Optimizing Returns with Investments

The Two Main Elements of Investing

Just because we plan on investing for years or even decades, this doesn’t mean that we don’t have to pay attention to our investments. This is true in spite of how popular it may be to ignore such things and even become negligent about them.

The idea of passive investing has become so popular and ingrained into investment culture that we usually do not even think of such things, and if we do, we simply brush off giving our investments even a minimal amount of attention due to our thinking that this doesn’t matter and in fact just isn’t a good idea.

Optimizing Returns with InvestmentsThat’s what we’re told by the investment industry, to just keep buying with our eyes closed, whether that be with a basket of securities or an index which tracks an index. We at least owe it to ourselves to question such things and see if this view actually makes sense, and if not, what else might make more sense.

We’ll look at this question from the perspective of the two issues of central importance to investing, which is seeking optimal returns and managing risk appropriately. Of the two, the risk management side is the more important, as there is more at stake here than just being disappointed with smaller returns, as risk management protects our capital and avoids losses.

We could say, quite rightly, that with our investment portfolios, it hurts more to lose than it feels good to win, and this is due to the fact that the first dollar is worth the most and every subsequent dollar worth a little less.

If things go wrong, this can mean that we can’t retire without great discomfort, and preventing that does need to be our goal first and foremost. Of course, our returns matter as well, and this article will address how we may help ourselves with that by committing to paying more attention to it and seeking better returns than just the random ones of buy and hold approaches.

Managing Our Investment Entries

We can start with the rationale that it doesn’t matter when we buy an investment if we’re looking to keep it for a long time. This question does speak to both risk and return, as if we’re careless with our entries or just don’t care, this is going to both expose us to more risk of loss as well as more risk that our returns will be less overall.

There are a lot of insights that we can gain from looking at how successful professional traders approach these things, and the only real difference between trading and investing is the length of time that the positions are held, with investors holding them a lot longer.

This does not mean that investors should be careless about their investing though, and when they are, this does impact their returns as well as their risk exposure. Traders cannot afford to trade carelessly like this, and some indeed do, but these are the ones that fail and usually fail quickly.

Good traders usually are very precise with their entries, and will often use charts of a tighter scale than they normally trade with to time their entries. A trade may look good on a chart with 15-minute bars, but if we look at it on 1-minute bars, we can spot situations where the momentum has reversed and this may indicate that now is not the time to get in, in spite of what the relatively looser 15-minute chart may say.

Investors aren’t going to ever want to be looking at 1-minute charts or 15-minute ones for that matter, but it does help to pay attention to the direction of the market on a shorter timeframe than will be used to monitor the trade once we’re in it. We don’t want to use these tighter timeframes once in the trade or investment, as this will have us getting an exit signal far too quickly, but prior to entering, we can afford to be more selective and pick our spots more.

Contrast this to the way investors usually do it, which we could call the blind method, because we don’t pay attention to these things at all. Even the most fundamentally inclined investors, who never wish to use market timing to decide when to exit trades, should still always use this for entries, provided that they care about their investments that is.

If we are looking to buy a stock or buy an index and it is moving away from us, to a degree that this is likely to continue for a while, why would we ever want to enter at this point in time? We might think that this is going to go up a lot over the next 20 years but this is no reason to enter at a wrong time where we’ll be more likely to realize early losses with it.

If something is trading at $100 for instance and it was $120 not long ago, it may appear to be more of a bargain, but not if it goes down to $80 before things stabilize and it starts moving our way more. Our paying an extra $20 a share isn’t much of a bargain at all.

Of course, we never know these things for certain, it’s all a matter of probabilities, but that’s what investing and trading is, taking advantage of probabilities that favor us and seeking to avoid probabilities that are against us.

In our example, if we’ve moved down this $20 and things are still pointing downward, that doesn’t indicate bullishness at all, and we should wait until there are good enough reasons to enter the trade or investment before we pull the trigger. While we may be left holding the funds in cash while we wait, this is clearly better than entering something that we expect and hope will go up but this probably won’t be happening right now.

