The Old Two-Step

August 15, 2017

In this week’s edition of Two-Minute-Tuesday Roger gives his two-cents on the state of the markets.

How Are Your Investments Seeded?

February 19, 2015

How Are Your Investments Seeded?

The Spring daffodils poking their heads up is a clear sign the college basketball season is beginning to wind down and the celebrated NCAA Division I Men’s Basketball Tournament often nicknamed “March Madness” is right around the corner. People all over the country will be scrambling to fill out their brackets and cheer on their favorite teams.

For the uninitiated, the tournament begins with 68 teams and operates in a knockout format, concluding with just one team left standing after three emotion-filled Weeks and 67 exciting games.
It’s also the foundation for recreational office pools and bracket tournaments shared among friends and family. As these fun-loving participants fret over their brackets and debate which of their favorite teams has the talent to make it to the finals, included in everyone’s selection process is each team’s designated “seed” which shows where the team is ranked in their region and overall.

The NCAA began seeding teams in 1979 as a way to ensure that the strongest teams didn’t meet each other early in the tournament. The seeding also gives the average sports fan a starting point from which to make their picks as well.

Let’s not kid ourselves, no matter how diehard a basketball fan you are, you are also an attorney, and you don’t have time to follow 68 teams throughout the season. Further, you have no idea who those 68 teams are at the beginning of the season.

The Process

Selecting the teams you believe will advance in your bracket is biased. For instance, being born and raised in Northern Ohio I give preference to those teams in the Big Ten conference merely because those are the teams with which I am most familiar.
I can say with confidence that this is no way to make prudent investment decisions. I am not the most astute college basketball fan in the world, but I would consider myself to be somewhat knowledgeable in that arena. While the Big Ten is arguably the best overall conference in college basketball, having a “hometown” bias does not always improve one’s odds during “March Madness,” nor does it necessarily help one’s investment returns in the financial markets. The most sound investment decisions that I have ever made have been based completely on objective, (as opposed to subjective) information.

History of Games Won

With this in mind I’ll share a few observations from analyzing the NCAA brackets for the past twenty-eight years to ascertain how often those highly ranked teams win. We know that picking a number 16 seed to beat a number 1 seed is not statistically a good bet in most pools. In fact, never in history has a 16 seed beaten a 1 seed.

While past performance certainly does not guarantee future success, the data show that seeding is a helpful predictor of success. Top-seeded teams don’t always survive the test to the Final Four, but historically these teams win more than 78 percent of the games they play. A #16 seed has never won a game and the #13-#16 seeds combine to win just slightly more than 10 percent of the games they play.

Selecting teams to win the NCAA tournament is the same as picking investments for your portfolio. The intent is to identify the investments with the greatest likelihood of outperforming the overall market.
The most objective tool I have found to do this is relative strength. Incorporating relative strength into your portfolio analysis will force you to invest in the right areas of the market, (like the Energy sector from 2000 to the middle of 2008). But possibly, and more important, relative strength will force you to get out of investments that aren’t working, (like the Equities market in early 2008).
So don’t scoff at the person who fills out brackets based entirely on seeds. They’re playing the percentages, Whether or not they realize it. This goes a long way to explaining why the winner of the office pool is usually the person who knows little or nothing about basketball. (Chances are, it’s also the person everyone else turns to for help with the photocopier or retrieving voicemail messages).
No matter what method you choose to complete your bracket, enjoy the Tournament. It truly is the Mardi Gras of American sporting events year after year.

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Roger S. Balser is the Managing Partner and Chief Investment Officer of Balser Wealth Management, LLC with more than twenty-five years experience. He works one on one with individuals to help regain control of their investment and retirement portfolio(s). Roger’s addressed a host of professional organizations nationwide and weekly give his two cents on the popular “Two-Minute-Tuesday.” If you have any questions about the particulars of your investment portfolio or retirement plan at work, or would like to discuss potential opportunities within the equity market, please contact Balser Wealth Management, LLC, 36873 Harriman Trail Avon, OH 44011, 440-610-3012, roger@balserwealth.com

Roger S. Balser

Out With the Old, In With the New: Themes For 2015

December 19, 2014

Out With the Old, In With the New: Themes For 2015

The question I’m most often asked at the beginning of each year is, “Where do you seen the Dow Jones Industrial Average heading this year?” The new year always brings wild predictions from “experts” who have allegedly figured out what this market is going to do.

