If I thought of my portfolio as a football team, how would the whole thing look?
Offense;
quarterback
fullback
halfback
wide receiver
wide receiver
tight end
left tackle
right tackle
left guard
right guard
center
Defense
middle linebacker
right tackle
left tackle
left end
right end
right outside linebacker
left outside linebacker
cornerback
cornerback
left safety
right safety
Who is my quarterback?
The quarterback runs the offense. The quarterback manages the ball (capital). Views the field, calls and executes the play. Deploys the ball; hand-off, pass, keep and run, sneak. The quarterback is the field general.
no better quarterback than the conglomerate CEO; candidates are Warren Buffett, ( CEO of Loewes, Markel, )
running backs; grind out the yards, 3-5 yards per play, over and over. These are growth and income companies; can be relied on to make money in most market conditions; Full back is big and strong, can carry others on his back; large cap, drives through tough times, pounds out a bit of growth and steady dividends year in, year out;
Half-back; a bit smaller, more nimble, with explosive potential; smaller-cap, higher earnings growth, plenty of cash flow, could belt out a big surge in earnings, increase dividends sharply
offensive line; Center; hikes the ball; puts money in motion; this is a low growth, big dividend company; churns out the cash and dividends, market is mature, not much room for growth, but a cash-producing machine.
Guards: Similar to center; large cap, create earnings through production of commodities, food, consumer staples
Tackle; Similar to guard; perhaps a different sector, very steady earnings,
Tight end; this one can run; catch a pass; higher growth potential, dividend at low end of acceptable, but with strong dividend growth potential
Wide receivers; Pure growth/speculative; dividend may be a token, or none. potential for explosive growth.
Defense; These players are those that protect you against a market swoon. They are the contrarian sectors; they are best when the current phase of the market is in decline.
So, who is in the front line against a market melt-down? First, it has to be a company whose product is used in good times and bad. Utilities come to mind. Second, it's performance can't be threatened by a loss of earnings and large debt service. Most utilities have debt, but poeple also keep paying their utilities until times get really tough. Low debt, staple companies sound good to me.
What defensive players might be in the back-field? Linebackers, cornerback and safety; They have to counter the effects of a dramatic downdraft, like intercepting a runner, or a wide-receiver who has broken through to catch a long pass; The first line of defense is sector diversification, as rarely are all sectors performing similarly at once. The next would be investments that run a bit counter to a broad market move down. Hard to know, but perhaps short term bond funds, or international diversification. Finally, a store of value that counters a global meltdown. I would think that would be a contrarian investment, one that rises when everything else is falling. Precious metals might be an example. I'm not particularly interested in owning gold, silver, platinum and the like, so I'll have to think about whether there is something out there that fills this role better.
I'm also not interested in those short-index funds aimed at rising when the market is falling. They're simply an insurance policy that costs money as long as it is in force.
One "store of value" is simply owning equities that pay consistent dividends. Even if valuation drops, payments continue and with reinvestment, share count rises. That compounding occurs irrespective of share price, and if dividends are preserved or grow, it is a contrarian compounding, as lower valuation causes share counts to accumulate even faster. That reduces position value volatilaty (even if not price volatility) REITS make a good means of owning real-estate, because you can incrementally grow your holdings, rather than purchasing them in illiquid hunks.
more on this to eome
Sunday, December 30, 2012
some thoughts on the temptation to speculate
Some thoughts on avoiding the temptation to speculate, or to avoid the risks associated with speculation.
Risk to capital;
The reason for Benjamin Graham's "margin of safety" teaching.
The reason for Warren Buffet's first two rules: "never lose money", and "never forget rule number one"
Risk avoidance drives investors to fixed income investments, which then exposes them to inflation risk, or valuation risk on the fixed income investment, if not held to maturity.
The opposite end of the investing spectrum, growth stocks, places the investor at risk to capital if he chooses a company without talented and disciplined management, without long term growth prospects, with technology at risk for obsolescence.
