portfolio checkup (II)

measuring performance

As I wrote yesterday, one reason for doing a portfolio checkup is to give yourself a report card/planning tool for assessing your portfolio performance and making appropriate adjustments.

getting to know yourself

A second reason is to, as time goes by, analyze yourself–the strengths and weaknesses, blind spots, or maybe just plain quirks–that influence your investment performance in recurring fashion.

For example:

1.  On the most basic level, consider whether you should involve yourself in active management at all.  Are you putting in the time and effort to follow the stocks/funds you own?  Do you have a well thought out reason for having purchased them in the first place?  Are they, either all individually or in the aggregate, adding to performance?  …or are you losing money on almost everything?

If you fit this laast description, maybe you should stock with a paper portfolio for a while and keep your real money in index products.

2.  A variation on #1–do you have more stocks than you have time to follow?  From a making money perspective, it’s better to do a few things well than a lot of things badly.

3.  Do you spend all your time on your strong-performing stocks and forget about the weak ones?

This is the normal human tendency, but it’s one to overcome as fast as you can.  If anything, your time allocation should be the opposite.

If you fit this description, you may just have too many stocks.  Or maybe you can’t bring yourself to sell a stock at a loss–which is the most common mistake that even the most seasoned investors make, in my opinion.

In either case, this is a behavior pattern to recognize, and a situation to deal with immediately.

4.  Are there types of stocks you typically do well with or do badly with?

This is a very broad question.  In my career, for instance, I’ve found I’ve done the best with stocks in consumer, technology, leisure/entertainment and real estate industries.  I’ve done the worst with financials and medical products/devices.

I can still remember clearly information sources from twenty-odd years ago that provided detailed and highly persuasive (to me, anyway) research that invariably turned out to be wrong.

I know I’m out of my depth in markets like Indonesia or Korea.

In cases like this, it may be interesting to know why you’re successful or unsuccessful in certain areas–but it’s not necessary.   The more important thing is to realise that your experience is what it is.  Just stop doing the things that always turn out badly!!  (For most people, this is much easier to write than to do.)

5.  Do you sell too soon?  …or do you hold on too long?

This, by itself, is useful to know.  In my experience, there are usually psychological cues that you either respond to or ignore that produce this behavior–or there are trading signs, either in volume or price action, that you use that produce the same result. By looking for and paying attention to them, you may be able to improve this aspect of your game.

6.  Do you buy badly?

The cliché (and to steal a line from Hegel, things have to be very true to get to be clichés) is that value investing is all about buying well; growth investing is all about selling well.  To my mind, buying badly means acquiring the stock at a price where there’s little potential for profit.  For growth stocks, this typically means buying just as growth begins to decelerate; for value stocks, this means buying assets worth $1 for $.80 each instead of at $.30-$.40.  For all stocks, this point is usually when the stock is the most popular.

7.  Where do you get your ideas?  They can come from anywhere.  Some sources–maybe your own experience as a consumer–are great; others, like the brokerage house in #4 above, may be awful all the time. Once you’re aware of patterns, you can pay closer attention to the good sources and eliminate the bad ones.

Be careful of TV and radio shows.  Investors who are guests on stock market shows always talk about their largest positions.  They never (for legal reasons) talk about stocks they’re thinking of buying or are in the process of acquiring.  Sometimes, although this is unethical conduct, they talk up stocks they are warming up to sell.  The commentators on these shows are by and large professional news presenters, not professional investors.



portfolio checkup

A friend who’s studying in the Netherlands and just starting out as an investor emailed me a question about what a portfolio checkup/cleanup is supposed to do.  I thought I’d reply in this post and in tomorrow’s.

two objectives

Basically, you analyze your portfolio carefully and at regular intervals to do two things:

–so you know for sure how your portfolio plan is working and what quantify which stocks or ideas are adding to or subtracting from your performance, and

–so you gradually learn about your investing personality.  By this I mean what things you typically do well and which ones you aren’t so good at.  You want this information, as painful as it may sometimes be to find out, so that you can emphasize the former and minimize the latter.  After all, the main goal is to earn/save money–not to massage your ego.

