A recent study by The Journal of Portfolio Management shed light on something TBH Franklin has wondered about for years. How do the popular stocks perform over the long haul? The study pointed out stocks that were the most active by volume by its market value underperformed the following year, and the least active by volume per its market value outperformed the following year.
So what are the reasons for the popularity effect? Well, unlike other assets when demand rises, the prices rise and it draws more people into the stock “to try to make some money.” There is a saying for these momentum trades, “go with the trend, until it bends.” While these trades may have a short term positive, the long term effect is detrimental to a portfolio. It is best to find stocks that have great fundamentals and a great management team that is trading at a discount to their intrinsic value, and then buy.
Picking stocks can be detrimental to the long term value of a portfolio if not properly diversified. We often run into clients and prospects looking to buy stocks on something they read or saw, which plays into a pickup in volume. Our goal with clients is to get them focused on the long term aspects of a portfolio, but understand that some people want to set aside some play money. For those instances, here are a few guidelines to remember:
“The Market” is everyone else! Are you confident you are smarter than the PhD guy from Harvard? Do you believe information is inefficient and that you can act on public information faster than everyone else? Set a price to get out if it goes up or down (limit orders may be a good way to do this). If you believe in a stock at $34/ share, will you believe in it at $30/ share? Be tax sensitive for your gains or losses. If you double your money, remember if you take off half your position, you are only risking your gains.
Looking for that next adviser who can work with you on these things, make sure your estate plan and any other financial goals are being achieved in unison with the financial plan.
This sounds easy in principal, but how does one go about an assessment to determine risk? We prefer to use more than just a simple seven questions model. Using a service like Riskalyze allows you to input some information then answer some questions. After that, you can use that information to build a portfolio that matches this risk score. We have found that it is best to try to get another risk score every year or two, which allows the adviser to see if risks have changed as market conditions change. The inherent thing is to take more risks when things are good and less risk when things are bad, so taking multiple samples over a set of time allows for a more accurate reading. Using a risk model really allows one to see if individual stock picking is for you. The more aggressive you are, the more likely owning individual stocks may be for you. The more conservative you are the more likely bonds and ETFs are more suitable.
Investing is a marathon, not a sprint. A stock that grows fast like a pear tree, may also suffer from its weakness too. With the slightest wind or bad news, the stock could tumble. Do your homework on a stock because if you are listening to last year’s news, your stocks will reflect it. Travis S. Anderson