Ralph Bovitz, CPA, PFS

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Buy Low, Sell High - A How To

By Ralph Bovitz

     The key to successful investing is buy low, sell high!  Is this possible?  That depends on your interpretation - if you mean always buy at the very bottom and sell at the very top, the answer is no.  It is possible, however, to commit to an investment plan that is, over the long run, based on historical performance, profitable – avoiding the dreaded buy high and sell low.

     When you are too busy practicing law to watch your portfolio, can you still buy low and sell high?  When your caseload is so heavy you can barely breathe, can you, should you put your portfolio on a modified version of autopilot?  You can and will, once you recognize several characteristics of investment planning.  You will also reduce the urge to sell in a panic, which often translates into selling low, not high.

     First, you need to adopt an asset allocation strategy that consists of creating a portfolio of two or more types of assets that don’t behave the same.  Stocks and bonds are major “types” of assets that typically behave differently.  For example, if the stock market is going up, the bond market is likely to being going down – or going up, but not at the same rate.  Large company stocks and small company stocks, as well as foreign and domestic stocks, often react to business conditions differently. 

    So step one is to allocate your investments to various asset types, based on your risk tolerance.  If you have a low risk tolerance you will allocate a larger portion of your investment to bonds, for example.  Of course, the lower the risk, the lower the potential for growth and return.

     To illustrate a very simple asset allocation strategy the hypothetical investor might invest 50% of their investable assets into stocks, let’s say the Standard & Poor’s 500 Index.  (The Standard & Poor’s 500 Index is often used as a representative of the stock market’s 500 largest U.S. company stocks.) Assume the other 50% of the portfolio is invested in a mutual bond fund portfolio.

     When do you make this stock market investment?  Is this the right time or should you “wait a little”?  No one really knows when the right time is.  Several studies show that more people are chasing performance, however.  That means people are hearing (at the courthouse) or seeing (on financial TV) that this mutual fund, stock or bond is doing so well, let’s get on board; this is a winner!   More than 10 times the money flowed into mutual funds after the best-performing quarters when compared to the worst ones. Unfortunately, studies also show that the rate of redemptions (selling out of mutual funds) was nearly 18% of fund assets in 1996 but jumped to nearly 33% in year 2000, the year the market declined.  Putting it another way, investors are buying high (after the best quarters) and selling low (after the worst quarters).

      This tendency to buy into a rising market is sometimes described as momentum investing.  When everything is going up, “how can I lose” is often the attitude.  Frequently, you may be buying into a cycle that is ending, but you don’t know that until several days or weeks have elapsed.  So as is often said, no one has successfully and consistently timed the market --- getting into or out of the market at the right time.

      So when do I invest?  Well, if you have a long time horizon, defined as not needing to tap your portfolio for 5 years or more, then today is as good a day as any.  While some studies indicate invest all at once, you might want to spread your risk and develop confidence in your plan by investing a fixed amount each month or quarter.  Yes, you may invest in the stock market today and the market may decline 5% tomorrow.  For example, if you invested in large company stocks (S & P 500) in 1981, your return that year would have been a loss, nearly 5%.  However, if you did not bail out, 1982 would have delivered a return of more than 21%!

     In fact, a $10,000 investment in large company stocks (the S & P 500 Index) in 1970 would have grown to $430,460 by the end of year 2000.  Investing $10,000 in 1991 would have grown to $49,997 by the end of year 2000.  From 1996 to year 2000, your $10,000 S & P 500 Index portfolio would have grown to $23,210.

     Can this historical performance be improved?  That depends.  It takes courage.  You have to be prepared to buy when it seems you should be sitting tight or even selling before things get worse!  Let’s look at 1981-1982 again, assuming an asset allocated portfolio of $10,000 invested in S & P 500 large company stocks and $10,000 invested in bank certificates of deposit or a bond fund.  By the end of 1981, an investment of $10,000 in the S & P 500 Index, the stock-half of your portfolio, would have been worth $9,500.   If, on December 31, 1981 you sold $500 of your bond fund and invested the proceeds into the S & P 500 Index, restoring your stock investment to $10,000, that $10,000 would have grown to $12,140 by the end of 1982.  Failing to add $500 to your stock portfolio in this way would have produced a stock value of “only” $11,533 by the end of 1982.  Either result is not too shabby.  Have you ever sought a judgment that was “high” but wondered if you could you have asked for more but didn‘t have much faith in the outcome, if you did?  The point is, when part of your portfolio declines in value and you move funds from the better performing side to the “losing” side, you have sold high and bought low.  You need faith to buy low and wait it out.

     When you sell a portion of your portfolio that has a higher value than the other portion, you have “rebalanced” your portfolio.  In a nutshell, you have restored your portfolio to the relative values that existed when you began your investment program.  Let’s return to our hypothetical 50/50 portfolio, 50% large company stocks and 50% bonds. Assume a year later your portfolio value is 45% stocks and 55% bonds.  You may want to sell enough bonds and invest the proceeds into the stock portion of your portfolio to restore the relative values of your portfolio to 50/50.  Thus, you have sold (bonds) at a high and gone out to purchase stocks when they are lower.  You are selling high and buying low.

      What triggers the rebalancing decision?  That depends, again.  When you are presented a series of facts in a case, don’t you want to know which side you are on?  Clearly, if your client takes position A, doesn’t the other side find an attorney willing to take position B?  The same thinking applies to rebalancing.  First, you have to decide what constitutes a percentage or dollar difference from the original asset allocation mix that warrants rebalancing.  For example, where your original asset allocation is 50% large company stocks and 50% bonds, you might decide a 5% change warrants rebalancing.  Thus, if relative values become 45% stocks and 55% bonds, you would sell enough bonds and reinvest the proceeds into the stock market, to restore the asset allocation to 50/50.  Again, You are selling high and buying low. Many financial planners deem a 5% change between portfolio components a trigger to rebalance.

      When do you do this rebalancing?  You shouldn’t be looking at your portfolio every day.  After all, you have a practice to manage and work to do.  You need to be practicing law, increasing your billable time or winning more cases, to produce the funds to increase your investments.   So when do you rebalance?  Most financial planners recommend no more often than once a year.  Otherwise, you are guilty of being a market timer.  Moreover, frequent rebalancing increases your trading costs.  Finally, to avoid numerous tax hits, rebalancing your portfolio is more appropriate for investments in the retirement portion of your portfolio, such as your IRA, Keogh or 401 (k) plan.  With your taxable investments, you must be cognizant of taxes, when you rebalance your portfolio, by selling high and buying low.









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