#1  figuring out performance

There’s a purely mechanical aspect to this.  You have a benchmark like the S&P 500, by which you judge your performance (you could achieve this return by buying an index fund.  You should only spend time and effort to select individual stocks or focused ETFs/mutual funds if you expect a return higher than the index fund will give you).

Over the past three months, the S&P 500 is down about 7.5% (ouch!).  Over the past month, it’s up about 9%.

Your first task is to calculate how your portfolio has performed vs the S&P over the interval you’re studying–both as a whole and each individual issue.  (For what it’s worth, after a long period of doing well, my stocks have been clobbered over the past month.)

what to do with this data, once it’s collected

a.  look for outliers, especially big losers.  Everyone has losers.  Everyone, even the most seasoned professional, also has an almost infinite capacity for denial.  My first mentor as a portfolio manager used to say that it took three winners to offset the damage that one big loser can do if it’s left to run amok and not caught early. So finding losers and eliminating them is important.

b.  ask if your plan is working.  This presupposes you have a plan.  A checkup may well bring out that you’re not bringing your intelligence, knowledge and experience to the party but are, so to speak, mailing it in and hoping that’s good enough.  (We all find out quickly that it isn’t.  Although individual market participants may not be the sharpest pencils, the collective entity is extremely acute.)

For example, in general my plan is:

–world economies are still expanding, although slowly.  So I’m still positioned for an up market.  The EU has me worried.  I’m thinking about shading toward larger, stodgy sort-of-growth stocks as a defensive measure but haven’t done anything much yet.

–there will continue to be a sharp separation between haves (mostly meaning having a job) and the have-nots (the 10% or so long-term unemployed in the US).  I want to own stocks that cater to the former and want to avoid stocks whose market is the latter.

–Asian, especially Greater China, exposure is a good thing, because that’s where most of the world’s economic energy is centered

–I think the continuing proliferation of smartphones, tablets and e-readers plus the rapid development of cloud computing mean there’s money to be made in at least some tech stocks.

For me, the relevant question is how this is working out for me overall.  The answer is:  great, until about a month ago.

A second aspect of figuring out performance is to look, stock by stock, at plan vs. performance.  Reading any of my posts about TIF will get you my stock-specific plan since I bought the security about a year ago.  Again, until about a month ago, things were working well  …since then, not so much.

c.  acting on this information

Even in the best of times, the stock market is always a process of two steps forward, one step back.  Also, all stocks, even the long-term winners, have periods of underperformance.  There’s a real experience-and temperament-based art to deciding how to react to the data that show your stocks are underperforming.

In my case, I’m thinking so far that this is a temporary adjustment phase.  But I’ve also got to at least begin to consider how I’d rearrange my holdings if the underperformance persisted.  This thought process–and the possible move to action–is partly a question of risk tolerance, partly of conviction in the correctness of my analysis of individual stocks, and partly a judgment, based on experience, of what is a normal trading pattern vs. a fundamental change in market direction.

More tomorrow.

analyzing your portfolio performance over the past three months

measuring performance

I’ve written before about how important it is for us as stock market investors to calculate and analyze the performance of our portfolios on a regular basis.

There are two related reasons for doing this:

1.  We want to identify what ideas/stocks are working for us in the portfolio and which ones aren’t.  Based on this, we decide where to take profits and where to stop the bleeding.

2.  We also want to learn about ourselves, and our strengths and weaknesses in decision-making.  This isn’t like training for the Olympics.  We don’t need to be perfect at everything.  But we want to at least be able to identify situations where we continually shoot ourselves in the foot–and just not do that anymore.

doing it now

On July 7th, the S&P 500 closed at 1353.  On October 3rd, it closed at 1099, for a decline of 18.8%.  On an intraday basis, from 7/7-10/4 the fall was 21%.

The markets appear to be stabilizing now, as politicians in Europe make noises about finally addressing the EU’s Greece/banking crisis.  It’s too soon to say for sure that the worst is over (although I suspect it is).  But whatever the case may be, it’s important to look at your portfolio after a decline of this magnitude and ask yourself how you fared.

how to do it

In all likelihood, you don’t have data from your brokerage account that tells you either what your portfolio as a whole, or any individual security in it, was worth on the beginning and end dates.  So the easiest way to proceed is to use a Google chart to compare the performance of the S&P 500 (or whatever benchmark you measure your portfolio against) with each of the stocks/mutual funds/ETFs you own.  You can find more details toward the end of my post on “method to the madness” a few days ago.

what to look for

1.  One question is whether you’ve outperformed or underperformed the benchmark. But that’s just the start.

2.  Growth investors outperform in up markets and underperform when the market is declining.  Value investors, who have a more defensive bent, do the opposite.  So a second question is whether your portfolio has performed in line with your design.

