Making and Monitoring an Investment Plan

The current plan

This post is mostly about how to monitor an investment plan that you’ve established.  I’ll have (a lot) more to say about setting up a plan in subsequent posts under the Portfolio Management series.  But to get to monitoring, I have to write a bit about what the plan is.

The series of posts in the Strategy category  on setting up a portfolio for 2010 is an example of creating an investment plan (a portfolio strategy, if you want to give it a fancy name) for your stocks that could/should last for a year.  The year is just a planning horizon.  The plan may not actually last a year.  The future may come faster than you anticipate, if you have a good plan.  And if your plan isn’t working out, the sooner you discover this and work out a better plan the better.

Having a plan is crucial.  It’s your GPS. Otherwise, you’re just aimlessly trading.  In the worst case, your holdings have some rhyme or reason to them, but the strategy they embody, or the assumptions about the economy or the stock market they express, are the opposite of what you’d do if you thought about the bigger picture.

Simpler can be better

A plan doesn’t have to be complicated.  All you need are three things:

1.  one or more ideas you’re confident about and can list the reasons why you’re confident,

2.  the specifics about how you’ll implement the ideas in shaping your equity holdings, and

3.  what outperformance you expect to achieve, and over what time frame.

The plan I outlined in my 2010 posts was an extremely simple one.  It was:

1.  stocks were extraordinarily cheap, especially cyclical ones, by historical standards.  Recession, although deep, was already almost two years long, interest rates had been dropped to zero and big fiscal stimulus had been enacted.  All the news was extremely negative (remember Cramer’s Doomsday scenarios?).  So a huge amount of bad news (too much) was already baked into prices.

I also thought (my first 21st century recession posts) one reason people were so bearish was that they were misreading the signals from the business community.  In addition, in a simply mechanical sense, earnings were so bad in the December 2008 quarter that I thought comparisons would almost surely turn positive in the December 2009 quarter.  So good news would come, at the latest by September or October.  At some (earlier) point, the market would begin to recognize this.

Therefore, I thought there was no percentage in betting that things would get worse–people had been beating that horse to death for some time.  Instead, one should emphasize stocks that would benefit from world economies getting better, because the stocks were very cheap and I could expect earnings to bring that home to investors by autumn.

2.  I suggested keeping 85% of equity money in an index fund and distributing the remaining 15% as follows:  technology 5%, consumer discretionary 5%, materials 2.5%, industrials 5%.

3.  I thought that one could expect 100 basis points of outperformance of the S&P 500 over a year from doing this.

Now to monitoring–

The most important thing here is the process, not the results. There will inevitably be periods when the plan goes awry, at least temporarily, but your analysis should be just as thorough and just as unemotional in bad times as in good.


From the Keeping Score page, you can see what has happened over the past four months to the equity portfolio described above.

1.  The future has come faster than I was planning for.  Sentiment has shifted dramatically in a bullish direction since April.  Stocks are still cheap, but are no longer so startlingly under valued across the board as they were. All four overweight sectors have outperformed significantly.  Defensive stocks have lagged the S&P by an unusually wide margin.

This brings up a question:  is there anything left in the current plan?

2.  The financial sector has been the star performer in the market.  It was not one of the sectors I had selected to overweight.

Another question:  should we overweight financials now?

3.  By having outperformed, the overweight sectors have become a bit more overweight.  This isn’t a good or bad thing.  It’s just the way arithmetic works.

Question:  are the overweights now too large for comfort?

4.  I expected 100 basis points of outperformance in a year.  We have about 70 so far.

Again:  what’s left in the current plan?

…drawing conclusions…

1.  I look at today’s situation from two different angles.  On the one hand, the economy is stabilizing and may soon begin to improve.  Companies have shown positive operating leverage in June quarter earnings, even on flat or declining sales.  So the positive leverage could be greater than the market expects when revenues begin to improve.

The Cash for Clunkers program shows, among other things, that consumers are willing to spend when they see compelling value–an argument that consumer spending during the upcoming holiday season might be good.  So earnings comparisons, aided by the weak December quarter last year, could be surprisingly strong.  I think earnings momentum remains with cyclical stocks for a while yet.

On the other hand, consumer staples are being badly affected by trading down.  Healthcare prospects are unclear.  Traditional telecom and entertainment continue to be hurt by development of the internet.  So they are riskier places to be than one might think.

All in all, I think the portfolio is still in the right place.

2.  I’ve been wrong about financials, but being wrong hasn’t hurt the overall portfolio badly.  If I were to do anything, it would be to add a bank with emerging markets exposure or which have not taken government assistance.  For the portfolio under discussion her , though, I’m going to stand pat.

3.  Yes, the overweights have risen, but not by a lot.  I’m not enthusiastic about putting money into the underweight sectors.  In a different portfolio, I’d trim the overweights back toward the original levels and use the proceeds as part of the money going into an individual bank stock.  But here I’m going to do nothing yet.

4.  For the moment, I think my “mistake” here has been to set the performance target too low.  The fact that things have worked out better than I had thought isn’t of itself a reason for change.  But it is a reason to accelerate my thinking about reshaping the portfolio over the next few months.  Instead of having a new plan for January, I probably should have one for October.

…and acting

Also, I can’t wait this long again for another formal review of the holdings.  How often to do this is another whole issue in itself, which I’ll talk about in other posts in this Portfolio Management series.  For now, though, I should look again in a month, at the latest.

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