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7:53 pm - Tuesday December 6, 2016

What is the Recommended Investment Strategy for Household Investors?

| Economics, Investing, Risk Management | Rating: 4.5
by Numan

I’ve promised to update you, my readers, on my investment decisions. I’ve decided.

After months of deliberation I’ve finally decided on getting my feet wet again and bought some stocks on Monday. As readers of The Personal Financier know I am a big fan of investment vehicles that track certain indices such as index funds or ETF’s so I’ve decided on gradually increasing my exposure to the markets via these financial instruments.

Needless to say I have a gift for timing the market, the other way around. Since my recent purchase leading indicators, such as the S&P500 had shed over 5%. That was rather expected as the markets rallied these past couple of months.

In this post I’ll share my personal considerations behind my recent decision to increase exposure to stocks. If I breakdown my decision into three main lines of consideration they would be:

  • My considerations regarding my desired investment style.
  • My considerations regarding the market environment.
  • My decision to use index funds and ETF’s and invest gradually using dollar cost averaging (Investing a certain sum each period).

My considerations regarding my desired investment style
So why did I decide to reinvest in stocks again? The reasons behind my newly discovered enthusiasm about the markets and why I decided on gradually increasing my exposure to stocks has a lot to do with what I consider a desired or suitable investment style for me and many other household investors (in my opinion, of course).

During the past couple of years I’ve been fortunate enough (ironically) to not have to worry about my savings and investments as I had none. I’d bought an apartment and literally invested my funds there releasing me of my need to consider alternative investments. Luckily enough the apartment I had bought has yet to suffer the impact of the housing crisis.

Now, two years later I’ve managed to save up a sum which necessitates more serious consideration regarding where to invest it and how to both preserve it and grow it, if possible.
Naturally, the state of the markets was enough cause of concern for me to seriously consider my investment plans. Losing my hard earned money is not an option.

The more I thought of it I understood I was failing to obey my view on investments, a view that I had learned after paying “tuition” in investment losses in my early investment years.
#1 I decided sitting on the fence won’t get me far
I find out I was literally sitting on the fence. Avoiding decision allowed me to remain unscathed during the recent plummet but I did not earn anything either. I’ve written a post titled “Who Dares Wins” but failed to follow it.

There is no need to take huge risks for huge profits, just thought out risk for a better chance of meeting my personal financial goals.
Sitting on the fence is not a solution to anything. It’s a very easy way out. Usually when I avoid deciding I know something is wrong. So I decided to slowly climb down from the fence.

It does feel much better to have decided and to have the feeling of taking a path and having a purpose. My savings were idling in a short term deposit which barely covers the bank’s fees with the low interest rate environment. I had to do something and feel like I’m doing something.
#2 I was guilty of timing the market
I just can’t help it. I don’t think many can. I always try and time the market. Since one does not usually keep objective score of one’s efforts of timing the market we never know whether we are any good at it. I most certainly am not.

No one thought the market would rally 50% after Citi’s March earning release. Missing out on such a rally is very costly in terms of investment. And now, having raced 50% up the more probable scenario is a downward technical correction in prices… and then? Timing the market almost never works so I’ve decide to stop and just invest a portion at a time thus averaging these corrections out and enjoying the long trend in prices which will hopefully be a bullish one.
#3 I finally remembered I am a long term investor
It took some time but I’ve finally remembered I’m actually a long term investor. I think it’s hard on humans to invest for the long term. We are programmed to be impatient and impatience is a bane for investors.

I think the birth of my baby boy had something to do with it. I’ve decided on treating my investments as his. An 18 year investment term should be enough to be considered long term (some may argue).
My considerations regarding the market environment
In my recent posts I’ve written about a correction in prices which is probable to follow the recent rally. I had thought the stress tests will give enough reason for sophisticated investors to realize profits and change the trend. This hasn’t happed, yet. Markets have shed 5% but this can be considered only profit taking on an uptrend.

I still believe a correction is in order but since I’ve decided on quitting my market timing efforts I’ve decided to ignore this belief. This is actually a great relief. No one seems to really know what’s going on anyway.

It certainly wasn’t short-term considerations regarding the economy which got me to reinvest. There seem to be fundamental reasons to believe the global economy will get better in the near future (2-3 years).
#1 Very low interest rate environment leaves little choice
There is money out there looking for reasonable returns. With interest rates this low this money has little choice of investment and will turn, eventually, to the stock market. Interest rates on deposits are so ridicules many investors will find it very hard to accept.

This low interest rate environment will hopefully serve to set the markets back in motion with cheaper credit more motivation to capitalize on this opportunity.

There are risks to such a low interest rate environment, together with increasing influx of money into the markets. Inflation will follow and will have to be controlled but hopefully we’ll be on a correct course by then.
#2 Risk appetite seems to be returning to the markets
One of the effects of the recent crisis has been a dramatic impact on risk appetite. When risks seem to be that high no return is justifiable. Risk appetite is perhaps the most important thing for the stock market which is, in essence, a risk-return tradeoff.

Recently there seems to have been a shift in trend and the risk appetite is reappearing. The public’s share in the stock markets is increasing through institutional investors and, hopefully, it won’t be long before the mass market will find stocks appealing again.
#3 Cyclicality
As my market timing days are over I am better equipped to use one of the characteristics of financial markets in my advantage. Cyclicality is a common trait of financial markets. Though it never seems so in times of prosperity or times of depressions, the tide will turn and the markets will change.

Keeping a presence in the market is vital for long term success and profiting of cyclicality.
My decision to use index funds and dollar cost averaging
My considerations should be clear by now in light of my investment style and market beliefs.
#1 Beating the market is as hard as timing it
Chances are you or the institutional investor you’ve chosen though a fund or IRA cannot beat the market. For this reason buying the market is the way to go. Fees and commissions paid are often unjustified and hurt portfolio performance with no real abnormal returns over the market.

Index funds are cheap in fees, are simple to follow I believe serve best the needs of household investors.
#2 Dollar cost averaging is a good way to gradually increase exposure
Uncertainty rules the markets, especially today. I would be very nervous had I invested my entire savings in one period. The market is still very fickle and dangerous. Naturally the risk – return equations dictates that averaging investments over time will yield lower returns, and it does, but it is important for sleeping at night.

Dollar cost averaging enables me to remain content even when markets correct themselves downwards. I’ll just buy more, cheaply. When markets are bullish again I’ll profit on the average investment.
I believe the outlines I’ve described to be the optimal solution for independent household investors under the current market conditions. I am not recommending anything to anyone. I’m simply describing my strategy as I’ve promised to do in the past.

I would not like to expose the size of my investments but rather the portion. I’ve invested 10% of my portfolio in stocks (US Index) and will continue to do so on a monthly basis.

I will update my readers on how my portfolio progresses. By next week I will hopefully have finalized my planned asset allocation and will share it as well.

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