In the middle are the "safe equities"; large caps, dividend-paying, dividend growing, mid-caps, REITS, MLPs, utilities, etc. These are not speculative investments, as they aren't likely to POP to much larger valuations in short intervals. They carry risk to capital, although not as much, as your dollars purchase a lot of infrastructure, bricks and morter, inventory and their purchase price is not as loaded with expectation of highly inflated future earnings.
This kind of investment is "doomed" to modest appreciation and relatively generous dividend distributions. If one is disciplined and reinvests dividends, the total returns are solid, if unspectacular.
One can only have outsized returns in this market by carefully guarding capital, deploying when valuations are artificially low, recognizing overvaluation and redeploying strategically; in short, paying close attention, having nerves of steel and a willingness to buy and sell based on a series of rules that do not accommodate any sentimental feeling about one's holdings.
However, that kind of torture is, in my opinion, far preferable to the torture of making a bet on a growth stock and seeing it end badly for one reason or another.
One place where one can potentially juice the returns in the staid world of unsexy holdings is in the world of options. Now, options have "risky" written all over them. However, coupled with the disciplined approach to unsexy large cap investing, they appear to offer some added performance at very low risk.
I'm talking specifically about cash-covered puts and covered-calls.
Let's examine the cash covered put; Say, for instance, you intend to purchase another block of the most unsexy large-cap stock you can imagine, as part of your portfolio foundation. The next ex-dividend date is 3 months away and the stock price is a bit above it's moving averages, has a slightly higher than normal P/E, trading at the upper edge of it's recent historic range. Your cash is only at risk if it isn't earning interest, or if it purchases an asset that then depreciates.
Take a stroll through the options premiums; There's a 2 month covered call that, if excercised, will allow you to purchase the stock at 1% cheaper than it's current price. Figuring in transaction fees, you will make 0.9% on your cash to sell that put. If, in two months, you don't receive the stock because the price hasn't dipped, you have 100.9% of your cash 2 months from now. Say, for instance, the stock moved up instead of down and now you are faced with the un-savory prospect of buying it at an even higher price. WAIT...is it overvalued? would you be better off selling another cash-covered put?
Say, for instance, you do this 6 times in a year and still you don't own the stock. It has gone through 4 dividend distributions (3.5% return), and is up 5% from the price when you first committed your cash. You have 5.4% return on your cash and you don't own the stock. Have you lost money? Has your money earned nothing?
Say, for instance, you sold that put, pocketed 0.9% and 2 months later you own the stock, but it's price dipped 1.5%. You're down 0.6%. The ex-dividend date comes and goes, and you're now up 0.8% on the dividend. You own the stock and you're up 0.2% Have you lost money? Did you want to own that stock in the long term? Remember, you also have the put premium, and your purchase price is effectively the strike price minus the put premium. You purchased at 1% down, added 0.9% in put premium, so you purchased at 1.9% down, no a stock that lost 1.5% of it's value at the time you committed; so you're up 0.4% and then comes the dividend (0.8%, in this example) and you're up 1.2% in 3 months, with a lower stock price. Is that bad? Is that worse than having purchased and lost 1.5% when the stock price declined?
Remember; buy low. At any reasonable purchase price, if you can buy at 1-2% lower, you're that much further ahead. If you miss a dividend date, you're missing an opportunity to harvest cash. But if you time the puts correctly, you'll never miss one, as long as you own the stock. If not, you're banking put-premiums.
What about that covered-call;
You own 500 shares of boringconsumerstaplecompany that pays out 5% dividends per year and grows earnings at 3-4% per year. You're happy with your dividend-reinvested total return of 8-9% per year. Since the stock is predictable as the rising of the sun, you can't expect to see large capital gains.
On the other hand, there's a call premium that'll pay you 1% over 2 months, as long as the stock doesn't rise too far too fast. 1%, repeated 3-4 times in a year, improves your total return by 30-50%.
If the stock is called, you bank the appreciation up to the strike price, plus the call premium. You can turn around and purchase that stock right back, bank the next dividend and do it again. You may cap your earnings in any given period, but that doesn't mean you can't get right back in if you desire.
You may forgo a bit of capital appreciation; but you haven't lost ANY of your capital.
