Our Core Beliefs
1. Businesses Produce Real Wealth
The equity markets generally rise over the long term. Over the last 120 years, annualized real returns of US equites are roughly 6.5%. That is more than 3x the real returns of bonds (2%) and 8x the real returns on T-bills/cash alternatives.1
2. Time Horizon Matters. Equity markets are always subject to short term volatility.
The other quarter of the time, when the return was negative, it’s important to stay invested and keep proper perspective (see belief #1). The longer your investment time horizon, the higher the odds of achieving a positive return in the stock market.2
3. “Wealth isn’t primarily determined by investment performance, but by investor behavior.” – Nick Murray
We can’t control the market cycle, the economy, the Fed, interest rates, etc. What we can control is our emotions. While it would be easy enough to say we should take a stoic approach to our investment portfolios, we believe that would be naïve. Money is emotional, people are emotional. Therefore, one of our favorite sayings is, “we believe the best portfolio is the one that you can “stick with.””
1This material contains an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources.
2Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.
After identifying our cash and bond buckets, we can now focus on the growth allocation of the portfolio. A quick Google search of “Active vs. Passive Investing” yields 18,900,000 search results! We don’t believe we need to put ourselves in one camp or the other. We believe in building a portfolio using a combination of indexed strategies and actively managed strategies. We start with a “strategic allocation” in a global equity portfolio using a broad range of asset classes. We make subtle shifts in the allocation as warranted but this portfolio is always fully invested and holdings don’t change very often as we rely heavily on our belief #1. We call this buy and hold portfolio our “Core” equity portfolio.
In addition to the Core portfolio that uses a strategic allocation, we manage several strategies that use a tactical allocation approach. We believe the tactical allocation addresses our core beliefs by flipping them around:
- Core Belief #3 – In order to have good investment behavior, you need to be able to emotionally handle the tough times
- Core Belief #2 – Knowing that there is ALWAYS the possibility of Short-Term Volatility that could lead to poor investment behavior, we want to have a game plan to address the short-term volatility
- Core Belief #1 – having a game plan in place to address the short-term volatility allows us to stick with Core Belief #1 that equity markets provide the best real returns over the long term
Our tactical strategies are governed by evidence-based factors that we believe complement the Core portfolio. We use a rules-based approach and technical analysis when applying these factors (e.g. – momentum and relative strength). Our tactical portfolios fall into two broad categories:
Growth with Risk Management
Warren Buffet once said “The first rule of investment is: Don’t Lose. And the second rule of investment is: Don’t forget the first rule.”
We manage various strategies that attempt to mitigate the reality of core belief #2 by using “stop losses”. Even with the use of stop losses our portfolios will fully participate in the early stages of a broad market decline. The reason for using stop losses is to attempt to limit the amount of downside risk we have during a prolonged market decline.
We’ve all heard the saying “buy low, sell high”, yet studies have shown that momentum (the tendency for winning stocks to continue performing well in the near term) has been one of the stronger generators of returns. We use a variety of different technical indicators to identify positive momentum.
By combining our core strategy with our tactical strategies, we believe we offer a growth portfolio that may 1. Produce real wealth over time 2. Respect the volatility of the markets and 3. Allow us to ‘stick with’ an investment portfolio that will help breed good investment behavior.
Tactical Investment Strategies
In addition to our buy and hold “Core” portfolio of stocks and bonds, we use different active management strategies that we believe complement the “Core” Portfolio.
DH is the most aggressive investment strategy we utilize in a portfolio. We came up with the name “DH” because of our affinity for baseball. In baseball, “DH” means “Designated Hitter.” The Designated Hitter only appears in the game when the team is on offense.… [Read More] The Designated Hitter does not play defense. So it is with our DH strategy: the account will always be fully invested and has no built in mechanism to raise cash or become defensive.