Some people have developed theories that the Dow Jones Industrial Average will close the year above 20,000, while others are positive that the market is doomed to fail, so it would be better to pack up and pull out. And the financial pundits and news media appear to be trying to tell the market what to do as opposed to listening to what the market is telling us.

I understand that all of this can leave you with knots in your stomach, unsure of which way to turn. In situations like this, it’s easy to throw in the towel, dump your entire portfolio and sit with the cash. However the idea that buying nothing, or standing on the sidelines playing it “safe” is completely misguided.

Listening to all the predictions can leave your head spinning. It’s why I don’t make predictions on where the market is going. In truth, I’ve embraced the words of a great American financier, John Pierpont Morgan, who, when asked what he thought the market would do — prompting people to move to the edge of their chairs in anticipation — simply responded, “It Will Fluctuate.”

The cold hard truth is I have no idea what the market will do in 2015. Santa did not bring me a Magic Eight Ball for Christmas much less a crystal ball. But the best gift I’ve been given is a set of indicators that tell me whether supply and demand is in control of the overall market, sectors and individual stocks. Using these instruments one can navigate just about any type of market. And while I’m hard-pressed to make market predictions, these indicators allow me to piece together a helpful list of “themes” for the coming year.

Develop a Discipline

In the past 29 years I’ve learned to follow the “Point and Figure” methodology, which is entrenched in the irrefutable laws of supply and demand. While the idea of charting price changes each day may seem simplistic, it reminds me of a quote from George Washington who opined, “Discipline is the soul of an army. It makes small numbers formidable; procures success to the weak, and esteem to all.”

With all of the financial data available at our fingertips, the daily high and low is a “small number.” The same is true of a relative strength calculation. But the self-discipline to apply these principles makes them very formidable. For instance, those small numbers let us know that the U.S. housing industry was beginning its recovery back in November, 2011. The numbers let us know the healthcare sector demand was coming back in July of 2012. More significantly they signaled to us to divest our portfolios of all stocks in November, 2007 and not reinvest in U.S. equities until March, 2009. It always was and always will be the power to understand — and the ability to act — that turns information into profits.

You Must Remain Agile

In 2001 I advocated that we were in a “Structural Fair Market” in which there could be several periods where the market could run up 20% and several periods when the market could drop 20%. And when the dust settles you’re usually right back where you started. And that is essentially what happened. If you’ve were a buy-and-hold investor you made no progress toward increasing your portfolio’s value and yet you are twelve years closer to the day when you will need the money.

In March of 2013 our stance changed and we entered a “Structural Bull Market.” This does not mean the market will move straight up. What is does mean is that the emotional sell-offs will be followed by terrific rallies.

For the investor who is prepared to move with the tide, you’ll be able to take advantage of big up-moves in the market and avoid the pitfalls that really put an account behind the eight ball.

Leadership Will Change

Just as produce in the supermarket rotates in and out of season, so do trends in the markets. There is a reason you feast on corn on the cob and fresh watermelon slices at your July 4th picnic and have pumpkin pie for Thanksgiving. In your portfolios you must be prepared to rotate as well.

One example of the influence that sector rotation can have on your portfolio is a hypothetical study. In this study four different equity strategies were used: Buy and Hold, Perfect Market Timing (each year), Buying the Best Performing Sector (each year), and Buying the Worst Performing Sector (each year).

The first investor is Mrs. Buy and Hold. She just buys the Standard & Poor’s 500 and keeps her investment in a safe deposit box where it never changes. Our second investor, Mr. Perfect Market Timer, is only invested in the S&P 500 when it has a positive return. Our last two investors are sector investors, one of which is clairvoyant enough to know each and every year what the best performing sector is going to be for the year, and subsequently places 100% of their portfolio in that sector. The fourth investor is an unfortunate person as he manages to find the worst performing sector each year.