I don't think it makes a bit of sense to sell a put on a stock you don't want to own in the long term.
It doesn't make a bit of sense to sell a covered call on a stock that is rapidly rising and raising dividends rapidly. That should reward you adequately for owning that stock. However, some of the more boring and predictable stocks may allow you to sell insurance premiums to other investors and take the "float", knowing that you will only have to pay out in the form of accepting shares or giving them up a fraction of the time, and you can re-enter the market in a moment, once that transaction is complete.
That's a form of trading that really doesn't put your hard earned capital at much risk, knowing you are either acquiring stock at a price you deem to be favorable, or acquiring cash from an investment that is rising in value, perhaps over it's intrinsic value.
If you are managing a stable of stocks, some as holdings, some as prospects, even if your shares are called and you have been handed some cash from a closed call transaction, there should be a candidate stock waiting in the wings to take your money at a lower price-point and put you in position to sell another call. If it's a stock you want, you're in pig heaven. If it's a candidate for a cash-covered put, your money is back in motion, even if you've lost the capital appreciation that your called-stock is experiencing.
Remember that rule;
"never lose money".
If you believe the "never lose money" dictum applies to your long positions, should you hedge your holdings? Should you have trailing stops?
Buying puts is insurance, but it costs you capital. Buying calls is a bet on stock appreciation, but you still pay real dollars for the premium and you don't get it back, even if you win. It might make sense if you have a small stake and want to participate in a large bet, with capped downside of only sacrificing the premium if the story doesn't pan out. That sounds like a gamble to me and I don't like gambling. I like making money, either more or less, but never losing.
With respect to options, that means selling cash-covered puts and covered calls, as neither involves the risk of losing capital, as long as you avoid highly volatile stocks that can fall dramatically.
more on this at a later date...
Risk to capital;
The reason for Benjamin Graham's "margin of safety" teaching.
The reason for Warren Buffet's first two rules: "never lose money", and "never forget rule number one"
Risk avoidance drives investors to fixed income investments, which then exposes them to inflation risk, or valuation risk on the fixed income investment, if not held to maturity.
The opposite end of the investing spectrum, growth stocks, places the investor at risk to capital if he chooses a company without talented and disciplined management, without long term growth prospects, with technology at risk for obsolescence.
In the middle are the "safe equities"; large caps, dividend-paying, dividend growing, mid-caps, REITS, MLPs, utilities, etc. These are not speculative investments, as they aren't likely to POP to much larger valuations in short intervals. They carry risk to capital, although not as much, as your dollars purchase a lot of infrastructure, bricks and morter, inventory and their purchase price is not as loaded with expectation of highly inflated future earnings.
This kind of investment is "doomed" to modest appreciation and relatively generous dividend distributions. If one is disciplined and reinvests dividends, the total returns are solid, if unspectacular.
One can only have outsized returns in this market by carefully guarding capital, deploying when valuations are artificially low, recognizing overvaluation and redeploying strategically; in short, paying close attention, having nerves of steel and a willingness to buy and sell based on a series of rules that do not accommodate any sentimental feeling about one's holdings.
However, that kind of torture is, in my opinion, far preferable to the torture of making a bet on a growth stock and seeing it end badly for one reason or another.
One place where one can potentially juice the returns in the staid world of unsexy holdings is in the world of options. Now, options have "risky" written all over them. However, coupled with the disciplined approach to unsexy large cap investing, they appear to offer some added performance at very low risk.
I'm talking specifically about cash-covered puts and covered-calls.
Let's examine the cash covered put; Say, for instance, you intend to purchase another block of the most unsexy large-cap stock you can imagine, as part of your portfolio foundation. The next ex-dividend date is 3 months away and the stock price is a bit above it's moving averages, has a slightly higher than normal P/E, trading at the upper edge of it's recent historic range. Your cash is only at risk if it isn't earning interest, or if it purchases an asset that then depreciates.
