(CC image by Jim Linwood on Flickr)
Have you ever been to one of the world’s financial centers – London, New York, Hong Kong, Chicago, to name a few – and seen the huge glass-walled towers full of luxury offices?
When you hear about the massive salaries and bonuses being paid to the high-ranking people inside those offices, which house companies like Goldman Sachs, JP Morgan, Morgan Stanley, Lehman Brothers (rest in peace), Bear Stearns (another RIP, maybe they’re not so smart after all?), PIMCO, Wellington, Edward Jones, and so many more – how does it make you feel?
Certainly, these firms perform many useful functions for large institutional investors, who must maintain portfolios full of thousands of individual securities and file tons of paperwork.
But what about the office down the street in your town? The branch office that handles the accounts of high net-worth individuals, corporate middle managers, hard-working entrepreneurs and diligent savers from all walks of life. They work in the brand-new building, drive around luxury cars, and advertise constantly on TV. They must be doing something really hard to earn all that money, right?
What if I told you that they’re not doing a single thing you can’t do, if you have only:
- A computer or tablet,
- The ability to listen to podcasts (a shameless plug for our podcast!) at some point during your week, like during your commute,
- A minimum of 1-2 hours per week to review your investments (or only per quarter, if you prefer a more “hands-off” approach).
The more time and dedication you’re willing to put in to building these skills, the better your results will be, of course. But even with just the basics, you can do most of what the “professional” advisors down the block are doing, and you can do it for a much cheaper price.
Even if your portfolio is as high as $10 million, this is within your reach. You can learn it, and you don’t need to be a math whiz to do so.
Let me illustrate.
The Five Components of Successful Investing
This is the approach I developed to manage my own assets, which I accumulated across 10+ years of working in the corporate world. Although I’ve developed advanced analytical tools to perform each one of these steps, this is the overall process I follow. You can do it too.
Each step will be the foundation for lots and lots of future podcasts and posts. For now, I’ll introduce the topic by giving just a brief outline of each step.
1. Determine why you’re investing.
Is your goal to have a secure retirement? To save for your kids’ college? To leave a legacy for future generations? To become filthy rich and own 5 Lamborghinis? No matter how ordinary or ambitious the goals, you need to know what they are.
Your goals impact your risk tolerance as well. I like to distill the concept of risk tolerance to one sentence to make it easier to think about. “If my net worth went down by [X%] in a short period of time, I would get very worried about my investments.” Fill in the [X%] for yourself, it is a personal choice. Yours might be as low as 2%, or as high as 100%!
Lastly, figure out your liquidity reserve. That is, how much money you must keep safe and secure because you might need it in the not-too-distant future. This is an emergency fund for job loss or, if you’re self-employed, a downturn in your business. Three months, six months, or a year of expenses are common amounts. Add on any big expenses you know are coming up soon, like a car purchase or down payment on a house. The total is your liquidity reserve, or how much you absolutely must keep away from potential risk.
2. Develop long-term forecasts.
When it comes to forecasting, you can do all of the work yourself, rely on outside resources like Torpedo Trading, or fall somewhere in between the two extremes. If you want to develop your own forecasts, you could mimic my comprehensive approach. I developed my forecasts using: historical returns adjusted for long-term cycles, volatility assumptions, and correlation matrices. If not, it’s much simpler to tune in to the podcast and follow the blog since you will find the results of all this hard work there, for free! Alternatively, you could make your own forecasts based on independent research, talking with other investors, your favorite advisory services, astronomical cycles, or whatever you heard on CNBC yesterday. (OK, not the last two examples.)
I re-evaluate my forecasts about once per quarter, sometimes sooner if there is a major shift in market conditions for a particular asset class. Trends I define as long-term usually last 10 years or more, so they will not change much.
I chose about 25 asset classes in total, including: the 11 stock sectors, gold, oil, corporate bonds, Treasury bonds, and others. You could use as few as 6 to 8 and get decent coverage of the investing spectrum.