3.  Is your design really what you wanted?  Is it appropriate for your financial circumstances, or is it too risky–or not risky enough (not the usual problem, but possible)?

4.  What were your strongest and weakest stocks?

5.  Is there a pattern to either the good ideas or the bad ones?  Be careful here.  Over this period, utilities stocks would have been stellar names, capital goods or materials stocks were probably at the bottom of the pile.  That’s not what I mean. You’re looking for behavioral patterns that lead you astray so that you can change them.

Do the weak stock ideas come from names you hear on CNBC?  Are the good names ones where you know the financials backwards and forwards and the bad ones those you know less well?  Are the horrible stocks tips from cousin Fred the broker?  Are the large positions winners and the small positions losers–or the reverse (which would be a more serious issue)?

Some fixes are easy:  turn off the TV; do your homework; don’t act on Fred’s advice; don’t bother with the small positions (or weight each position equally if the small ones are good but the big ones are killing you).

6.  How are your positions doing in the rebound?  Stocks rarely outperform in both up and down markets.  Great if you have one or more of these.  In contrast, in my experience it’s a big red flag if a stock underperforms on the way down and remains an underperformer in a market bounce.  Any like these are ones that need your immediate attention.

7.  Are the reasons you bought each security still valid?

two other thoughts

–Looking at your portfolio decisions with a critical eye is something you need to do regularly.  One time won’t be enough to detect behavior patterns.  But you’ve got to start somewhere.  My experience is that even professionals make mistakes that would be easy to correct–like “don’t listen to Fred”–except that they aren’t aware they’re making them.

–For an analysis like this, don’t use year-to-date numbers.  What you want to see is how your stocks have done in the downturn.  Otherwise, if you have had significant under- or outperformance earlier in the year, that performance difference will just muddy the waters.  An example:

Suppose you have a security/portfolio that was 20 percentage points ahead of the S&P through July 7th.  That would mean you had a gain of 27.7%.  On October 3th, your holdings are down 2.7%, which is ten percentage points better than the market.  How much performance have you lost during the downturn?

The answer isn’t ten percentage points.  It’s five!  During the period we’re considering, the S&P 500 fell by 18.8%.  Your investment went from 127.7 to 97.3.  That’s a fall of 23.8%.  The difference between the fall in the index and in the investment is five percentage points.  The rest of the year-to-date loss comes from the fact that the investment has lost its 18.8% from a starting point that already incorporates a large year-to-date gain.  The gain portion also suffers a loss.

I’ve updated Current Market Tactics

I’ve just updated Current Market Tactics.   If you’re on the blog, you can also click the tab at the top of the page.

LAST CALL: Please take my survey, if you haven’t already.   PSI reader survey


What is a “correction,” exactly? Is one going on now?


A correction is the signature countertrend movement of a bull market.

It’s normally short–lasting two or three weeks.  It’s also shallow, although psychologically  it may not seem like it at the time.  Typically, the decline will be more than 3% but fall considerably short of 10%.

trigger vs. cause

I think it’s important to distinguish between the trigger for a correction and its cause.

The cause, which is always valuation, is usually easier to see.

Stock markets are ultimately driven by the economic performance of the companies whose stocks are publicly traded.  Bull markets occur during periods when corporate profits are not only expanding now but are also expected by investors to continue to do so for an extended period.  During times like this, investors can easily  become overenthusiastic and bid stock prices up to levels that are too high too soon, given consensus expectations for profit growth.  In fact, they tend to do so repeatedly.

