Those of you that follow this blog know that I am also a private investor that uses various investment tactics to supplement my retirement income. Although I won’t give out individual investment choices, I will share with you some of the different strategies I have used and reused over the years. Prior to the early March onset of the Iran War, I changed some of the tactics I was using in favor of those likely to be impacted by increased volatility brought on by the current administration.
Core Investments: The core portion of my portfolio constitutes the vast majority of the total. It has been centered around income generating stocks, including master limited partnerships, real estate investment trusts, and business development companies. I have not invested in either bonds or preferred stocks in several years, but have had good returns from regular dividend-paying equities. Some of the best paying stocks were business development companies (BDC’s) in the Finance Sector, with payouts in double digit percentages that included some bonus payouts. But the risks of these investments began to rise as the BDC’s invest primarily in private equity and loans which are not disclosed to investors and make the stock more difficult to evaluate. Over the last twelve months or so news reports pointed out the risks and some of the problems that the sector was facing, and a long, slow, downward slide of these stock’s values began to materialize. When this happened, I decided to underweight these holdings and then liquidate them outright to prevent any other losses. As I built up the cash from this rotation out, I noticed that the energy sector looked to be under-valued. So, in matter of a few weeks, I moved in and selected several stocks primarily in the midstream portion of crude oil processing. The midstream companies include storage facilities, pipelines, water removal, and liquid natural gas processing (LNG). Then came the Venezuela maneuver followed by the Iran War, and the price of crude oil nearly doubled overnight and remains at ultrahigh levels. The rise or fall of most equities in the sector is tied to the price of crude oil—crude climbs, the price of energy stocks climbs and vice-versa if it falls. And they have nearly always been great dividend paying stocks. Some are master limited partnerships which give shareholders a higher return owing to a tax benefit that keeps the dividend (derived from partnership income) from being taxed twice: once by the company and again by the shareholder. I further picked up a few real estate investment trusts (REIT’s) that have a similar tax advantage and likewise pay good dividends.
Long/Short Game: Taking advantage of the artificial intelligence (AI) boom is something that I wanted to do but could not adapt a useful strategy since a large number of AI equities were not doing really well and not many of the ones that were doing well paid worthwhile dividends. So, I looked into reviving the long/short game I was playing a number of years ago whereby I would invest simultaneously in long positions followed by short positions as the markets moved up and down. This highly risky strategy proved to be a good fit with the volatility of some of the lesser known, AI related stocks accentuated by the Iran War and the accompanying volatility of risk-on versus risk-off investing. During risk-on, investors will pour money into more risky ventures that lack a track record of success. This phenomenon is noted by sharp increases to the NASDAQ index that tracks most tech-heavy equities. Risk-off is the opposite where the risky stocks are sold and the more stable earners are selected causing the NASDAQ to drop sharply. Timing the markets is not an activity I would suggest for anyone, but under certain circumstances if an investor is one step ahead, a lot of short-term gains can be made. My approach is to take a certain amount of money and divide it into ten “chips” all of the same size and make selections from there. Each position is held long enough to make a 3-6% gain, then sold thereby realizing the gain. I often will use the gains (only) to offset losses from other positions, but the capital is always recycled, although not necessarily immediately. This way the investor retains his commitment to the game, but avoids overinvesting. The short side works about the same way except that the broker will require the investor to maintain at all times enough cash in the account to cover all the short positions or a charge up to 8.5% interest will be assessed. Sometimes a borrowing fee will be applicable. It’s good advice for most investors to limit short selling except when the markets are crashing. Running the game will often involve a lot of trading making it necessary to have access to a computer handy during the hours the markets are open (cell phone apps will work, but I prefer a desktop).
Stock Selection Process: To select a group of ten stocks for the game I decided to create a watch list of nearly one hundred candidates. To develop this list, I acquired the symbols for several exchange tradable funds (ETF’s) that have most of their money invested in AI related stocks, and then broke them down into their constituent stocks. I then reviewed each stock for its fundamentals to see where it might fit into the game: either on the long side or short side. The stocks that had low debt to equity ratios, good net income percentages, and suitable five-year trends went into the long side. The short side had stocks that lost money, had unfavorable debt/equity ratios, and/or couldn’t maintain a growth trend. Some stocks fit on the short side but are red hot with buyers pouring in from everywhere. I try to avoid these hot rockets as they sooner or later will disappoint—either fail as a long pick, or keep climbing as a short pick. I identify all dividend paying candidates by changing the font color and placing them on the long side (it’s not a good practice to short dividend paying stocks very often). The decision of when to buy or sell often depends upon the trend the stock is taking. Moving Average Convergence/Divergence (MACD) and Bollinger Bands can help the investor track the trends. The overall market trends are also important as the investor should seek to buy low, but sell high. Screening tools can help also—I use MarketEdge Second Opinion, along with my broker’s research tools. In any case, a good entry point is required to avoid being stuck below water either way you invest (long or short).
Realized Versus Recognized Gain or Loss: The object of the game is to pull money from gains out of the box and spend it or invest it elsewhere. When the stock shows an increase in price over the original investment it has a recognized gain. But what the investor really wants is the gain to be realized, and that means cashed in. A recognized gain in day one could be a loss the next morning, accentuating the need to be tuned in to your holdings during market hours. One of the keys to day trading is to attempt to catch the stock on an upswing and, without being greedy, cash it before it drives back down again. By holding the stock hoping for higher gains, the investor risks losing the gains that are available. Keep in mind that if the conditions call for it, the investor can reinvest in the same stock later—the stocks are reuseable! After a position is closed, I return the stock to the watch list, and I review the watch list a few times each week. I also keep a shorter, immediate-use, watch list with the stocks that are ready to go into the game, either long or short.
The Time Value of Money: All investors should understand that money and time are interconnected, and that money always has a time value as widely noted by interest. The clock is ticking with the stocks in the game as well, but the “interest” is not as easily recognizable. Take for example a $10,000 position held for a week and then cashed for a 5% gain or $500. Multiply the gain out to an annual basis (in this case, $500 times 50 for one week out of the year) making it $25,000 on an annualized basis. Five percent each week would be virtually impossible to earn repeatedly with a buy-and-hold strategy, but by moving the money around from stock to stock and cashing it in when a gain becomes available the investor can pick up some interesting returns. Most advisors will tell you to keep your money invested no matter how volatile the markets are in order to avoid missing out on the days the markets go up. It makes sense since very often the market’s direction is determined by giant orders queued up the night before by hedge funds, banks, even brokerage houses. The very second the markets open in New York, these orders come racing through pushing prices for the markets in one direction or the other. Therefore, to take advantage of the price changes the private investor must be in the market the day before. But if you have ten chips to play, you don’t need to put them all in at once—instead try putting two or three in, and then achieve a sense of the market’s direction when you log in the next morning. When the markets are up, the private investor should recognize gains and take the profits as soon as they come. For those that are under water, the upward moves might take a little longer, but if you’ve screened them carefully enough, the long ones should prevail after a few days, or weeks. Holding a declining stock for very long increases the risk of a loss somewhere, so a formula should be developed to dispose of these losing stocks in a way that minimizes losses.
Conclusions: The game has been likened to picking up quarters in front of a bulldozer. It’s true that the trading rewards will be smaller, but by cashing them in the investor ameliorates the risk. Keep in mind that I have over three quarters of the total portfolio invested in long-term, dividend-paying stocks that I will occasionally swap out for other stocks that have better returns on the horizon. The remainder is in the game including whatever cash is left over.