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Context with Investments

July 14, 2016

Many times we get caught up in insignificant things that can have no meaningful effect on the final or overall outcome. We take things out of context. Here are some illustrations to consider with respect to investing:

  • Let’s take someone with a $900,000 stock portfolio that is managed quite well, and $100,000 that is held back to “play around” with and 10 stocks are bought for about $10,000 each. If just one of those stocks went down 50% to $5,000 most people would get very upset and feel bad about their choice. However, in relation to the entire $1,000,000 portfolio it is not meaningful or even representative of the total return you might expect. That $5,000 loss is taken out of context.
  • Let’s look again at that portfolio and assume that the entire $100,000 portion goes up 50% or $50,000. Again, in relation to the entire portfolio, it is not significant. You might feel good about it, but in reality it represents a 5% overall gain, and it might draw energy or attention away from evaluating how well your managed investments are performing and whether the present constitution of the portfolio is in accordance with your original plan or if it had drifted away from the targeted asset allocation.
  • When considering gains you need to measure them in relation to the entire portfolio for a given period of time. A 50% increase in that group might occur immediately and then there would be minimal upward or downward changes thereafter. Over a 5 year period the initial 50% gain become an annualized 10% gain which represents a 1% increase in the portfolio return. Not as attractive as it originally seemed.
  • The $100,000 portion in some respects is being managed by you so you should ask yourself what are the investment and trading costs, time commitment by you and effect of income taxes on realized gains and how that factors into your total return.
    Further, whether those stocks pay a dividend is also significant. For example if your base portfolio pays a 2% dividend and your side grouping pays 1% then you are behind 1% each year on that portion of your investments. Again, overall it is not significant, but like a constant drip, it does wear away your returns.
  • Alternatively, if you pay a management fee of 1% on your primary portfolio, and no fee on your playing around stocks, then that offsets the loss of the dividends. Again, not that significant to the entire picture.
  • A recurring theme by me is that you should stick to a plan and that the purpose of your investments should be to provide for your and your family’s financial security.
  • Does the trading bring you closer to your goals, or is it a “feel good” activity that is not treated with the same seriousness as the rest of your investments? Sometimes the “feel good” really is a “feel important” action that is not allied with your primary goal of providing for your financial security.
  • While you might have a big gain in a short period on your side portfolio, it is the sustainability of that gain over a longer term that really will matter. How will those stocks (or the ones with the really big gains) end up in ten years compared to the market as a whole? One way to look at this is to examine the long term performance of individual companies as shown in their annual reports. If you do this for enough companies you might notice that most end up comparable to the market index appropriate for that industry. The ups and down balance out and everything ends up close to each other over that period. If this is so, then why not just stick to index funds or large mutual funds rather than individual stocks?

The context of what we do is important and related to the big picture; but we sometimes take the importance of what we do to the overall situation out of context.

One Comment leave one →
  1. 6hawthorne permalink
    July 14, 2016 8:12 pm

    Hi Ed good article interesting bob

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