In previous posts I discussed the Dogs of the World strategy, and then mean reversion.
To implement and
take advantage of mean reversion, you must be able to, as the saying' goes 'buy
low, sell high '('BL-SH').
Like many such catchy investment principles, it's simple but not
easy.
Firstly, note I said buy low and sell high.
To maximise your returns using this approach, you must be able to do both. Let’s break this
down.
The market dogs strategy requires that you dispense with being a 'buy
and hold' investor - you are simply an investor.
A corollary of this is that you also need to dispel yourself of
the belief in the 'long term'.
And finally, it is, to some extent, possible to time the market.
You’ll hear many financial people mention Buffett, buy, and
long term in the same sentence.
But those who think Buffett is not a market timer are not quite right - he
purchases most stock when markets crash or correct, after all. Market timing!
In other words, the economy has business cycles and there is no reason that your
investment strategy can't cycle as well.
Buffett adopted this approach from his mentor Ben Graham, who
also spoke of the advantages of buying stocks when the overall market is low.
Formula for profit
John Templeton was another great investor had a formula for
determining how much money you should have in the market given its overall
price level.
So, the first aspect of BL-SH is to consider the level of the
relevant market overall.
As Ben Stein points out in his excellent book Yes, You Can Time The Market:
'People come to accept the notion that the price of the market
was irrelevant, when price was so ruthlessly applied elsewhere'.
Many advisors will tell you about individual company valuation
and company fundamentals.
Now, I am not saying that individual company valuations are not
important.
But what I am saying is that you can greatly enhance your
returns when the whole market is cheap.
Take a look at the following:
Source: Meb Faber
Now tell me buying low is 'risky'! For individual companies, perhaps, but for sectors and countries, not so much.
My post regarding mean reversion should hopefully get you thinking.
This post gets you to action that principle on both counts
- buying low and selling high.
The reason why is that if you simply and patiently wait for
cheap markets, then you raise the probability of success.
If that table above doesn’t get you thinking about buying low,
then probably nothing will (in which case stick to buy and hold with diversified products - and there's nothing wrong with that!).
Being a 'long-term' investor?
Valuation - many financial folks tell you not to 'time the
market' or derivations of this theme.
The fact is that, on average, you'll be better off selling after a
good return and looking for the next bargain.
This way your money will compound
faster - if you can pull it off.
I have spent more words so far on buying low rather than selling.
Why? As Charlie Munger, Buffett’s long-time business partner
said, 'a stock well bought is half sold'.
Using the market dogs strategy, only if we are still under water do we hold and I’ll explain
that in my upcoming blog post on rebalancing and asset allocation.
So when do you sell and what is a good return? Well, have a look at
the chart below.
Note how after 12 months, that the returns often begin to decline. So
take profits and avoid the cardinal sin of many investors - getting greedy.
So, how do we buy low, sell high?
1. Look for markets/sectors/styles that are out of favour. You
can buy product that reflect indices of a whole country and sectors via ETFs (or individual companies if you must and that’s your bent).
A cheap market usually implies that individual companies
within the asset class are cheap.
Note that does not mean you can buy any old
company, but usually large systemic type companies with modest debt levels are a
good place to start.
2. Remember there are two parts to this equation - so sell after
12 months when the tax implications are positive and then repeat the 'buy low' process again.
Remember profits are not realised until you sell.
3. Mean reversion should be at the forefront of your mind, so you need to not get psyched out if the stock falls further.
I’ll deal with asset allocation and rebalancing in the next two posts on this strategy.
I’ll deal with asset allocation and rebalancing in the next two posts on this strategy.
