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– Continue reading →