As you might imagine, each of the investors had markedly different results from their initial investment of $10,000 back in 1993. Mrs. Buy and Hold shows a portfolio value of $42,422 through 2013. Mr. Perfect Market Timer has a portfolio value of $1,495,760. Ms. Best Sector Timer has seen her portfolio grow to $2,671,726! All while Mr. Worst Performing Sector Timer’s portfolio plummeted to $908.

To put it another way, the average annualized return for the Buy & Hold strategy since 1993 has been 7.12%. Mr. Perfect Market Timing is 26.93%. Ms. Best Sector Timer is an amazing 30.49%. And on the other side of the coin, the average annualized return for Mr. Worst Performing Sector Timer’s portfolio is a -10.80%.

Please keep in mind I am not recommending that you put all your money in one sector. I’m just attempting to show you the gap between the best and worst performing sectors each year and the opportunities available if you utilize the tools available to rotate between sectors.

LOOK FORWARD NOT BACKWARD

We all make mistakes. I hate to make a mistake as much as anybody, but no one is perfect. However, we all become better people if we learn from those mistakes. Don’t worry about 2014 if your investment portfolio severely underperformed. If you made some mistakes with your account, look at it as a learning experience. Gain some knowledge from it. If 2014 was a good year for your portfolio, think about what you did different from the previous year to make it better.

Think of what you actively did to help make it a good year and try to do more of it. Try to ACT don’t REACT. Don’t let things happen to you; you should make them happen yourself. Be proactive, not reactive. THINK AHEAD. CNBC and Bloomberg Business will tell you what’s happened. You need to think a few moves ahead.

It truly does not matter what the market holds for us in 2015. As Yogi Berra, one of the all time great catchers in baseball, said, “You can observe a lot just by watchin.”

The market is the same way. There are so many sophisticated computers out there that can make hash out of any equation Einstein could think up, but it’s the investor who simply pays attention to a few basic indicators, keeps it simple, and adheres to a logical, organized plan that does the best.

Two Key Rules of Market Engagement

Rule #1: Don’t Lose.

Investing is truly not a business of hitting grand slams. It’s a business of avoiding substantial reductions in capital.

This is contrary to how most of us are stimulated by advisors and firms. Investment firms are always coming up with their lists of investments that will double or triple in value over a relatively short period of time.

All you need to do is align your portfolio to what Albert Einstein referred to as one of the mathematical mysteries of the universe. And we all know that Albert Einstein was a pretty fair mathematician.

The mystery that Albert Einstein was referring to was the power of compounding. And the only thing that destroys the power of compounding is the loss of principal.

It would serve you well to have in place a discipline to recognize and trigger action at “unacceptable levels” of capital loss.

Rule #2: Take Losses.

You may be thinking, “Wait a minute Roger, first you say don’t lose, now you are saying take losses.”

Why?

I will be wrong.

We live in a world of probabilities and possibilities.

That is the way it is.

The unsuccessful advisors assume they will never be wrong.

Successful advisors understand that they will be wrong.

We have as part of our investment strategy a discipline that keeps us from pursuing disasters over long periods of time.

That keeps us from having an emotional attachment to any investment. It allows us to say what is, is. I was wrong. Here is what we should do about it.

It is counter-intuitive.

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Two-Beers, One Napkin and a 401(k)

May 1, 2013

Two Beers, One Napkin and a 401(k)

What would you do if you found out your investment was earning 1% a year? Would you review your investment and make some changes or would you take a “wait-and-see” position?

The reality is that lots of good folks are sitting idly while their retirement plans wallow. The tragedy is that a good portion of these folks aren’t even aware of just how badly their plans are performing, or even worse, that they have the ability to alter their plans with some basic information.

Here’s a discussion I had in early 2013 with a close friend that proves my point.