Actual earnings expansion may eventually show–and it often does, in bull markets–that the consensus is too conservative.  But the market rarely stands still for an extended periods of time.  It either goes up, or it goes down (don’t ask me why, that’s just the way it is).  So if the justification for the price you’re paying in February for a stock will only come through an earnings report that will be made in October or in the following January, your stock probably isn’t going to sit there and wait.  If there’s no way it can go up for now, you can be very sure it’s going to start to go down.

Put a slightly different way, if the consensus thinks that S&P 500 earnings will be at best $100 for 2011 and that investors will be paying 14x for those profits, the consensus target for the S&P–until the market begins to factor in 2012 earnings–is 1400.  At 1350, this implies only about 3% upside for the market for, say, the next six months.  That isn’t enough financial incentive to choose stocks over some other, less risky investment, in my opinion.

It isn’t that the market thinks bad things will happen in the economy.  It’s a question of the odds of making a satisfactory return.  Sooner or later, this fact dawns on investors.  They slow down their buying to a trickle.

This is the position we were in a week ago.

What must–and always does–happen in this situation is that the market has to decline enough to restore favorable odds.   Last year the magic number for “favorable” seemed to me to be more than 10% but less than 15%.  My guess is that this year the number is lower,because investors are more confident, maybe 10% or so.

The trigger for a correction can be anything.  Many times it comes out of the blue. You should also note that the trigger doesn’t necessarily have to make any sense.   In 2010, for example, INTC reported the first of a series of stunningly good profit results early in the year.  The consensus concluded (incorrectly, as it turns out) that this was the high point for tech earnings in the current business cycle.  So the entire market, which had been a bit frothy, sold off.

This year the trigger is unrest in the Middle East.  My guess is that if equity markets had been 10% lower, stocks would have shrugged off events in Libya.

where are we now?

Proceeding in logical order, the first question to answer is whether we are still in a bull market or whether what we are seeing now is not a correction, but evidence of a reversal of the markets from bull to bear.

True, market tops are notoriously difficult to recognize–more so for always-bullish growth stock investors like me.  But we’ve just begun to see economic recovery take hold in developed markets.  Corporate profits seem to me to be very likely to continue to expand.  Valuations aren’t crazy high.  Interest rate hikes are a long way away.  Therefore, I interpret what we’re in now as a correction.  (Also, as it turns out, I’ve been writing that one is due for some time.)

Applying the rules of thumb I outlined above, stocks in the S&P 500 should be weak for another 5-10 trading days and bottom somewhere around 1250.

On the other hand,  there seems to have been a mini-panic in New York trading around midday last Thursday that may have taken a lot of the negative sentiment out of the market.  From intraday high the previous Friday to intraday low on Thursday, the S&P fell around 4%, which would just barely qualify for the depth of a decline.

I think trading in the next few days will be interesting to watch.  Last week’s decline really wasn’t deep enough or long enough to qualify as a correction, no matter what happened on Thursday.  So there should be more weakness to come, unless underlying sentiment is super-bullish.

what to do in a correction

As I’ve mentioned a number of times in other posts, stocks that have gone up a lot usually suffer the worst in a correction.  “Clunker” stocks (and everyone holds one or two), on the other hand, don’t decline much because they’ve never gone up.  The most useful thing to do when the market is declining is not to hide under the bed, but to upgrade your holdings.  Sell the clunkers at relatively attractive prices and buy healthier stocks at a discount.  You should make gains from doing this.  At the very least, you’ll have gotten rid of securities that would have continued to subtract from performance.

I found myself doing this on Thursday.  That’s pretty early in a correction to be acting.  I’ll be interested to see how this works out.

fixing mistakes: psychological barriers

Merry Christmas!!

One of my first bosses used to say that it takes three good stocks to offset the negative effects of one clunker.  Today, I’m not sure that’s the right ratio–a lot depends on investment style.  Also, I think the number is bigger than that in bear markets, where bad news is discounted heavily and good news is ignored, and smaller in bull markets.  But the ratio is certainly greater than 1 at all times.  That’s why it’s catching mistakes early is crucial to investment success.

