06-25-2020: How Strong is Your Intestinal Fortitude?

Some things I am going to say in this evening's blog are patently obvious, but sometimes, even the obvious is ignored. Some things you may not agree with and that is definitely okay, too. This all has to do with how well your managed accounts are performing and how often you should check on the status of your account(s).


As you most likely know, I am a big believer in letting "the market" determine whether we should be bullish, bearish or neutral, with regard to our investment bias. So, you might come to the (correct) conclusion that there is a strong correlation between the holdings that we have in a portfolio and the bullishness or bearishness of the market.


This is true for every moment of every trading day. To one degree or another, strong moves one way or the other in the stock market will have an impact on the share price of the holdings in any of our model portfolios. If the move is sufficient to trigger a holding's stop loss price, the holding will be sold. If the stop is above its basis, the result will be a REALIZED gain. If the stop is below its basis, the result will be a REALIZED loss. But (and this is important), prior to stopping out, the holding would have had a higher UNREALIZED value. The sell-off in the market can move a holding's UNREALIZED 'value' lower and, on paper, appear as a loss; even if the stop out generates a REALIZED profit.


Was that last sentence as confusing as it seems when I re-read it?...


Watching these actions, moment by moment, can be gut-wrenching. One moment, you're up big time; the next moment, all of that beautiful gain is gone... just gone. You're asking yourself, "What the heck happened?"


If these kind of whipsaws cause your emotions to overreact, then this evening's blog may prove useful to you.


Each week, I post in my Client Letter, how much gain or loss (realized) will be seen in each portfolio model, if 100% of the stop loss settings are triggered. This is the worst-case scenario of each portfolio, assuming the client has been with me from the beginning of the year. But, even if a client has been with me for a shorter period of time, they can see the negative impact of how much the portfolio’s unrealized gains will be impacted by hitting 100% of the stops.


Your emotional well-being would be greatly served if you ONLY concentrated on this one number... the net gain or loss if all stops are triggered. This number ignores the huge up-day or huge down-day that occurred last week. You stop watching your account moment-by-moment. You quit second-guessing whether or not you agree with your manager's investment decisions. You just look at the net asset value of your account(s) if the market suddenly turned and all the stops were triggered.


But, most of my clients watch what's going in their accounts every day... some of you (and you know who you are) are refreshing your account balances every few minutes and you run the gamut of euphoria and depression. My advice to you is this... just stop it. You'll be a lot happier if you look at your accounts far less often.


When the market hits an air pocket (like it did yesterday), the unrealized gains will be negatively impacted. Likewise, when the holdings move up in strong, up-trending markets, the unrealized gains are positively impacted. Unrealized gains and unrealized losses are not your real returns. You ONLY see your real return when those unrealized values turn into realized values; and, that only happens when you sell.

That's right... the only way to move from unrealized to realized is to sell. If you were with a traditional money manager, you would (likely) only see your account on a quarterly basis and these short-term swings in the market would never be seen. I show my clients what is going on in their portfolios weekly and they can look at their individual accounts any time that they want. This often leads to folks getting emotionally impacted by the hour-to-hour ebb and flow of their accounts. While I do believe it is important for clients to stay aware of what is happening in their accounts, the instantaneous assessment of making or losing money is sometimes very hard for their emotions to handle.

I cannot dictate what the market will do, of course, but I can react to it. My job is to generate more realized gains and less realized losses for my clients, but sometimes this takes time; more than an hour or a day or a week or a month.

And, lastly... Most investors do not quantify risk. We do and we are always looking for ways to increase return while lowering risk. I show how our portfolios stack up against the S&P 500 every week in my Client Letter, in the Beta and Sharpe Ratio results. Some of my portfolio models are far less risky than the market. One of my models (the Aggressive Growth model) is quite a bit more risky than the market (S&P 500).


Strategies that have more risk than the market, are expected to do far better than the market when the market is in a strong trend up or down, but sudden trend reversals can significantly negatively impact our higher risk strategies. It all comes down to the process (investment methodology) and how well the process works over time.


I guess, my best advice is this: Understand the process; know that the process is being followed with discipline; read the Weekly Report on the stop loss status; and if you believe in the process, give it time to perform. You will sleep better at night, if you do.