Enjoying a couple of beers after a round of golf, my friend, Steve, boasted how much his retirement plan had grown over the past 13 years. Steve said he began with $50,000 in his plan and now his account was over $282,000.

Surprised at those impressive numbers, I inquired how my friend succeeded at his realized gain of $232,000.

Grinning from ear to ear like the Cheshire Cat in Alice in Wonderland, Steve told me, “I bought the Standard and Poor’s 500 Index (S&P500) at the end of 1999 and just left it there. I’m a ‘long term’ investor, you know.”

Being a veteran player in the investment game, Steve’s statement naturally peaked my curiosity. Since 2000 there have been a host of sharp downward movements in the market. From the Asian flu epidemic to the tech bubble, Enron fiasco, 9/11, The Great Recession, the 2009 Economic Recovery that never was, and finally the European Debt Crisis, I was struggling with the notion that my friend could have discovered gold in down markets.

So I grabbed a napkin and a pen and asked Steve if we could demonstrate just how he did it. I told him to write $50,000 in the top left hand corner of the napkin and $282,000 at the bottom right corner. Then I asked, “Steve how much did you add each year in contributions to your retirement plan?”

“$15,000 every year,” he proudly replied.

“For all 13 years?” I inquired.

“Yep.”

I instructed him to multiply $15,000 by 13, and write the total in the center of the napkin.

He jotted down $195,000, thought for a minute and shrieked (and it wasn’t a very manly shriek), “Wait! $195,000 of my ‘gain’ was my own money — from my paycheck? That makes my real gain just a measly $37,000 after adding my own contributions.”

And without my prompting, Steve then divided his $37,000 gain by 13 years, and sheepishly wrote down $2,846.

“Steve, I estimate you’ve earned a little over one percent a year,” I said, feeling kind of sorry that I had initiated this little exercise.

While my friend motioned the bartender over for another beer he looked down and asked, “Roger, there’s no way I can retire if I keep this up, is there?”

“It’s going to be difficult,” I answered. “In hindsight, you would have been better off in a money market account and experienced a lot less volatility.”

“So is there a way I can be smarter about what I buy and when I buy it,” he begged?

“I think there is, Steve,” I answered. “Are you aware that there are two Standard and Poor’s 500 indexes?

I was referring to the investment vehicles that contain the same 500 stocks, but are bundled differently, are traded differently and produce different returns. One is “capitalization weighted” and the other is “equal weighted.”

The S&P 500 Index (SPX) is capitalization weighted in a way that is similar to how the U.S. Congress is weighted. The most populated states have the most representation (Congressmen) and the smallest states have the least. California has more votes than Rhode Island. The capitalization weighted S&P 500 gives most of the votes to the biggest stocks like Exxon Mobil.

Conversely, the equal weighted S&P 500 Index (RSP), gives an equal vote to every stock in the 500, similar to the U.S. Senate. In the Senate every state has two Senators. Rhode Island has just as many as California and Texas. So they have equal votes in the Senate.

Back in 2000 I began to explore exactly how these two markets traded. I ran a calculation called Relative Strength, which basically compared the capitalization weighted S&P 500 (Congress) to the equal weighted S&P 500 (Senate), to determine where to place investment dollars.

For the first time in more than seven years it revealed that the Senate was the place to be. To me this was huge news. But oddly enough, the major business media like Fox News, CNBC, The Wall Street Journal, Investor’s Business Daily never picked up on the story. And still today the business media only talks about the capitalization weighted S&P 500. When this reversal occurred it signaled a major change in our investment posture.

To make Steve even more depressed, I pulled out my iPad and demonstrated that from the beginning of 2000 to the end of 2012, the SPX was down close to 3% while the RSP was up nearly 89%.

“So why didn’t the retirement guy at my company tell me about this?” Steve asked. “Isn’t he supposed to be helping us?”

“Because that guy’s not paying attention,” I explained. “Most investors and their advisors are just riding the train and staring out the window at the pretty scenery. If they were paying attention you’d be in a much better position.”