We use a momentum indicator to determine our stock selection. We target 25 stocks in the portfolio based on the strongest momentum. We will diversify across industry sectors to make sure we aren’t overly concentrated in one area (i.e. – all tech in 1999 or financials in 2007). We evaluate each stock at the close of each week to determine if the stock is no longer showing positive momentum. If the stock is no longer showing positive momentum for two consecutive weeks, we will sell the stock and replace it with another company displaying strong momentum.
This strategy is aptly named “Intersection” as we use both fundamental and technical research to determine which companies belong in this portfolio. To qualify for inclusion in this portfolio, a stock must pass our 14 technical screens and have what we believe… [Read More] are favorable fundamental characteristics. Both the technical world and the fundamen-tal world need to be of like mind, or “intersect” if you will.
We run our screens on a nightly basis and if a company meets all the criteria, we purchase a 6.25% position in the portfolio. Once the stock is purchased, we establish a “Stop Loss” as well as a “First Target” price. If the stock price rises to our First Target, we sell one-half of the position. If the stock ever goes below our Stop Loss price, the stock is sold out of the portfolio. The Stop Loss price adjusts along with the stock. If the stock prices rises so, too, will our stop loss.
ECP stands for “Earnings Consistency and Predictability.” Our screening process targets companies with what we believe to be the best combination of safety and growth.… [Read More]
ECP also has a “market timing” factor built into its process. We only add positions into the ECP portfolio when our market timing indicators give us the “green light” to buy stocks. In this strategy, we put together a concentrated portfolio of 10 stocks which are equally weighted at the time of purchase.
Once an issue is added to the portfolio, we use an initial “Stop Loss” of 15% and a “Profit Target” of 50%. The 15% stop loss dynamically adjusts upward if the stock price moves higher. If the price reaches our upside target, the stop tightens significantly as we attempt to protect the vast majority of the gain. When a position is sold, it is replaced so that we maintain a portfolio of 10 holdings if our market timing indicators are still flashing a “green light.” If our market timing isn’t telling us that it’s time to buy, the proceeds of a sold position will remain in cash until our market timing indicates that it’s OK to buy again.
This strategy is called “TAP” which stands for “Tactical Allocation Portfolio”. We use technical indicators, momentum and relative strength, to determine an allocation… [Read More]to various asset classes.
This strategy employs a “Three Legged Stool” approach. We use relative strength to analyze six different asset classes – US stocks, International Stocks, Bonds, Commodities, Currencies, and Cash. We invest in the two strongest asset classes based on “Relative Strength”. This accounts for two of the three legs in the portfolio. If no asset classes are showing strength when compared to cash, this portfolio can be 2/3rds in cash or cash alternatives.
The final or third leg of the portfolio is always invested in US stocks. We again use relative strength on a sector level to determine the strongest sectors within US stocks.
Our covered call process is a portfolio with a goal of generating income from the sale of “Call” options. A Call Option is a contract that we sell against the shares we own. As an option seller, we get paid a premium for taking on the obligation to sell our shares at an agreed-upon price and for an agreed-upon period of time. Generally speaking, we sell … [Read More]options expiring within 30 to 60 days. We try to build and maintain a portfolio of no more than 10 companies with good fundamental and technical parameters.
RSI which stands for “Relative Strength Index” is a technically based “mean reversion” strategy using various indicators to identify issues with potential short term price movement. We screen for stocks trading away from their historical averages, assuming they tend to return to their average price, and attempt to capitalize on these short-term price deviations.… [Read More]
Stocks that are in a longer-term uptrend but a shorter-term downtrend are considered for purchase when the price of the stock meets all of our purchase parameters. It is our most concentrated strategy with only 5 positions maximum in the portfolio and an average holding period of only 4-5 days.
The position is sold as soon as one of two conditions is met: 1) the gain on the position = 7% or 2) the stock closes above its 5 day Moving Average.
1 Asset allocation does not protect against loss of principal due to market fluctuations. It is a method used to help manage investment risk. Please note that all investments are subject to market and other risk factors, which could result in loss of principal. There is no assurance that the investment process will consistently lead to successful investing.