|
Stock and Bond Trading as a Conservative Investment
Strategy
It's likely
that either curiosity or skepticism led you to this article, and I would
agree that, for most individual investors, trading is approached in a
totally speculative manner. Stock trading, in its more popular forms
(Day Trading, Swing Trading, Penny Stock Speculating, etc.) includes
none of the elements that a conservative investment strategy would have
at its very core: Little if any attention is given to the fundamental
Quality of the equities selected. Any Diversification that exists in the
portfolio is determined by chance alone and is, at best, a transient
result of the selection guesswork. No attempt whatever is made to
develop an increasing and dependable stream of Income. But stock trading
by individual investors doesn't deserve quite as bad a "rep" as it has
earned. After all, its very foundation is Profit Taking, probably the
most important (and possibly the most often neglected) of the activities
required for successful investment portfolio management. Unfortunately
for most non-professional equity traders, loss taking is a more common
occurrence.
Bond, (and other Income Security) trading
is generally avoided by most non-professional traders. Obviously, it
takes more investment capital to establish positions in Corporate and
Municipal Bonds, Real Estate, or Government Securities than it does in
Equities, and the volatility that traders thrive upon is just not a
standard feature of the mundane world of debt securities. Surprisingly,
most investment advisors and stock brokers have not discovered that
there is a more exciting approach to Income Investing that is actually
safer for investors and less inflexible in the face of changing interest
rate expectation scenarios.
Certainly, Wall Street financial
institutions pressure their representatives to push individual new
issues and/or investment products, but I think that the Market Value
fixation that stretches from Wall Street to Main Street is the real
culprit. Income securities need to be "valued" for long-term income
growth and traded with great pleasure… albeit much less frequently.
Consequently, most
trading is done in an Equity only environment that, by its very nature,
is too speculative for most mature (in whatever sense you choose)
investors.
But this is not the way it needs to be. Since
stock prices are likely to remain volatile in the short run and cyclical
in the long run, there will always be opportunities for profit taking.
[Note that it is the combination of volatility, market accessibility,
universal equity ownership, and confiscatory taxation that have made
"Buy 'n Hold" a tar pit Investment strategy.] Similarly, there are no
rules against taking advantage of the cyclical nature of interest rate
sensitive security prices.
Trading is the world's oldest form of
commercial activity, and it is unfortunate that it is treated with such
disrespect by our dysfunctional tax code. It is even more unfortunate
that it is looked at askance by client attorneys and brokerage firm
compliance officers… masters of hindsight that they are.
Trading does not
have to be done quickly to be productive, and it doesn't have to focus
on higher risk securities to be profitable. And perhaps most
importantly, it doesn't have to avoid the interest rate sensitive income
securities that are so important to the long-term success of any true
investment portfolio.
No matter how beaten up a speculative day trader
becomes, whatever profit taking experience there has been is invaluable.
Once a trader/speculator is weaned off the gambling mentality that
brought him to the "shock market" in the first place, he can apply his
trading skills to investing and to portfolio management. The transition
from trader/speculator to trader/investor requires some education…
education that cannot be obtained from product salespersons.
Step One is to gain an appreciation of
the power of Asset Allocation using the principles of The Working
Capital Model. Asset Allocation is the process of dividing the portfolio
into two conceptual "buckets". The first of these will contain Equity
Securities, whose primary purpose is to produce growth in the form of
Realized Capital Gains. The other bucket will contain various securities
whose primary purpose is to produce some form of regular income…
dividends, interest, rents, royalties, etc. The percentage allocated to
each is a function of a short list of personal facts, concerns, goals,
and objectives. The cost basis of the securities, absolutely not their
constantly changing Market Values, must be used in all Asset Allocation
calculations. Asset Allocation is a critical portfolio planning exercise
that is: based on the purpose of the securities to be purchased, long
term in nature, and never "rebalanced' or altered due either to current
market circumstances, hedging, or some form of market timing (which, of
course, is impossible).
Market Values are used in the selection
process that identifies trading candidates that will fill the buckets…
cash from all income sources, by the way, is always "destined" for one
bucket or the other, and may be held unused if no proper candidates
exist. Selecting potential Equities must first be "fundamental", then
"technical"… i.e. based on the Quality of the security first, and the
price second. My experience is that higher quality companies purchased
at a 20% or more discount from the 52-week high, with a profit target of
approximately 10% (realized as quickly as possible) is a very manageable
approach. The proceeds find their way back into the "smart cash" pot for
Asset Allocation according to formula. There will be times when "smart
cash" grows quickly while the list of new trading candidates shrinks,
but when trading candidates are all over the place, "smart cash" is
replenished with a portion of every income dollar produced by both fully
invested buckets! Thus, insistence upon some form of income from all
securities owned makes enormous sense!
But what about
trading the Income Bucket securities? Enter the Closed End Income Fund,
in the form of a common stock, and in a surprising variety of income
producing specialties ranging from Preferred Stocks to Oil Royalties,
Treasury Securities to Municipal Bonds, and REITs to Mortgage Income. No
more worries about liquidity and hidden markups. No more cash flow
positioning or laddering of maturities. And best of all, no more calls
of your highest yielding paper when interest rates fall. Instead, you
are taking capital gains, compounding your yield, and paying your dues
to the Equity Bucket. And when interest rates move back up… you'll have
the luxury of reducing your cost basis by adding additional shares. Of
course its magic… that's what we do here on Wall Street!
|
