Chicken Investing

04/04/2003 12:00 am EST

Focus:

Steven Halpern

Editor, thestockadvisors.com

If longevity is a testament to quality then Dow Theory Forecasts, with more than four decades in this industry should speak worlds. The organization publishes The Pure Fundamentalist, DRIP Investor, and its famous forecast service. This is done under the name Horizon Publishing and here, editor Chuck Carlson indeed sees a clearer horizon for those ready to step back into the markets.

 

Step 1 – Get a Bigger Boat

 

"This is a metaphor I use for the market after taking my family fishing in rough seas during which we all got ill. Of course, one reason we all got sick was that we had a very small boat. Had we been on a bigger one, the rough waters wouldn't have felt so rough. This analogy holds for investing in stormy markets. The bigger your boat, the more likely you are going to ride through the storm without getting sick, How do you create a bigger boat? First, you need to make sure that your investments are diversified across asset classes - stocks, bonds, and cash. This is probably the most important step you can take in any investment program, yet it is one that most fail to do.

 

“What determines the proper asset allocation? Your age and investment time horizon are two important factors. Also, your risk tolerance and other financial responsibilities must be taken into account. One rule of thumb that has worked pretty well is to subtract your age from 110 and set that as the amount of stocks in your portfolio. Under this rule of thumb a 55-year old would have roughly 55% of their assets in stocks and say, 30% in bonds, and the balance in cash. While not all 55-year olds are alike, this rule provides a good starting point.  In addition, if one wants a proven all-weather allocation mix that tends to work well, we suggest the time-tested 67% stocks, 25% bonds, and 8% cash.

 

“The second part of building a bigger boat is through diversification within asset classes. Your portfolio may hold 25 tocks and five funds, but if they hold the same well-known growth stocks you won’t have the diversification you seek. Your overall portfolio should hold seven general groups - large-cap, mid-sized, small-company growth, large-company value, mid-sized value, small-company value, and international.  Why would you want so many styles? Simple. Nobody has the perfect crystal ball that says what investment style will be in favor at any point in time. While it may be impossible or impractical to cover all these styles in all portfolios, an investor should endeavor  to create a portfolio that is as broad  as possible when diversifying within asset classes.

 

“Now I realize that diversification is a risk-controlling strategy, which means it also limits potential upside. Remember, risk and reward are joined at the hip. You cannot achieve higher expected returns without assuming a higher level of risk, and vice versa. However, remember, the title of this article is Chicken Investing. What we are discussing here is a strategy for weathering volatile markets, not a strategy for hitting investment home runs.

 

Step 2 – Don’t Be Afraid to Sell

 

“Perhaps the hardest part of an investment program is knowing when to sell. But just because it is a difficult decision, doesn’t mean we can simply ignore selling in the investment process. To be sure, I am a long-term investor and would rather buy and hold a stock as opposed to trading frequently to generate gains. Having said that, the world is changing and what may have been a good decision one or two years ago may not be the right decision today. Thus to cope with volatile markets, we must not be afraid to sell stocks when appropriate.

 

“How do we know when to sell? To answer that question, you really must know why you bought the that stock in the first place. If you bought a stock simply because it was going up – known as momentum investing – and it made money, then you should sell when the investment starts to go down. Such a strategy is perfect  for protective tops where you automatically sell a stock when it falls to a certain point. Meanwhile, if you bought a stock because you like the company’s consistent track record of earnings and growth, you should consider selling when the firm’s track record is not so pristine. Again, if you know why you bought you will have a better handle on knowing when to sell.

 

Step 3 – DRIP-Toe Into the Market

 

“Yes, I know it’s hard to put money into stocks when they are falling. But I also know that stocks are a lot cheaper today than they were three years ago.  And what are you doing? Probably nothing. That is usually the way it is when markets decline. When stocks are falling, nobody wants them because you think they will get cheaper. The problem is that that makes it very difficult to get back into the market.. If stocks are falling, you wait for lower prices and when they rally, you don’t want to chase prices. Consequently, you may never buy. And that’s unfortunate since now is the when you can buy good stocks on sale.

 

Another way to invest in volatile markets is via DRIPs – our personal specialty. Because DRIPs allow you to invest relatively small amounts of money in blue-chip stocks, investors can keep funneling money into the market in amounts that still allow them to sleep at night.  Bottom line: volatile markets provide the perfect time to slowly build equity positions. All you need to do is to take advantage of these plans.

 

Editor’s Note: While much of the news has rightfully been focused on Iraq, the Bush administration has proposed a number of individual savings plans that fit in line with the comments shared above.  Individuals should follow these developments, and we will likewise try to keep you informed on upcoming legislation.

 

Step 4: Easy Holds

 

Personally, I believe that if you tend to buy and hold stocks for the long term, you are better off focusing on stocks that won’t require you to make too many decisions.  Easy holds are those companies that have a history of steady operational performance, solid finances, decent relative strength during both up and down markets, and reasonable valuations. Over time, these types of stocks should provide steady, reliable returns for investors. Hopefully, one thing we’ve learned over the last three years is that investing is not easy. That’s why it is important to develop strategies to be proactive during all market environments. This simple four-step plan is everything you need to weather the current market climate and position your portfolio for better days down the road.”

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