averaging, fear and greed, investment checklists, investment process, investment theme, noise, risk vs. reward, stock picking, technical analysis, worship the spreadsheet
It’s New Year’s Eve…and in the end, it’s been a pretty tough & frustrating year for many investors out there. [‘Less you’re Irish & stuck close to home – just look at this friggin’ chart!] And while the holiday season’s all about celebrating the year gone by & ahead, it can be tough (as the booze kicks in) not to get a little disheartened and experience some real doubt about your portfolio & your stock-picking prowess.
And the financial media’s no help – the talking heads & market strategists chatter about the biggest winners of the past year, and opine on the stocks & trends to focus on in 2016. How on earth are they be so confident & so prescient? It’s simple…’cos that’s how they get paid & promoted! Just like CEOs, just like politicians, just like your boss, the big bucks are paid almost inevitably to the big swinging dick. Not the fidgety little guy in the corner, analysing stacks of data & second-guessing himself to death. Truth is, they don’t need to be right, that’s irrelevant. Because they’re looking to attract attention, earn fees, increase AUM, etc…and ultimately, confidence sells.
Trouble is, you need to be right.
But you don’t feel confident, like they do. And so the dance continues… They go on TV, and dish out all the confident narrative & commentary you crave. Except the only obvious market truism (‘stocks go up, over time…’) isn’t a good soundbite. Instead, they analyse monthly data points. And speculate about a possible Asian pandemic. And worry over an escalating Middle East war. And hyperventilate about a junk bond-induced economic melt-down. Or a terrorist attack, or maybe even an assassination, if they get lucky. And so on, ad infinitum.
But almost inevitably, it’s all just noise…
Because we fear the unknown. And our need to anticipate & interpret it creates a vacuum of doubt…where Fear & Greed inevitably rush in. The TV anchors, the talking heads, the market strategists, the fund managers, the bankers, the brokers – they’re all compelled to manufacture & analyse a never-ending stream of noise. But no matter how rational & persuasive they may sound, it’s mostly driven by fear & greed as they worry about their popularity, their bonuses & their jobs. And in turn, your reaction (no matter how you agree, or disagree), is mostly driven by fear & greed too…as you worry about possibly exhilarating gains & gut-wrenching losses in your portfolio. Except, in reality, this noise chamber of fear & greed we all inhabit is basically irrelevant.
Not that it stops it from being dangerous…
I read some Ken Fisher recently (for my sins): His brain fires funny, but he really hammers the point home. He demonstrates economic data points, pandemics, assassinations, terrorist attacks, even (non-world) wars, are all pretty much irrelevant to the market. And he confirms how worthless market/economic forecasts (& forecasters) really are. Not to mention there’s no such thing as a consistently successful market-timer. But any serious investor knows all this already. And should be familiar with those 10 Best (or Worst) Days studies which show how drastically different your returns could have been. Call me lazy…but challenge me to cherry-pick (or avoid) a handful of best/worst days over the course of decades, and I’ll throw my hands up in despair.
And without a doubt, that’s the correct response.
Because none of the noise, the analysis, the anxiety, is likely to ever yield anything useful. Except for fear & greed, that is…and the dangerous mistakes & poor decisions it can inevitably cause in your investment process & portfolio.
Far better to give up on trying to outguess the market, and simply rely on the fact it goes up over time! And occasionally focusing on the long term macro picture & a few secular investment themes (which I always strive to do), is the only necessary (or desirable) framework for a serious investor. Which hopefully offers a helpful tail-wind or two, while leaving plenty of time & wiggle-room for your outlook to evolve. And it’s worth remembering that maintaining/raising portfolio cash is generally a fool’s game…but fear & greed will endeavour to trick you into playing it, thereby robbing you of possibly substantial long term returns. With a New Year upon us, it’s time to ignore the noise, and focus on trying to conquer our fear & greed. [And so doing, allow ourselves to ultimately focus on picking the best companies (not just stocks)]. As Buffett reminds us:
‘When investing, we view ourselves as business analysts, not as market analysts, not as macroeconomic analysts, and not even as security analysts.’
But tackling fear & greed is easier said than done…how on earth do you conquer such powerful deep-seated emotions, esp. when they’re invariably disguised as rational thought & analysis? Obviously, I’ve written about it before (here & here), and offered a dozen tips & tricks which I hope were useful. But more & more, I’ve realised one technique (above all else) has established total dominance in my investment process, so let’s revisit & expand on it properly here. I called it:
Average In, Average Out
The trouble for most investors is we tend to
focus on obsess over just one or two big decisions at a time: i) The exciting new stock we just discovered & want to buy hand over fist, or ii) the multi-bagger (or loser) stock we agonise over selling, or iii) the alarming & excessive (or insufficient) level of cash in our portfolio!
