Investment Strategy: The Investor’s Creed Revisited

Fascinating, aren’t they, these security markets of ours, with their unpredictability, promise, and unscripted daily drama. But individual investors themselves are even more interesting. We’ve become the product of a media driven culture that must have reasons, predictability, blame, scapegoats, and even that “four-letter” word, certainty.

We are becoming a culture of speculators, where hindsight is replacing the reality-based foresight that once was flowing in our now real-time veins. Still, the markets have always been dynamic places where investors can consistently make reasonable returns on their capital. If one complies with the basic principles of the endeavor and doesn’t measure progress too frequently with irrelevant measuring devices, growth in working capital, market value, and spendable income are quite likely to happen… without undue risk taking.

The classic investment strategy is so simple and so trite that most investors dismiss it routinely and move on in their search for the holy investment grail(s): a stock market that only rises and a bond market capable of paying higher interest rates at stable or higher prices. This is mythology, not investing.

Investors who grasp the realities of these wonderful (speculation driven) marketplaces recognize the opportunities and relish them with an understanding that goes beyond the media hype and side show “performance enhancement” barkers. They have no problem with the “uncertainty”; they embrace it.

Simply put, in rising markets:

  • When investment grade equity securities approach the “reasonable” target prices you have set for them, realize your profits, because that’s the “growth” purpose of investing in the stock market.
  • When your income purpose securities rise in market value the equivalent of one-year’s-interest-in-advance, take your profits and reinvest it in similar securities; because compound interest is the safest and most powerful weapon we investors have in our arsenals.

On the flip side, and there has always been a flip side (more commonly dreaded as a “correction”), replenish your equity portfolio with now lower priced investment grade securities. Yes, even some that you may have just sold weeks or even months ago.And, if the correction is occurring in the income purpose allocation of your portfolio, take advantage of the opportunity by adding to positions, increasing yield and reducing cost basis in one magical transaction.

  • Some of you may not know how to add to those somewhat illiquid bond, mortgage, loan, and preferred stock portfolios quite so easily. It’s time you learned about closed end funds (CEFs), the great “liquidators” of the bond market. Many high quality CEFs have 20 year dividend histories for you to salivate over.

This is much more than a “buy low, sell high” oversimplification. It is a long-term strategy that succeeds… cycle, after cycle, after cycle. Do you wonder why Wall Street doesn’t spend more time pushing its managed tax free income, taxable income, and equity CEFs?

  • Unlike mutual funds, CEFs are actually separate investment companies with a fixed number of shares traded on the stock exchanges. The stock can trade (real time) above or below the net asset value of the fund. Both the fees and the net/net dividends are higher than any comparable mutual fund, but your advisor will probably tell you they are more risky due to “leverage”.
  • The leverage is short term borrowing and is absolutely not the same as a margin loan on the portfolio. It’s more like a business line of credit or a receivables financing tool.

I’m sure that most of you understand why your portfolio market values rise and fall throughout time… the very nature of the securities markets. The day to day volatility will vary, but is generally most noticeable surrounding changes in the longer term direction of either market, income purpose or growth purpose.

  • Neither your “working capital” nor your realized income need be affected by the gyrations of your market value; if they are, you are not building a “retirement ready” portfolio.

So rather than rejoicing through each new stock market rally or lamenting each inevitable correction, you should be taking actions that enhance both your working capital and its income productivity, while at the same time, pushing you forward toward long term goals and objectives.

  • Through the application of a few easy to assimilate processes, you can plot a course to an investment portfolio that regularly achieves higher market value highs and (much more importantly), higher market value lows while consistently growing both working capital and income… regardless of what is happening in the financial markets.

Left to its own devices, an unmanaged portfolio (think NASDAQ, DJIA, or S & P 500) is likely to have long periods of unproductive sideways motion. You can ill afford to travel eleven years at a break even pace (the Dow, from December 1999 through November 2010, for example), and it is foolish, even irresponsible, to expect any unmanaged approach to be in sync with your personal financial objectives.The Investor’s Creed

The original “Investor’s Creed” was written at a time when money market funds were paying above 4%, so holding uninvested equity bucket “smart cash” was, in effect, a compounding of profits while waiting for lower equity prices. Income bucket cash is always reinvested ASAP. Since money market rates have become minimal, equity “smart cash” has been placed in tradeable equity CEFs with yields averaging over 6% as a replacement… not as safe, but the compounding makes up for the increased risk over money funds.

It sums up several basic asset allocation, investment strategy, and investment psychology principles into a fairly clear, personal portfolio management direction statement:

  • My intention is to be fully invested in accordance with my planned equity/fixed income, cost based, asset allocation.
  • Every security I own is for sale at a reasonable target price, while generating some form of cash flow for reinvestment.
  • I am pleased when my equity bucket cash position is low, signaling that my assets are working hard to meet my objectives.
  • I am more pleased when my equity bucket cash is growing steadily, showing that I’ve been capitalizing all reasonable profits.
  • I am confident that I’m always in position to take advantage of new equity opportunities that fit my disciplined selection criteria.

If you’re managing your portfolio properly, your cash + equity CEF position (the “smart cash”) should be rising during rallies, as you take profits on the securities you confidently purchased when prices were falling. And, you could be chock full of this “smart cash” well before the investment gods blow the whistle on the stock market advance.Yes, if you are going about the investment process with an understanding of market cycles, you will be building liquidity while Wall Street is encouraging higher equity weightings, while numerous IPOs are taking advantage of euphoric speculative greed, and while morning drive radio hosts and personal friends are boasting about their ETF and Mutual Fund successes.

While they grow their hat sizes, you will be growing your income production by holding your income purpose allocation on target and salting away the growth purpose portion of your profits, dividends, and interest in an equity based alternative to “de minimis” money fund rates.

This “smart cash”, comprised of realized profits, interest, and dividends, is just taking a breather on the bench after a scoring drive. As the gains compound at equity CEF rates, the disciplined coach looks for sure signs of investor greed in the market place:

  • Fixed income prices falling as speculators abandon their long term goals and reach for the new investment stars that are sure to propel equity prices forever higher.
  • Boring investment grade equities falling in price as well because it is now clear that the market will never fall sharply again… particularly NASDAQ, simply ignoring the fact that it is still less than 25% above where it was nearly twenty years ago (FANG included).

And the beat goes on, cycle after cycle, generation after generation. Will today’s managers and gurus be any smarter than those of the late nineties? Will they ever learn that it is the very strength of rising markets that, eventually, proves to be their greatest weakness.Isn’t it great to be able to say: “Frankly Scarlett, I just don’t care about market directional changes. My working capital and income will continue to grow regardless, possibly even better when income purpose security prices are falling.”

My articles always describe aspects of an investment process I have been using since the 1970’s, as described in my book, “The Brainwashing of the American Investor”. All the disciplines, concepts, and processes described therein work together to produce (in my experience) a safer, more income productive, investment experience. No implementation should be undertaken without a complete understanding of all aspects of the process.

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