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The Art of Investing: Working Capital Model based Asset Allocation
Line Three reflects historical trading results and is labeled: Cumulative Net Realized Capital Gains. This total is most important during the early years of portfolio building and it will directly reflect both the security selection criteria you use, and the profit taking rules you employ.
If you build a portfolio of Investment Grade Value Stocks (IGVS), and apply a maximum 5% of cost basis diversification rule, you will rarely have a downturn in this monitor of both your selection criteria and your profit taking discipline. Any profit is always better than any loss and, unless your selection criteria is really too conservative, there will always be something out there worth buying with the proceeds.
Three 8% singles will produce a larger number than one 25% home run, and which is easier to obtain?
Obviously, the growth in Line Three should accelerate in rising markets (measured by the IGVSI). The Base Income just keeps growing because asset allocation is also based on the cost basis of each security class… get it?
Note that an unrealized gain or loss is as meaningless as the quarter-to-quarter movement of a market index. This is a decision model, and good decisions should produce net realized income.
One other important detail: no matter how conservative your selection criteria, a security or two is bound to become a loser. Don't judge this by Wall Street popularity standards, tealeaves, or analyst opinions. Let the fundamentals (profits, S & P rating, dividend action, etc) send up the red flags. Market value just can't be trusted for a bite-the-bullet decision… but it can help.
The Market Cycle Investment Management (Working Capital Model) Line Dance
This brings us to Line Four, a reflection of the change in Total Portfolio Market Value over the course of time. This line will follow an erratic path, constantly staying below Working Capital (Line One). If you observe the chart after a market cycle or two, you will see that lines One through Three move steadily upward regardless of what line Four is doing.
BUT, you will also notice that the lows of Line Four begin to occur above earlier highs. It's a nice feeling since Market Value movements are not, themselves, controllable.
Line Four will rarely be above Line One, but when it begins to close the cap, a greater movement upward in Line Three (Net Realized Capital Gains) should be expected. In 100% income portfolios, it is possible for Market Value to exceed Working Capital by a slight margin, but it is more likely that you have allowed some greed into the portfolio and that profit taking opportunities are being ignored.
Don't ever let this happen. Studies show rather clearly that the vast majority of unrealized gains are brought to the Schedule D as realized losses... and this includes potential profits on income securities. When your portfolio hits a new high market value watermark, look around for a security that is no longer an Investment Grade Value Stock and bite that bullet.
What's different about this approach, and why isn't it more high tech? There is no mention of the popular market indices, or comparison with anything other than investors' personal, reasonable, goals.
This method of looking at things will get you where you want to be without the hype that Wall Street uses to create unproductive transactions, foolish speculations, and incurable dissatisfaction. It provides a valid use for portfolio market value, but far from the judgmental nature Wall Street would like. It's use in this model, as both an expectation clarifier and an action indicator for the portfolio manager on a personal level, should illuminate your light bulb.
Most investors will focus on Line Four out of habit, or because they have been brainwashed by Wall Street into thinking that a lower Market Value is always bad and a higher one always good. You need to get outside of the "Market Value vs. Everything Else" box if you hope to achieve your goals.
Cycles rarely fit the January to December mold, and are only visible in rear view mirrors anyway… but their impact on your new performance Line Dance is totally your tune to name.
The Market Value Line is a valuable tool. If it rises above working capital, you are missing profit opportunities. If it falls, start looking for buying opportunities. If Base Income falls, so has: (1) the quality of your holdings, or (2) you have changed your asset allocation for some reason, etc.
So, Virginia, it really is OK if your Market Value falls in a falling IGVSI Market or in the face of higher interest rates. The important thing is to understand why it happened. If it's a surprise, then you don't really understand what is in your portfolio.
You will also have to find a better way to gauge what is going on in your markets. Neither the CNBC talking heads nor the popular averages are the answer. The best method of all is to track IGVSI statistics… if you need drugs; these are better than the ones you've grown up with. Have a nice change!
Click for Details --> Art of Investing Part 1
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|Please read this disclaimer:|
Steve Selengut is registered as an investment adviser representative. His assessments and opinions are purely his own. None of the information presented here should be construed as an endorsement of any business entity; the information is only intended to be educational and thought provoking.
Risk Management: Income, 401k, and IRA Programs
Take a tour of a professional investment managers' private SEP IRA program during ten years surrounding the financial crisis:
In developing the investment plan, personal financial goals, objectives, time frames, and future income requirements should all be considered. A first step would be to assure that small portfolios (under $50,000) are at least 50% income focused.
At the $100,000 level, between 30% and 40% income focused is fine, but above age 50, the income focus allocation needs to be no less than 40%... and it could increase in 10% increments every five years.
The "Income Bucket" of the Asset Allocation is itself a portfolio risk minimization tool, and when combined with an "Equity Bucket" that includes only Investment Grade Value Stocks, it becomes a very powerful risk regulator over the life of the portfolio.
Other Risk Minimizers include: "Working Capital Model" based Asset Allocation, fundamental quality based selection criteria, diversification and income production rules, and profit taking guidelines for all securities,
Dealing with changes in the Investment Environment productively involves a market/interest rate/economic cycle appreciation, as has evolved in the Market Cycle Investment Management (MCIM) methodology. Investors must formulate realistic expectations about investment securities--- by class and by type. This will help them deal more effectively with short term events, disruptions and dislocations.
Over the past twenty years, the market has transitioned into a "passive", more products than ever before, environment on the equity side... while income purpose investing has actually become much easier in the right vehicles. MCIM relies on income closed end funds to power our programs.
To illustrate just how powerful the combination of highest quality equities plus long term closed end funds has been during this time... we have provided an audio PowerPoint that illustrates the development of a Self Directed IRA portfolio from 2004 through 2014.
Throughout the years surrounding the "Financial Crisis", Annual income nearly tripled from $8,400 to $23,400 and Working Capital grew 80% $198,000 to $356,000.
Total income is 6.5% of capital and more than covers the RMD.
Managing income purpose securities requires price volatility understanding and disciplined income reinvestment protocals. "Total realized return" (emphasis on the realized) and compound earnings growth are the key elements. All forms of income secuities are liquid when dealt with in Closed End Funds.
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|Please read this disclaimer:|
Steve Selengut is registered as an investment advisor representative. His assessments and opinions are purely his own and do not represent the views of any other entity. None of his commentary is or should be considered either investment advice or a solicitation of business. Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be or should be construed as an endorsement of any entity or organization. The reader should not assume that any strategies, or investments mentioned are any more than illustrations --- they are never recommendations, and others will most certainly disagree with the thoughts presented in the article.