Friday, August 8, 2008
BUILDING A HOUSE OR A HOUSE OF CARDS?
In reviewing portfolios I have noticed that client issues are most often concerned with the performance of an individual security….or several individual securities. It obviously makes sense that a security that you own will catch your eye when it is dropping in value! The main challenge with this approach to portfolio management is that the damage is most often done long before the security caught your eye!
You are not an insider and neither am I. If we were we would be filthy rich and not overly concerned with our daily or quarterly portfolio movements. The investment professionals are the first ones in on a good thing and the first ones out when things go wrong. That’s where the expression “buy on rumour and sell on news” comes from. In fact, unless you are a full time and well networked analyst, you are unlikely to ever get a truly worthy stock tip. The way we small investors can make money in the market, is through two key rules: never chase last year’s winners and always look at the big picture.
The first is obvious. If you never listen to the "Mad Money" or read the business section of the paper and if you ensure that on pain of death you never attend an investment seminar, you should be well on your way to success. Money is made by working hard, saving your spare cash, and investing over long periods of time in quality investments. The secret is to understand that the quality investments are only the building blocks in the big scheme of investing.
Your portfolio needs a good architect if it is to survive in tough times as well as thriving in good times.
Building on the architect theme, your house is designed to look great and meet all of your functional needs with windows, a furnace, plumbing and all the services and rooms you require. But the builder did not just drop by the hardware store and see what was on sale or what paint is the latest hottest colour (hopefully). They filed a plan of subdivision and the building design had to be approved to ensure the house was safe. Then they hired skilled trades to ensure the plans were followed and everything was within the building codes. Your portfolio is built exactly the same way, or at least it should be.
Unfortunately, many portfolios are built from a series of security purchases based upon what is hot today. If kitchens are not big winners with buyers lets not put a kitchen in the house, ditto for bathrooms that just need to be cleaned regularly. Sounds crazy but look in some portfolios and you see huge gaps in the basic asset classes because they were not in favour, were not sexy enough, or simply did not pay the advisor enough commission.
To get specific:
-think of cash as being the furnace and electrical components of the house. Flexible in that they are not always needed, but important because when you do need them you need them at the flip of a switch.
- lets look at fixed income as the foundation and basement of the house; a solid foundation that assures no matter how bad the weather, the house is not going to blow away or float away!
- equities are the siding, the landscaping, the paved drive, the Jacuzzi tub, the chandelier. They are the portion that gives the place curb appeal and provide pride of ownership. Quality equities are often the difference between successful portfolios and drab portfolios. They give your portfolio the lift that allows you to hold inflation in check and build that new addition on the house.
- alternative investments are the four car garage with a Porsche and a BMW. You do not really need them but if you can afford the cost then live a little and spend your mad money! Who know they may become classics and go up in value!
Okay, that’s a bit of a stretch, but you definitely need to have a portfolio that is built with sound planning and that includes the five basic asset classes: cash, fixed income, Canadian equities, U.S. equities and Global equities. You need them in the correct proportion and you need to understand the purpose they serve.
When you are buying a new investment you need to ask yourself, which asset class should I be looking at and what purpose is the investment going to fulfill. There is no sense buying a door when you need a window! Similarly there is no sense buying an equity when you need a bond! Do not get carried away worrying about what security to buy until you know what asset class you should be shopping for!