Frozen stock portfolio? Let it go!
Many are cold, but few are frozen
Question:
Based on what I have been hearing, the next few years may not be as good for stock investing as in the recent past. Experts are one in saying that the Philippine economy will continue to expand. However, investment analysts are also saying that interest rates may start to move up in 2014 while global funds may shift their focus to the US and Europe. Given that I am heavy into Philippine stocks, what would be the best strategy for my portfolio?—Posted at PFA’s “ask a friend, ask Efren” service at www.personalfinance.ph
Answer: The first thing that you should do is determine whether your long-term objectives are aligned with the potential returns from and inherent risks with stocks. If they are not, then you should not be in stocks in the first place. But let’s assume you are meant to be in stocks.
Since you talk of a stock portfolio, you are probably invested in a number of listed companies. It is true that a diversified portfolio will be better protected against fluctuations in stock prices than one that is not. However, a portfolio that is invested in just one geographical location, in the grand scheme of global investing, is also not that diversified.
But take heart as there are things you can do with your geographically un-diversified investments in the face of prices moving sideways or heading south. If the price of a stock you own is lower than its intrinsic value (including potential cash dividends), and if by going up to that intrinsic value your stock will produce a capital gain that is aligned with your return objectives, then you should keep that stock.
If the price of that stock goes down further, you should consider buying additional shares to lower your average cost (assuming you still have the funds to do so). But be very patient as major stock trends move ever so slowly.
The ideal time you should sell winning investments is if you have achieved your target return and you already have to fund an objective like children’s education, car purchase, house construction or retirement expenses.
However, if the valuation of a stock you own is very close to, already at or even higher than its intrinsic value, then it may be time to let go of the stock for now, even if you bought it at a higher price, and seek shelter in some temporary fixed income instrument. Again, the attached strategy is based on your expectation that stock prices will either move sideways or decline.
Now selling a stock that would lead you to incur a loss is easier said than done. Disposition effect is what behavioral economists label as people’s propensity to sell winning investments early and hold on to losing ones. This kind of behavior also has to do with prospect theory, more specifically the fear of losing.
Prospect theory states that the intensity of the pain from losing, say P1,000, is much more than the intensity of the joy from winning the same amount. This is why people find it easier to save through automatic salary deductions. The amounts deducted are considered foregone gains because a person does not get the chance to see and “own” them. On the other hand, a person that has to be the one to periodically take out amounts from his pay for savings will view such withdrawals as outright losses.
So before you start tinkering around with your portfolio, prepare yourself first by understanding the natural inclinations you will need to go against. Theories in behavioral economics cannot be applied in a regimented way. On the other hand, they cannot be done away with not only because of their allure but also because we need them in life, just as we need fear to avoid too much risk taking.
One other thing; company valuations require a great deal of effort and skill. Asset management companies spend considerable amounts of money on research just to come up with their own valuation studies. Others are able to rely on the extensive research of large stock brokerages provided the former have hundreds of millions of assets under management. That is why the best alternative for people with much smaller portfolios is to buy into managed funds run by the big asset management companies.
One of my best friends once said that many are cold, but few are frozen. So yes, your portfolio as a whole may have turned cold. But not all of your individual investments may be frozen in return expectations if these were your reasons for buying them: a) above average earnings to be generated in the next few years or b) high and consistent dividend yields.
If you want to learn more about managing your investments, please visit www.personalfinance.ph. There is a host of free useful resources there. You may also attend one of the 2014 EnRich™ personal finance trainings as follows: Feb. 22 in San Fernando, Pampanga, March 1 in Baguio City, March 8 in Davao City, March 15 in Cebu City and March 22 in Quezon City. Details for the next EnRich™ may be found in the website.
Efren Ll. Cruz is a Registered Financial Planner of RFP Philippines. He is best selling book author of Pwede Na! (A Complete Guide to Personal Finance) in 2004, and is the chairman and president of the Personal Finance Advisers Philippines Corporation.
Source: http://business.inquirer.net/160995/frozen-stock-portfolio-let-it-go
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