All fertile ground for the excesses of fear & greed…which mostly boils down to: a) ‘What if I buy the stock/market & it dumps?!’, or b) ‘What if I don’t buy the stock/market & it soars?!’ Which quickly snowballs into ‘What about the Fed next week, the jobs numbers, the market P/E, the disruptive unicorn bubble…plus the famine, plague, and the rest of the Four Horsemen coming over the horizon?!’ I could go on – but I’m sure you get, or should I say feel, what I’m saying…
All too quickly, you forget the macro/investment theme framework that was guiding you, you abandon your investment checklist (please tell me you have one!), you ignore the business behind the stock, and you can’t make a decision to save your life…one day you want to plunge right in, the next you want to sell & just fondle your wads of cash. All those talking heads & fund managers, who never experience a moment’s doubt, start making perfect sense to you – maybe you should just let them take you by the hand & lead you to the promised land!?
And so the dance continues…
But so what? More or less, we all suffer this…and ultimately we’re all alone, when it comes to dealing with it. The answer is to remove fear & greed from the equation – by reducing your decision-making (& the money involved) to bite-size steps, as with any daunting endeavour:
- Always average into new stocks.
- Always average out of winning (& losing) stocks.
- Always average in/out of a number of stocks at a time.
I’m talking about (at most) a 1.0% portfolio purchase/sale each time, or maybe even 0.5% a pop, and always having a list of at least your Top 3-5 Buys & Sells lined up ready for the trigger.
[NB: I’m presuming you Checklist It (have a minimum/obligatory checklist in terms of metrics, financial strength, valuation, etc.), you Learn To Love The Black Box (a paper/digital trail of your investment thesis), and ask Well, Are You The Right Size? (intended holding size, in terms of risk/reward & overall diversification – an original 3.0%-7.5% position is probably about right)].
Now that might seem counter-intuitive – surely this multiplies the investment decisions & alternatives you’ll need to consider? Why yes, it does..! Which forces you into a far more methodical approach to portfolio purchases/sales. Reinvesting cash is no longer some grand market bet, it’s purely an investment process. And the real beauty of it: Whatever you arrive at, it’s only a small decision…it’s never going to be material & it will never make/break your portfolio. [And if you Worship The Spreadsheet (hypnotise yourself into believing you’re dealing just with figures, not money), and Forget Your Purchase Price (never include ’em in your spreadsheet…you’ll lose track averaging into everything anyway), it becomes even more of an academic exercise]. And that’s exactly what you’re aiming for…because it punctures the fear & greed, and removes it from the equation.
Since you’re too preoccupied with weighing up which stock diversifies your portfolio better, which stock’s cheaper, which stock looks better/worse technically, which stock’s got some news flow or results coming up, etc. etc. Basically, you’re busy looking for the best round peg for a round hole, and next week/month you’re looking for the best square peg, and so on… And rotating between stocks means you won’t become too anxious or attached to any of ’em up-front. [Though if you’re like Soros, buying a stock may be the best way for you to actually sit up & start paying attention]. And after a while, the buying & selling is more like investment housekeeping…the more of a habit it becomes, the more time & attention you free up to actually focus on selecting the best companies.
[Note: Averaging is not an excuse to buy falling knives – you only hear about the successes, not all the failures, far better to buy a cheap & neglected stock that’s been flat-lining for months & even years. And it’s not an excuse to end up with dozens of abandoned positions either – I don’t believe in averaging down on bad news, but having an aborted sub-3% position isn’t any better, it may be a good idea to just cut bait & move on. And as for a big loser, you may want to consider Stop Losses – sacrilege for the value purist, but ask yourself: If you’re so right, how come you’re losing so much money..?! Then again, if you have a great investment theme, Sell One, Buy Another (swap for a better/cheaper stock in the sector) might be the answer & a nice way to take some of the sting out of your loss.]
Ironically, it can also help you remain attached to stocks. Any serious investor has some kind of intrinsic value target in mind when buying a stock, and if/when it approaches that level, it can be terribly difficult holding on to the stock (esp. for value investors). While a selling discipline’s admirable, and likely sensible if it’s merely a value situation, a high quality compounder can run far longer & higher than you might ever expect. Again, fear & greed tends to play a huge role in your decision to pull the trigger (or not)… Of course, averaging out is equally a great way of defusing the fraught emotional challenge of selling stocks. [And Learn Some Voodoo (technical analysis, nothing fancy) – it really helps, one small step at a time, to get you into a stock, keep you in a stock & finally get you out of a stock].
And maybe best of all, it should eviscerate the fear & greed you feel every time you free up (or really feel like you should free up) some cash. No longer will you think of cash as a safety blanket to cling to, or a party wad that’s burning a hole in your goddamn pocket… Instead, as you average out of positions, you’ll automatically line up new/existing holdings which you’re continuing to average into – while an unexpected windfall exit (I’ve had a couple this year 🙂 ), will simply prompt you to line up steady/periodic buys to gradually run down your cash again.
