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Strategy

Congratulations!

You have just taken a major step toward improving your portfolio management technique by investigating this page. Here we will try to give you some background on why a strategy is necessary, how you can develop your own personal strategy, what you will need to consider, and conditions that alert you when it's time to act. You will have to provide the main ingredient, follow-thru, - - the perseverance and self-discipline so necessary for success.

Why a Strategy Is Necessary?

Americans lost $72 billion in their 401-K's in the year 2001. (CNN news item, July 14, 2002) Most had nothing but "hope", which can never replace a sound strategy and the courage to take action. Others had a strategy - - - but it was the wrong one ("Buy and Hold").
When the bull market began in August, 1982, the price/earnings ratio for the S & P 500 was just 8. On July 18, 2002, this PE ratio was at 28. The historical average for this number is 16. To get back to its normal level, either Earnings will have to rise, or Prices will have to fall, or some combination of both (in which case, Prices still have to fall, but just not as much since the ratio would be helped by rising Earnings).
Individual stocks (and to a lesser extent, mutual funds) do not always rise in concert with a rising market. Conversely, they all are more likely to fall when markets collapse - - - a reason to know when your holdings have entered an Exit Zone (compare your own stocks/funds with the falling market indexes in July and August 2002).
For too many investors, "Buy and Hold" has not been a winning strategy. It takes over 4 years to recover a 50% loss if the growth each year is 20% - - - BUT, markets (and most stocks) do not grow at 20% a year (see below).

S & P 500 Growth in Time Spans (1961 thru 2001)

	1 year S&P avg. % G/L	5 year S&P avg. % G/L	10 year S&P avg. % G/L	15 year S&P avg. % G/L	20 year S&P avg. % G/L
Average	12.44%	13.07%	12.68%	12.86%	13.06%
Median	16.48%	14.78%	14.62%	13.52%	12.79%
High	37.43%	28.72%	20.04%	19.61%	18.59%
Low	-26.47%	-0.77%	2.51%	6.80%	8.10%

Developing Your Own Strategy

Every investment carries its own risk, so proven rule #1 is: Diversify. Spread your investment capital across several stocks and/or mutual funds. The latter further reduce risk because of their own diversification. Make certain your holdings are not all linked to the same industry or sector. That way you minimize harm if one of them falls off the cliff (Enron, WorldCom, etc), or an entire industry (like Telecom) sails into the doldrums.
Next and equally important is rule #2: Investigate. Understand the goals, fees, history, and management of your mutual funds. Know what the company you have invested in is doing to produce its revenue: Is its market share secure and growing? Who is the competition? Is the firm's technology leading, and likely to survive?
Next, you might want to consider adding some "Closed-End Funds" (CEF's) to your portfolio. Like Mutual Funds, the CEF's also offer diversification by holding a variety of stocks which are traded as a bundle on the various exchanges (NYSE, ASE, NASDAQ). But unlike mutual funds, CEF's have a fixed number of shares and therefore their prices move in relation to market demand. Thus there are times when CEF's sell for less (at a discount) than their net asset value (NAV), and times when they sell for more than the NAV (at a premium). Astute investors can use these as a means of growing their capital. (see Resources/Links for more information on CEF's.)

Investment Capital vs. Risk Capital

Here is where you determine your own personal comfort level with risk. As stated elsewhere on these pages, there is no "one size fits all" strategy when it comes to investing. Each individual has his or her own limits, goal, timetable, and tolerance for risk. Also, you have to understand that all investments carry some degree of risk - - even cash, because inflation erodes its value over time. (For extreme examples of inflationary effects, look at the history of Turkey or any South American country. The U.S. is not immune to this disease; but fortunately so far our doses have come in smaller increments.)

For our purposes here let's define "Risk Capital" to mean you will not be severely hurt when losses occur, as they most certainly will. Nobody bats 1,000 in this ballpark - - and every winning trade is not a home-run. Singles and doubles will do just fine! Regardless of what you hear or read, there are no proven "get-rich-quick" schemes. Investing is hard work!