Take a stroll through the options premiums; There's a 2 month covered call that, if excercised, will allow you to purchase the stock at 1% cheaper than it's current price. Figuring in transaction fees, you will make 0.9% on your cash to sell that put. If, in two months, you don't receive the stock because the price hasn't dipped, you have 100.9% of your cash 2 months from now. Say, for instance, the stock moved up instead of down and now you are faced with the un-savory prospect of buying it at an even higher price. WAIT...is it overvalued? would you be better off selling another cash-covered put?
Say, for instance, you do this 6 times in a year and still you don't own the stock. It has gone through 4 dividend distributions (3.5% return), and is up 5% from the price when you first committed your cash. You have 5.4% return on your cash and you don't own the stock. Have you lost money? Has your money earned nothing?
Say, for instance, you sold that put, pocketed 0.9% and 2 months later you own the stock, but it's price dipped 1.5%. You're down 0.6%. The ex-dividend date comes and goes, and you're now up 0.8% on the dividend. You own the stock and you're up 0.2% Have you lost money? Did you want to own that stock in the long term? Remember, you also have the put premium, and your purchase price is effectively the strike price minus the put premium. You purchased at 1% down, added 0.9% in put premium, so you purchased at 1.9% down, no a stock that lost 1.5% of it's value at the time you committed; so you're up 0.4% and then comes the dividend (0.8%, in this example) and you're up 1.2% in 3 months, with a lower stock price. Is that bad? Is that worse than having purchased and lost 1.5% when the stock price declined?
Remember; buy low. At any reasonable purchase price, if you can buy at 1-2% lower, you're that much further ahead. If you miss a dividend date, you're missing an opportunity to harvest cash. But if you time the puts correctly, you'll never miss one, as long as you own the stock. If not, you're banking put-premiums.
What about that covered-call;
You own 500 shares of boringconsumerstaplecompany that pays out 5% dividends per year and grows earnings at 3-4% per year. You're happy with your dividend-reinvested total return of 8-9% per year. Since the stock is predictable as the rising of the sun, you can't expect to see large capital gains.
On the other hand, there's a call premium that'll pay you 1% over 2 months, as long as the stock doesn't rise too far too fast. 1%, repeated 3-4 times in a year, improves your total return by 30-50%.
If the stock is called, you bank the appreciation up to the strike price, plus the call premium. You can turn around and purchase that stock right back, bank the next dividend and do it again. You may cap your earnings in any given period, but that doesn't mean you can't get right back in if you desire.
You may forgo a bit of capital appreciation; but you haven't lost ANY of your capital.
I don't think it makes a bit of sense to sell a put on a stock you don't want to own in the long term.
It doesn't make a bit of sense to sell a covered call on a stock that is rapidly rising and raising dividends rapidly. That should reward you adequately for owning that stock. However, some of the more boring and predictable stocks may allow you to sell insurance premiums to other investors and take the "float", knowing that you will only have to pay out in the form of accepting shares or giving them up a fraction of the time, and you can re-enter the market in a moment, once that transaction is complete.
That's a form of trading that really doesn't put your hard earned capital at much risk, knowing you are either acquiring stock at a price you deem to be favorable, or acquiring cash from an investment that is rising in value, perhaps over it's intrinsic value.
If you are managing a stable of stocks, some as holdings, some as prospects, even if your shares are called and you have been handed some cash from a closed call transaction, there should be a candidate stock waiting in the wings to take your money at a lower price-point and put you in position to sell another call. If it's a stock you want, you're in pig heaven. If it's a candidate for a cash-covered put, your money is back in motion, even if you've lost the capital appreciation that your called-stock is experiencing.
Remember that rule;
"never lose money".
If you believe the "never lose money" dictum applies to your long positions, should you hedge your holdings? Should you have trailing stops?
Buying puts is insurance, but it costs you capital. Buying calls is a bet on stock appreciation, but you still pay real dollars for the premium and you don't get it back, even if you win. It might make sense if you have a small stake and want to participate in a large bet, with capped downside of only sacrificing the premium if the story doesn't pan out. That sounds like a gamble to me and I don't like gambling. I like making money, either more or less, but never losing.
With respect to options, that means selling cash-covered puts and covered calls, as neither involves the risk of losing capital, as long as you avoid highly volatile stocks that can fall dramatically.
more on this at a later date...
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