[OK, I’ll address the bear in the room! If you’re really feeling nervous & can’t shake it, focus on averaging into event-driven situations instead, ‘cos you’re probably wrong & cash still ain’t the answer. But what about another crisis, you ask – well sorry, where’s the leverage, the ballooning bank balance sheets, the pervasive feeling of irrational exuberance…we’re still climbing a wall of worry!]
And big picture, it helps you lead & lag investment themes. For example, I previously nominated the US (correctly, I believe) as the market facing the strongest head-winds, due to higher valuations, the strong dollar, and the Fed’s dithering (& possible incompetence). But rather than avoid the US, or agonise over the timing of a potential buy, I think it presents the ideal opportunity to slowly but surely average into high quality US growth stocks which have already (and/or perhaps will still) suffer a temporary share price/valuation setback. [I’m buying a US healthcare stock right now, but I’m v conscious of the campaign rhetoric to come in the next year (to be quickly abandoned post-election, judging by the last 30 years), so averaging into a full position between now & next November makes the most sense to me].
Ultimately, averaging is (by far) a more pleasant way to manage your portfolio: The price goes down, you get to buy more at a cheaper price (or re-evaluate if there’s a valid/sensible reason to stop buying) – while if the price goes up, you decide how hard to chase it, but you’re already feeling happy about the gains you’re making! [And frankly, you should always try to Average Up, Not Down…because good shares generally keep rising, while bad shares keep falling! Also, it’s worth paying up for good news & fresh confirmation of your investment thesis].
And the only disadvantage here really is blog boredom…
But as I’ve always said, an investment blog should be boring, if it’s really tracking a good investment portfolio – major buys & sells come rarely, investment theses evolve pretty slowly, intrinsic values compound, and positions are ideally held for years to come. And averaging in & out of positions offers little new to write about. While new holdings can often lurk just beneath the surface, undisclosed for long periods of time – like now, for instance, as I incrementally build four/five new positions, vs. rushing to top off a single holding & publish an investment write-up. All very churlish of me, I know… Albeit often more pleasant, as I’ve described – not to mention, failed positions may never see the light of day (I simply ‘execute’ them in private), or the price runs up & in the end there’s never a good opportunity for a write-up (always a shame intellectually, though I have to admit wads more of the folding stuff tends to alleviate my distress).
When all is said & done, dear reader, I really can’t recommend an Average In, Average Out approach too highly! Courage, mes braves – give it a serious try – even if you need to adapt it to your own circumstances & preferences, I guarantee you won’t be disappointed. And as we head into a New Year (Best of Luck in 2016!), and all those around you seem to be losing their heads & setting themselves up for ridiculously daunting & aspirational goals/resolutions, why not just smile, keep on investing, and calmly inform them:
Just average is best… 😉
Thanks for the question – few ways to think about it:
With a larger portfolio, you may use a full service broker. They cost more, but a good broker should be able to pay for himself in terms of trade price/volume (if you don’t agree, a discount broker will definitely suit better). Therefore, I see NO significant drag on performance due to broker fees – in fact, if you have a reasonable holding period, it should be cheaper (for example) than investment fund fees. [NB: Assuming NO minimum broking fee, which could be a killer on any small trades you execute – I’d expect any decent broker to waive this, as he should realise he’s earning a decent fee on your trades overall.]
With a smaller portfolio & a discount broker, there’s no reason you can’t execute trades for about 10 quid a pop. So if you’re averaging in/out in (say, as low as) 500-1,000 increments on a 25-50 K+ portfolio, it would cost an implied minimum broking fee of 1-2%. This might seem heresy to some…but I think that’s still perfectly acceptable, particularly if you agree averaging in/out removes fear & greed from the equation and makes you a better investor (and again, it’s no more expensive than investment fund fees).
Below that, yes, it tends to become more problematic in terms of absolute/minimum broking fees. There’s little way ’round this – you obviously have to compromise (i.e. increase the incremental size of your trades) in terms of averaging individual stocks, but hopefully my advice is still generally helpful, while averaging into/out of a number of stocks at a time would be a useful & valuable strategy regardless.
NB: When I started out myself as an investor (with a small portfolio), I obviously faced the same problem – which meant I owned less stocks & couldn’t average in/out so easily. However, I focused primarily on investment funds at the time (being a newbie investor), so at least I could still achieve greater diversification despite these limitations. Plus, I should again stress longer holding periods can be a huge advantage (not just in terms of taxes): Generally, the better the company/investment, the longer you end up holding it – and if you hold a stock for 5-7 yrs+, for example, the broker fee to buy & to sell is obviously pretty irrelevant when you ‘spread’ it over the entire period (& far cheaper than the annual/cumulative fees you’d pay on an investment fund).
ken hutchinson said:
Thank you for a most comprehensive and informative post. Good luck on all your investments
Thanks, Ken – Good Luck in 2016!
Ken Hutchinson said:
With all this averaging in and out, don’t charges become a drag on long term performance?