The No-Frills Investment Strategy
- Apr 15, 2005
- Part I: Picking the Right Investment Vehicles
- Risk: Reward Comparisons Between More Volatile and Less Volatile Equity Mutual Fund Portfolios
- Drawdown: The Measure of Ultimate Risk
- Changing Your Bets While the Race Is Still Underway
- Increasing the Risk: Maintaining a Portfolio of Somewhat More Aggressive Mutual Funds
- Upping the Ante: The Effects of Applying the Concepts of Relative Strength Selection to a Still More Volatile Portfolio of Mutual Funds
- A Quick Review of Relative Strength Investing
- Summing Up
Part I: Picking the Right Investment Vehicles
Successful investing involves two basic areas of decision: what do you buy and sell, and when do you buy and sell. We'll be moving along into the "whens" in chapters to come, as we develop a broad array of market timing techniques. Before we move into timing, however, we will consider some principles and procedures that should prove helpful in selecting vehicles in which to invest.
It's not how much you make that counts; it's how much you manage not to lose.
Let's start by considering just a few numbers. The Nasdaq Composite Index reached an all-time high on March 6, 2000, closing that day at 5048.60. The ensuing bear market took the index down to a low of 1,114.40 on October 9, 2002a loss of 77.9%. Prices advanced from that point. By December 3, 2003, the Composite had risen to 1960.20that's 75.9% above the lows of October 2002. And where did the buy-and-hold investor stand at that point? Downvery much down still, by 61.2% from the March 2000 close!
The moral: To make up any losses taken in the stock market, you have to achieve greater percentage gains than such losses entail. It does not matter whether the losses or the gains come first.
For example, if you lose 20% of the value of your assets, you have to make 25% on the remainder to break even. (If you start with $100,000 and lose 20%, you have $80,000. To bring that $80,000 back to $100,000, you have to show a gain of $20,000 which represents 25% of the $80,000 you have left in your account.)
If you lose one-third, or 33.33%, of your assets, you will have to make 50% on your remaining assets to break even. If you make 50% first, a loss of 33.33% will bring you back to your starting level.
If you lose 25%, you will need to gain 33.33% to bring you back to your starting level.
If you lose 50%, you will need to make 100% to restore your original capital.
If you lose 77.9%, you will need to make 352.5% on the assets left to break even.
I think you get the idea by now. Capital preservation is, by and large, more important for successful long-term investment than securing an occasional large profit. We will, of course, be reviewing a number of timing tools that are designed to provide more efficient entries and exits into the stock market, thereby reducing risk and improving the odds of maintaining and growing your capital assets. Let's begin, however, with strategies for portfolio selection, which should be very useful supplements to your market-timing arsenal.