taking out a fresh sheet of paper

the tyranny of what we own

The current structure of our equity holdings exerts an influence on our investment thinking in a number of ways.  Most are normally invisible.  Usually it’s only when performance begins to get ugly that we turn a totally objective eye on what we own.

For one thing, there’s a powerful psychological tendency for our gaze to jump over positions that are losing us money (because we need to be right).  As a result, the dogs of the portfolio stay hidden longer than any of us would like to admit.  That’s why regular performance attribution analysis is so important.  (I’m not saying that we should jettison a holding if it doesn’t live up to our expectations right away.  We should give those expectations a sanity check, though, if the stock takes a nose-dive shortly after day one.)

For another, in a taxable account, we all are tempted to let the IRS tail wag the dog.  That is to say, we all weigh, at least semi-legitimately, the capital gains tax due on profitable holdings as a cost of making any change.  Because the tax is a concrete here-and-now expense, as opposed to the maybe-it-will-happen, maybe-it-won’t potential of future capital gains, it tends to have much more influence than it should in the decision to sell or not.

In a wider sense, there’s always a certain inertia associated with any portfolio, even while it’s still meeting our general performance expectations.  It is our intellectual child, after all.  We’ve done a lot of work in bringing it into being.  We know that more trading and more portfolio turnover, however emotionally satisfying, are almost always associated with worse investment results.  So why rock the boat.

taking out a fresh piece of paper

Periodically, though, it’s useful to ask ourselves what we would buy if we were creating a new portfolio from scratch.

Try it.

Don’t work from a list of existing holdings.  Sit down instead with a blank piece of paper (or document or spreadsheet).   Use whatever research materials you have at hand–a copy of Value Line, a discount broker’s screening services, a list of S&P 500 sector weightings and major constituents.  Read the company annual reports and 10-Ks.  Figure out what a portfolio–built today–should look like.  While you’re doing this, don’t look at what you already own.

When you’re done, compare this list–names and weightings–with what you actually hold.

You may be surprised at the differences.

why write about this now?

When I was managing money for others, I’d do the “clean sheet” exercise every six months or so.  I asked the portfolio managers working for me to do the same.

As it turns out, I’m currently investing in an IRA a lump sum pension distribution I recently received.  I want the money to be in more mature, income oriented stocks than I’d normally be attracted to.  This is compelling me to create a new portfolio from scratch, one with somewhat different objectives than I’m used to.  Hence this post.

I decided to read through a three-month cycle of Value Line reports as a way of generating new ideas.  I’ve been looking at the safety rankings and historical data on dividends and earnings growth.

I’ve been surprised at how many potentially interesting stocks I’ve found.  (Some of the prose reports in VL are quite good;  in others, the main virtue seems to me to be that they have a specific word count rather than any information.  Be careful about the performance rankings:  as I read the aggregate data, they no longer have the predictive power they once did.)

What also strikes me is how few of the stocks I already hold I’m eager to put into the new account.  Part of this, I’m sure, is simply a difference in investment objectives.  But part may also be an indication that some of my holdings are beginning to show their age.

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