Recently I’ve been reading books on decision-making.  I got the first, Jonah Lehrer’s How We Decide, from one of my sons.  I saw a review of the second, The Art of Choosing, by Sheena Iyengar, and bought it myself.  Both cover a lot of the same material, and in the same order.  This may be due to the Columbia connection between the authors.  Lehrer was an undergraduate there; Iyengar teaches there.  How We Decide is more readable and refers to a much larger number of experimental results.  The Art of Choosing focuses more on research Ms. Iyengar has done herself, and emphasizes that the psychological picture we create of ourselves for ourselves will be internally consistent–but won’t always correspond with reality.

Both books highlight the fact that we all tend to hold beliefs that we come to on a non-scientific basis.  For example, we all tend to think that we’re above average at just about everything we do.  Once we’ve made a decision, we tend to defend it by searching only for information that reinforces our opinion.  We also tend to ignore or screen out any data that calls our initial decision into question.  In fact, if we have believed something different in the past, we also gradually rewrite our memories (shades of Orwell) so that we come to believe we’ve always thought what we think now.

Even worse than all this, the more important the initial belief, the more likely we are to do this.

While this tendency may be relatively harmless if I think I’m handsome or witty or a good dancer, it’s an absolute disaster for an investor.  It’s a very great difficulty for professionals, who need very strong egos to withstand two aspects of the job:  many of the economic factors that influence the portfolio are outside the manager’s control, and at least 40% of the decisions managers make turn out to be wrong.

The professional manager has to keep his confidence from shattering, but at the same time be open enough to reality to stop his mistakes from destroying his portfolio performance.

How do you do this?

Two ways:


You have to be aware of the tendency to need to be right all the time, and resist it.  You have to actively scan news sources to look for negative information about your investment ideas.   A professional has to make it clear to sellers of research that you don’t regard a negative opinion or negative information as insulting or a reason to stop associating with them.


In my experience, every portfolio has its dark corners where underperforming stocks fester. Periodic performance measurement and stock-by-stock attribution analysis are the only cures.

Some investors–I’m not one of them–will also have mechanical rules that compel them to immediately sell a stock if, for example, it drops by 15% from its purchase price or earnings results fall short of internal/external analysts’ estimates.  The first rule seems to me to work better for value investors than their growth counterparts.  The second appeals to me more, but–at the risk of succumbing to the self-deception I’m writing about–I don’t subscribe to it.  My issue:  the risk of missing an AAPL or a MON or a COH because of a temporary earnings disappointment is too high.






equity position size (ll): you and me

It’s much easier to write about how professionals deal with the size and number of positions they hold in their portfolios.  That’s because money management firms create products that have certain risk parameters and leave it to customers to decide whether they want the product or not.  It’s impossible, however, to write very specifically for individuals without knowing anything about their financial circumstances and psychological makeup.  So you should take what follows as general thoughts rather than specific advice.

two issues to figure out

I think there are two aspects to the question of position size for non-professionals.  Both stem from the fact that stocks are risky investments. One is objective, the other subjective.  They are:

–Your own objective financial situation, given your age, income and accumulated wealth.  The question is how much risk–and the associated possibility of loss–can you afford to take.  Determining this is what financial planning, whether you do it yourself (probably using the tools on a discount broker’s website) or hire a professional to help you, is for.

For a twenty-something, having 90% of savings in stocks and having one or two positions that are each 5% of equity holdings is probably ok–assuming you’ve done appropriate research.  The two big equity positions amount to 9% of the person’s accumulated wealth.  By far his largest asset, however, is probably his human capital–his lifelong earning potential–rather than savings.  He has plenty of time for a risky investment to work out or to recover from even a large mistake.

For a sixty-something, on the other hand, having two 5% positions is probably also ok–relative to one’s overall equity holdings.  But that’s assuming the person in question has an age appropriate asset allocation. In most circumstances going into retirement with as much as 90% of your savings in equities is crazy.

–Your temperament, your tolerance for risk and–a factor I didn’t really understand until I stopped being a full-time money manager–the amount of time and effort you’re willing to devote to studying the companies whose stock you hold and following corporate developments.

I’ve often listened to casino company CEOs trying to position their gambling services as entertainment.  They joke that if you spend $500 on opera tickets you get a few hours of music but, unlike a casino jaunt, you have absolutely no chance of leaving the performance with any of the money you came in with.