The moral to this sad story is that you shouldn’t assume the company guy or your advisor is keeping an eye on your investments. The moral to this sad story is that you shouldn’t assume the company guy is keeping an eye on your investments. You’re the best person for that task. You see, investors with advisors who pay attention to their investments generally are the ones who make out a little better.

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Benefits of Position Sizing

July 19, 2012

Benefits of Position Sizing

The recent financial markets have been tough, to say the least. Some things that worked the first part of the year stopped working weeks later. Other segments of the market have experienced tough sledding for a year or longer. In summary, it has been hard to gain any traction with a lot of your investments.

But we must play the hand we are dealt. Right now that hand is one that offers short-term (and sometimes fleeting) gains. In other words, there are small pockets or sectors where things are working, but our time horizon needs to be adjusted. We can no longer focus on the intermediate or long term rather we must focus on shorter term trading moves to grow your balances.

The most important aspect of any portfolio has always been position sizing, but it is crucial in this environment. Once we decide to buy a stock or ETF, we need to establish three control parameters entry price, position size and a logical point to exit the position if the trade goes against us. Does this really matter? Absolutely. Without properly assessing these three parameters upfront, we have no way of minimizing position risk while maximizing the account value. So today I wanted to go over my preferred method for sizing positions. It’s called the Percent Risk Method, and it works for trading accounts and longer term investment accounts.

The Percent Risk Method

First, we look only at positions that fit our risk-based criteria using Point and Figure charting. Let’s say you have a $500,000 investment or retirement account. Depending on the type of market we are in, we would choose position sizes ranging from 1⁄2% to 2% of your total portfolio value. As an example, let’s say we agree to use a 1% risk tolerance per position in your account. This means that each position will be sized so that the risk to your overall portfolio is no more than 1% of your $500,000 account. One percent of $500,000 is $5,000; so that will be our risk for the first position.

So let’s now approach that single position based on our calculated risk. In this example we will use our old favorite XYZ. Since we know (or can determine) our stop loss point for our trade in stock XYZ, we would determine the distance from our entry point to our stop loss point (risk to stop), and then divide that into our $5,000 risk for the position. The resulting value will be the number of shares that we can purchase to stay within our 1% risk tolerance.

Here’s an example: XYZ is trading at $49 on its trend chart, and we determined that this is a reasonable investment to consider. We have a pattern that would suggest exiting at $45. Our entry price would be $49, and our risk on this trade is $4 ($49-$45, our stop).

We now divide our $5,000 risk for this position by our $4 risk per share to give us a position size of 1250 shares. So if we buy 1250 shares of XYZ, and get stopped out with a $4 loss, you would lose $5,000 – which was your original risk tolerance for this. Naturally, as the distance to your stop loss point decreases, your share size will increase; conversely, the opposite will occur when you are considering stocks trading further from your stop point — the number of shares purchased decreases.

So again, with the percent risk model that we used, the most that is ever risked per trade is 1% of the account value at the time the trade is made. (So you mark the account to market each day before you can figure out what the 1% risk would be for any subsequent trades.) The main rule to adhere to with this method is that you must respect your stop points. Remember, your position is sized as a function of the risk to the stop point. So if your stop point is hit, you must stop out, or obviously will risk losing more that the previously decided 1%.

But the beauty of the percent risk method of position sizing is how much it can enhance your returns. If you have a large position in an individual security (and therefore the stop point will be tight), and that trade works out in your favor, it will add considerable money to the bottom line vis-à-vis a smaller position, all while risking the same as any other trade.

Another fundamental benefit of this approach is that it helps us deal with emotions. The Percent Risk model takes some of the emotional influence out of the process by forcing you to make smaller ‘bets’ when the market dictates, and forcing you to make sequentially equivalent bets on each trade. When the market is on offense, we would typically suggest taking a 1% position in every trade, regardless of how bullish your emotions are telling you should be on any single trade. This keeps any single position from beating you, and allows for the trading system to work based upon its own merit. Finally, the often-difficult, emotion-ridden decision of when to sell has been pre-determined when you go into the trade. The key, though, is to adhere to your pre-determined stop.

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