In designating a portion of your holdings as "Risk Capital", your goal is to build (or replace) "Investment Capital". This means that as your "Risk Capital" portfolio grows, you transfer a portion of it back into your "Investment Capital" portfolio. Obviously, this style of investing is not suitable for everyone. But those who feel comfortable with it should be able to build or re-build capital - - - with the caveat that they maintain their Risk/Investment ratio along with their diligence and perseverance.

Managing Your Risk Capital

Having carefully considered that a portion of your funds could be invested in short-term trades, you must then consider the actual trading costs: commissions, and taxes, if you are trading outside a sheltered account. Assuming these are negligible, then you begin: s-l-o-w-l-y at first, with small trades, avoiding all get-rich-quick ads for commodities, options, etc, and never selling short. Lastly, print this and post it where you will read it daily:

I will always sell when I have a profit of x% or a loss of y%!

If you follow this rule you will avoid that major pitfall which so often traps the average trader - - - GREED (defined as: holding on longer for more gain; or worse, holding on longer to recover a loss).

Now, where will you find trading opportunities? The prime rule here is AVOID TIPS. Profitable advice is seldom found at the water-cooler, or over the fence, or in the locker room, or even on the tube. Unless you specifically know the person, and that he/she is qualified by background, and that you will not be trading on "insider information", you are wiser to conduct your own searches.

Managing Your Investment Capital

Here your focus should be on a longer term - - - with the goal of having your nest-egg ready when you need it. This means you prudently invest in stocks and/or mutual funds that are not always making headlines or mentioned on the financial networks. Choose stocks that have a strong niche. Make certain you understand the industry or market. Don't chase yesterday's mutual fund stars - - - study their long-term history. Know their goals, and their management and strategy before you send your hard-earned dollars to them. Keep in mind your need to diversify not only by number of holdings, but also by business sectors.

Try to start with at least 3 holdings; and here it would be wise to use 1 or 2 mutual funds (or CEF's) to get the necessary diversification. You can begin to add individual stocks as you learn and feel more comfortable making decisions based on your own analysis. And that personal analysis is imperative! Investing is work - - - there are no short-cuts or easy steps to being successful. So, yes, listen to the advice of others; but always consider the source and the motive behind any recommendation - - - and then do your own "due diligence". Study before making a commitment. Do not get swayed by urgency - - - there will always be other, and perhaps better opportunities.

Hopefully, your choices will all carry a low "Beta" (a number less than 1) - - this means the stock is not as volatile as the market in general. If the S & P 500 goes up 5%, a low beta stock will move less than 5%. And by the same token, if the market drops by 5%, the low beta stock should drop less than 5 %. Be advised that some mutual funds carry a high beta, meaning they are geared to move not just 1 to 1 with the Index they are tracking, but 1.5 or 2 to 1. This can be wonderful if you are always on the right side, but disastrous if that index is falling. (Save the high beta stocks for your Risk Capital account). (see Resources/Links on where to find Beta.)

Like all things in nature, markets as well as individual stocks and funds have cycles of their own. Prudent investors can use these to their advantage by taking money "off the table" at or near the top of a cycle, putting the funds into a Money Market account, and then re-purchasing when the price drops back to normal levels (providing it is has remained a solid investment). The main point to keep in mind here is that stocks, funds, indexes, sectors do not all follow the same cycle. You need to be aware of where your particular holdings are in relation to their own cycles. You can get this help with our Hottinger "E-Zone" Signals.

A final word to remember: exogenous. This is used to describe events that occur unpredictably - - - 9/11 is the greatest and most tragic example. Others, like the collapse of WorldCom and Enron might have been seen on the horizon, if only because their price/earnings ratios were historically and astronomically high. No one can protect you from the unknown; but you can give yourself and your portfolio a measure of protection by keeping abreast of how your holdings are priced in relation the their historical norms, watching their P/E ratios, and reading the quarterly and annual reports, proxy statements, and 10-K documents you receive. Like all good students, those who do their homework achieve more. We wish you every success.

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