Monthly Archive for July, 2009

Question: If I reallocate my current holdings per your advice (possibly twice per month), won’t I be hurting myself by selling off the shares I have purchased at lower prices?  For instance, if I hypothetically have an average share price of $13 for a large number of shares in the C fund which I’ve invested in for 3 years, and then sell it off at $10 to buy L2010 or something else won’t I be taking continual losses over time?  In essence chasing the market?  If I were to sell 100 C shares at $10 to buy L2010, what happens if next month’s advice is to buy C shares when they are priced higher than $10?

Response: Here is the short answer, in two parts:

• First, what matters is the return, not the price. The principle behind my method is that one should pick the investment strategy with the highest possible return, given that it is within one’s risk tolerance.
• Second, both gains and losses are incurred at the time that they occur. There is no distinction between “paper” losses and “real” losses. All losses are real. There is no such thing as “locking in” one’s losses. Losses (and gains) are locked in as soon as they occur.

Now, let’s look at an example similar to the one that you give. For simplicity, let’s assume that you are not putting money in or taking money out of your account.

Let’s say a year ago, you had $13,000 in your account. You were following a certain investment strategy, let’s call in Strategy “A”. It does not matter what that strategy was. The strategy could have been to buy and hold the C Fund, or it could have been something else. Now, after a year, you have $10,000 left in your account. Strategy “A” has lost 23% ($3,000 / $13,000).

To recover this loss, you need to make 30% ($3,000 / $10,000). The problem is to find an investment strategy within your risk tolerance that is likely to recover this 30% the quickest. Another way of putting it is that you want to find the investment strategy within your risk tolerance with the highest return.

Say you estimate that Strategy “A” might return 10% per year. Then you find another strategy, Strategy “B”, that you think might return 15% per year. Given that the risk is acceptable, “B” is better than “A”.

Notice two things. First, price does not enter into the reasoning, just the projected return. Second, what the strategies themselves are does not matter. All that matters is their return and risk. The strategies could call for buying and holding, they could involve frequent trading, they could involve occasional rebalancing, or anything else. It doesn’t matter. Your decision is based only on the return and risk of the strategies.

My approach gets out of funds when they are losing money and gets into them when they are making money. You ask what will happen if you get out of C at $10 and then have to get back in at a higher price, say $11. It is true, if that happens, you will have missed the 10% up move in C. However, while you missed that return, you might have made an even higher return in whatever other funds that you were in.

If you know for a fact that C will go up by 10% and that no other fund or trading method will make 10% as quickly, then you should stay in C. But no one knows the future. There is also the possibility that, instead of making 10%, C actually loses money. My approach calculates the probabilities of various moves in all the investments and picks what it considers the optimal mix of investments.