The Poor Investor

Investigatory Value Investing

Category Archives: Diversification

Forecasting for Dummies

I recently attended the New Orleans Investment Conference and although I do not invest in mining companies and I’m not a “gold bug,” or a gold investor at all for that matter, I did take away a lot of useful information.

Though, perhaps the most useful piece of information was this:

Never forecast.

Now, admittedly, this was something I always knew, but the conference did help to solidify this thought some more in my mind. Watching people make big assertions about the price of gold going up, predicting stock valuations and movements in commodities only to see them be dead wrong two years later just made people look foolish. The people who made these forecasts and the people who followed them. All foolish. Imagine the hard-earned capital that was probably lost as well.

I worked at an investing research company for a short while and watched a seasoned analyst, who had been working there since the company’s inception, miss one of the most important calls in his industry.  One of the dozen or so companies he was following was bought out and he missed it completely.  It totally side-swiped him.  He even went as far as to say the company would never be bought out when another analyst brought up the prospect of the company being sold.  Talk about egg on the face.

Still not convinced? Well, think about this, do you even know what’s going to happen to you tomorrow? You know your life, your schedule, how many hours are in a day, etc. and I’ll bet you can’t accurately predict most of what happens to you tomorrow. You don’t know what your boss is going to say to you. You don’t know if you’ll get in a car wreck on the way to work. You don’t know if you’ll even wake up tomorrow. Test yourself. Try to predict a dozen or so things and see how many work out as planned.

So, if you can’t predict what’s going to happen to you, the person, or thing, you probably know the most about, how can you accurately predict what millions of investors are going to do? The bottom line is that you can’t. The best we can do as investors is look at the trees and forget about the forest. Will the market crash this week? I don’t know. Will it be down next year? No clue. However, I do have confidence that solid, well-managed companies trading for less than they are worth will most likely be trading at values higher than they are now. That’s the best we can do as investors. We take bets on stocks where the odds are in our favor and don’t when they’re not. And then we spread these bets out so we don’t bet the farm on one company because if there’s anything about this “not being able to forecast” thing it’s the whole “not being able to forecast” part.  You don’t know if “company X” will go to zero tomorrow. If “X” does go to zero, you want to have companies A, B, C, D, etc. to fall back on. Maybe it’s 20 companies, maybe it’s 100. That’s for you to decide. The point is to build your portfolio structure so that it won’t fall over if one brick crumbles. Keep the odds in your favor.

Examples of the “odds being in our favor” are things like companies trading at a discount to book value, or even cash value. Maybe it’s a company like BDCA Venture, Inc. trading below its NAV of $6.89 per share at $5.00 per share. Or maybe it’s a company like Electronic Systems Technology, Inc. trading at or near cash. Maybe it’s a management team that lowers the risk; management that’s honest about the direction of their company and can back up what they say with an excellent track record. People like Apple’s Tim Cook or Tibco Software’s Vivek Ranadivé. Perhaps it’s a catalyst on the horizon like a patent approval or a drug approval. Whatever it is, you put the odds in your favor in some way. If there’s nothing putting the odds in your favor, you’re no longer investing. You’re speculating; you’re gambling; you’re forecasting.

Never forecast.

Is Diversifying Your Portfolio Harder Now?

I was reading an article from Fidelity called “Where to Look for Returns” and came across an interesting table I wanted to share with all of you:

For those of you looking to diversify your portfolios this appears to be a lot more difficult nowadays.  It also appears that these high correlations are not going to change anytime in the near future.  Furthermore, it is my belief that return enhancement via the effects of rebalancing (great article about rebalancing) may be reduced due to these high correlations.

Note: Personally, I use TIPS for portfolio diversification since historically (and currently) they still have the lowest correlation to equities.

—-Written by: The Poor Investor

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