Once you have a forecasted return and volatility level for each asset class, just put all your money into the one with the highest forecasted return.
JUST KIDDING! That’s NEVER a good idea because of something called correlation. Quite simply, correlation is the tendency for two asset classes to move up or down at the same time. Even if you think bonds will have a lower return than stocks, you still want to include some bonds because they offer you diversification. During a year in which stocks drop 25%, bonds may lose only 5% or even go up in value. You might not have sufficient risk tolerance to take a 25% loss, but could absorb a smaller loss.
If you don’t want to be checking your portfolio or trading weekly or monthly, stop here! Your plan looks like this instead, a shortened version of the one from earlier in this post:
Simply keeping your asset allocation in line with the long-term targets will put you in good position for long-term gains. Once you’re confident in steps 1 and 2, it’s also enough to feel comfortable putting your advisor out of a job!
On the other hand, if you like to trade and you want the best plan, read on!
3. Develop intermediate-term forecasts.
By intermediate-term, I mean around 6 to 14 months. I find that to be the typical trend length in most markets.
Intermediate-term cycles operate within longer-term trends, which last from several years to decades. Aligning yourself with intermediate-term cycles takes more work and involves more risk than simply tracking the slow-moving long-term trends, but offers tremendously higher rewards.
I use a form of intermarket analysis that I developed with inspiration from an acclaimed book by John Murphy. I also use a few other advanced technical tools to identify likely turning points. More info on my approach can be found in this blog post.
You’ll use these intermediate-term forecasts to flex your asset allocations up or down from their long-term targets. For example, you might have set a long-term allocation target of 50% for stocks, but your risk tolerance and goals permit you to vary that percentage in a range between 30% and 70%. If you’re forecasting an intermediate-term rise in stocks, you would increase your stock holdings towards 70%. When your forecast changes, anticipating a drop in stocks, you would begin selling stocks down to 30% of your total portfolio.
My current intermediate-term targets (some asset classes have been grouped together here, like all the stock sectors). I’m not bullish on stocks or bonds right now.
4. Be aware of short-term market moves.
Notice I don’t say “develop short-term forecasts” or “watch charts every single day” here. This would be a full time job by itself. We’ve all got a life to live!
I’m not opposed to day trading, but it’s foolish to be playing tiny moves in an hourly or shorter chart unless you’ve already got extremely sound intermediate-term and long-term forecasts. Those moves will always dwarf the short-term oscillations.
If you’re under- or over-weighted in an asset class based on the intermediate term forecast, you’ll be trying to increase or reduce your position in that asset class. Simply be aware of whether the last few days have trended down or up so you’re buying on a dip or selling on a pop.
I use my live stream and YouTube channel, both of which are free to watch, to keep viewers up-to-date on the latest developments in the financial markets. Please consider subscribing to be updated when I release new content on those platforms.
5. Choose what you’ll buy and sell from each asset class.
I call this step “mapping your investment universe”. Learn how it works and see an example here.
I usually recommend the major ETFs because they’re liquid and cost-effective.
It’s certainly appropriate to pick individual securities instead of ETFs here, wherever you feel comfortable doing so. For example, maybe you work in the health care sector so you keep up on the trends in that area. Or perhaps you love the latest tech products, and you’ve got a good lead on what will be hot and what won’t.
As part of this step, you’ll also want to consider whether options (calls or puts) are appropriate for you or not.
At Torpedo Trading, we maintain a list of preferred ETFs for each asset class. The list changes from time to time as the fund companies make changes or add new funds. This list will be provided to members once our membership program goes live.
More to Come
Stay tuned for future podcasts and posts that will dive much deeper into each of the steps above. I hope this post will serve as a helpful reference for the overall process and how it works.
I’m here to help you take control of your investments, and avoid being gouged by expensive advisors. This framework will set you on the path towards success.