Asset Allocation Based Performance Analysis - One
It matters not what lines, numbers, indices, or gurus you worship, you just can't know where the stock market is going or when it will change direction. Too much investor time and analytical effort is wasted trying to predict course corrections… even more is squandered comparing portfolio Market Values with a handful of unrelated indices and averages.
If we reconcile in our minds that we can't predict the future (or change the past), we can move through the uncertainty more productively. Let's simplify portfolio performance evaluation by using information that we don't have to speculate about, and which is related to our own personal investment programs.
Every December, with visions of sugarplums dancing in their heads, investors begin to scrutinize their performance, formulate couldas and shouldas, and determine what to try next year. It's an annual, masochistic, right of passage. My year-end vision is different.
I see a bunch of Wall Street fat cats, ROTF and LOL, while investors and their alphabetically correct advisers determine what to change, sell, buy, re-allocate, or adjust to make the next twelve months behave better financially than the last.
What happened to that old fashioned emphasis on long-term progress toward specific goals?
When did it become vogue to think of investment portfolios as sprinters in a twelve-month race with a nebulous array of indices and averages? Why are the Masters of the Universe rolling on the floor in laughter?
They can visualize your annual performance agitation ritual producing fee generating transactions in all conceivable directions. An unhappy investor is Wall Street's best friend, and by emphasizing short-term results in a superbowlesque environment, they guarantee that the vast majority of investors will be unhappy about something, all of the time.
Your portfolio should be as unique as you are, and I contend that a portfolio of individual securities rather than a shopping cart full of one-size-fits-all consumer products is much easier to understand and to manage.
You just need to focus on two longer-range objectives: 1) Growing productive Working Capital, and 2) Increasing Base Income.
Neither objective is directly related to the market averages, interest rate movements, or the calendar year. Thus, they protect investors from short-term thinking associated with anxiety causing events or trends while facilitating objective based performance analysis that is less frantic, less competitive, and more constructive than conventional methods.
Briefly, Working Capital is the total cost basis of the securities and cash in the portfolio, and Base Income is the dividends and interest the portfolio produces. Deposits and withdrawals, capital gains and losses, each directly impact the Working Capital number, and indirectly, Base Income.
Securities become non-productive when they are no longer Investment Grade Value Stocks, or no longer income producing. Good sense management can minimize these unpleasant experiences.
THE ART OF INVESTING
Let's develop an "all you need to know" chart that will help you manage your way to investment success (goal achievement) in a low failure rate, unemotional, environment. The chart will have four data lines, and your portfolio management objective will be to keep three of them moving ever upward through time.
Note that a separate record of deposits and withdrawals should be maintained. If you are paying fees or commissions separately from your transactions, consider them withdrawals of Working Capital. If you don't have specific selection criteria and profit taking guidelines, develop them.
The Market Cycle Investment Management (Working Capital Model) Line Dance
Line One is labeled Working Capital, and an average annual growth rate between 5% and 12% would be a reasonable target, depending on asset allocation. (An average cannot be determined until after the second full year, and a longer period is recommended to allow for compounding.)
This upward only line (Did that raise an eyebrow?) is increased by dividends, interest, deposits, and realized capital gains and decreased by withdrawals and realized losses. A new look at some widely accepted year-end behaviors might be helpful at this point. Offsetting capital gains with losses on good quality companies becomes suspect because it always results in a larger deduction from Working Capital than the tax payment itself.
Similarly, avoiding securities that pay dividends is at about the same level of absurdity as marching into your boss's office and demanding a pay cut. There are two basic truths at the bottom of this: 1) You just can't make too much money, and 2) there's no such thing as a bad profit.
Don't pay anyone who recommends loss taking on high quality securities. Tell them that you are helping to reduce their tax burden.
Line Two reflects "Base Income", and it too will always move upward if you are managing your asset allocation properly. The only exception would be a more than 70% equity allocation, where the emphasis is on a more variable source of Base Income… the dividends on a constantly changing stock portfolio.
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