Improving our entries will improve our overall return, and while we may think that this doesn’t matter so far down the road, it certainly does. In this case, the $20 a share we save ourselves will still make a difference of $20 times the number of shares we buy whether the calculation is done now or years from now.

Granted, the difference we see here may be much smaller than this, but it all adds up, and we owe it to ourselves to enter into investments at the right time, which means doing our best to ensure that this happens. It doesn’t happen by chance.

Seeking to Improve Returns While in Investments

The same principle applies after we’ve entered the investments, during our ownership period. We have been taught to keep our eye on the big picture, and whatever happens along the way, we are supposed to just assure ourselves that these things work out pretty good in the long run and we should therefore just commit to that and ignore everything else.

One of the reasons why this is not a good idea at all is because this attitude will result in our having to accept lesser returns than if we actually paid attention. This is something that we can know with greater certainty than what we may claim we know about the investments themselves or pretty much anything else related to investing, because it’s simply easier to be right over a shorter period of time than it is a longer one.

The road to the long run with investments is a windy one, and all you have to do is look at long-term charts to see how much these things move in both directions over time. Taking advantage of this does not require a crystal ball or exceptional skill, as these cycles manifest themselves fairly clearly and clear enough that you could even teach a child to be on the right side of them more often than not with a few simple lessons.

If we expect a downturn in our positions, with a high enough level of probability, which with investments basically only means being more probable than not, and we just sit back and take it, more often than not we’ll realize a loss during this time.

The fact that we may be able to overcome this loss later during the next up cycle or a future one doesn’t mean that it’s OK to just sit back and do nothing and put all this down to the vagaries of markets.

Just like with poor entries, these decisions affect our bottom line provided that we’re actually able to be right more than we’re wrong, which again isn’t that hard to do on a broad scale anyway. Most investors would be lost if they had to predict where something may be tomorrow, even though that’s not that difficult either, but when you’re dealing with only the big moves, those ones announce themselves very loudly indeed, which we call bull and bear markets.

A good example is the breakdown of stock markets during 2007-2008. We call this the Great Recession and financial trouble was plastered everywhere once it began, which led to a dramatic drop over the next 5 months that was pretty steady.

No one was bullish on the stock market during this time and the only real question was how far would it fall over the next while. Those who rode out the storm saw their stock positions lose over half their value and eventually make it all back and then some.

The smart money though got out of the stock market once this was underway, and only suffered much more modest drawdowns. Once the smoke cleared, they were free to re-enter, and bought their positions back at a considerably lower price.

The difference between the two, the exit and then subsequent re-entry, is all pure profit on top of what the investments have made since. We dropped over 1000 points on the S&P, and while it gained that back plus a lot more, it’s just better from the perspective of returns to get this a lot more plus quite a bit that we made from avoiding most of the massacre that preceded this comeback.

It’s been almost 10 years since, and the market has moved virtually straight up from there, to the point that it would be completely unreasonable to think that there was anything bearish enough during this time to get out of our long positions. The time will come where this will change, when this impressive bull run ends and we pull back by a significant amount.

Those who are paying attention and are ready for it will stand to profit, maybe not by shorting it but to at least be prepared to step aside when things trend the other way enough.

The previous major bull market lasted almost 20 years, but it did come to an abrupt halt in 2000, where it gave back almost half its value.

Seeing your portfolio decline by that much isn’t fun, and realizing that we could have increased our returns by looking to mitigate this damage may have us feeling even worse, but if we are truly looking to enhance our returns, we at least need to be willing to consider looking to be in our investments when they are more bullish and perhaps pull back when they become pretty bearish.

We are, after all, in this for the money, so the money should matter enough that we actually try to do things to make more and to actually pursue our goal of optimizing returns more faithfully and successfully.

Ken Stephens

Chief Editor, MarketReview.com

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.

Contact Ken: ken@marketreview.com

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