As far as the stock market is concerned, this is a “Know thyself.” issue.  If you’re going to act on “hot tips” from a friend or from some guy on TV whose background and track record you know nothing about, you’re entertaining yourself, not investing.  You’ll probably lose your shirt.  So keep positions to negligible amounts.

One other editorial comment:  there’s a whole generation of Americans on the verge of retirement, whose pension savings are in IRAs or 401ks or other defined contribution pools of money.  We’ll likely live for thirty more years.  But there’s no monthly check in the mail from the company we worked for, like our parents had.  Our lifestyle will depend on the investment results from savings we’re responsible for managing.  Not taking much time or interest in doing so is probably not the greatest option.

let’s say you want to invest, not just entertain yourself

1.  Investing is a craft skill–like being a baseball player or a carpenter.  It doesn’t require you to be an Einstein.  It is experience-intensive, though.  This means you have to do your homework and serve an apprenticeship.  You start by investing small amounts, keeping records of your decisions, analyzing your results and thereby figuring out what you’re good at and what you’re not.  Even the best professional investors aren’t good at everything.  But they know they do a few things very well and stick to them.

2.  I’m not a fan of paper portfolios.  I don’t think they have enough meaning.  If you wanted to be a professional baseball manager, better to manage a high school team than to be in a bunch of fantasy leagues.  Start with tiny amounts of money.

3.  Over years of training portfolio managers, I’ve found that inexperienced managers always have great difficulty in making position sizes large enough to make a difference to performance.  As I mentioned in my post yesterday, a 50 basis point (.5%) position is probably not going to affect overall portfolio results one way or another.  It’s a waste of time.  In addition, if you have nothing but 50 basis point positions, you have to watch 200 stocks.  That’s an impossible task–and you’ll probably be killed by not catching your mistakes in time (that’s another topic, but trust me, it’s true).

For most seasoned professionals–growth investors, anyway–their top 10 positions make up around a quarter of their portfolios.  If you were to analyze it, the rest would probably look a lot like the manager’s benchmark index.  So the portfolio will likely rise or fall on the ten stocks big positions.  The task of monitoring them is manageable.  And if two outperform the benchmark by 20% each in a year, the manager will have about a 100 basis point gain vs. the index (it probably won’t be exactly 100 bp–it’ll depend on whether the market is going up or going down).  For US managers, that’s usually enough to put you in the top quartile.

4.  I think individual investors, once they’ve gotten enough experience to make intelligent judgments, should consider taking a (modified) page from the professional’s book.  This means:

–invest most of your equity allocation passively, through index funds or index ETFs

–complete your equity holdings with a small number of individual stocks (I have around a half-dozen, but I’m willing to spend a lot of time monitoring them)

–determine a maximum position size. Consider both the possible impact of a losing position on your equity holdings and on your overall savings.  If you’re, say, fifty years old and subscribe to the rule that your equity holdings should be the same percentage of your total savings as 100 – your age (which I think is a reasonable first approximation), then you have 50% of your holdings in stocks.

Suppose the individual stock you have the most confidence in were to be 5% of your equity holdings.   If that stock went to zero, you’d lose 2.5% of your wealth.  Is that acceptable?  If that is, then I think a reasonable approach to active management would be to establish three 3% positions and have the remainder of your equity holdings passive.

You should, of course, have a plan for what happens if your stocks go up, as well as for what you’ll do if they go down.  But the action you derive from determining a maximum position size is that you begin to trim the position if you’re fortunate enough to have it reach 5% of the equity total.  You don;t just let it grow.

–determine a minimum active position size, as well.  This is a much trickier topic than it appears on the surface.  I think positions below 1% of your equity holdings are a waste of precious analytical resources.  Let’s say you set that as a minimum size.

The complexity arises this way:  suppose you start out with a 1% position and the stock drops by 20%.  Do you average down and restore the position to 1%?  …or do you say you’ve made a mistake and sell?  A lot depends on your own level of self-awareness and your tolerance for risk.

As for myself, for example, bitter experience has taught me that if I have a large position that goes against me and I average down, disaster quickly follows.  So when a large position performs poorly nowadays, I either decide to hold on or to sell.  I never add.

On the other hand, averaging down is a standard tool of most value investors.

So alhtough it’s important to have worked out a plan, though, it will depend a lot on you as to what the plan actually is.