, yeah, I bought a few hundred shares of NLY this week.