Brick By Brick Investing

Strategic Attack – Fundamental Analysis

Detailed Assessment & Planning – Investment Plan

Disposition Of Army – Defensive Investing

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Art of War Chapter 4 Summary explains the importance of defending existing positions until you can advance them and how you must recognize opportunities, not try to create them.

Translation for investors:

Never lose money
Patience is a virtue

Asset Allocation

All too often I observe retail investors making a grave mistake with their portfolios. This mistake is improper asset allocation in regards to their investment portfolio. Contrary to popular belief asset allocation is equally important if not more important than the actual stocks you decide to invest in. The most common industry misconception in regards to proper asset allocation is the belief of having numerous stocks in portfolio in order to be ”diversified.” This belief leads investors to believe they can avoid catastrophic losses but this couldn’t be any farther from the truth. It is my belief that investors should focus on investing in the best and largest businesses at the right price instead of diving into numerous stock positions in order to feel a sense of security.

What is Proper Asset Allocation? – I can almost guarantee at some point in our lives we have known someone (or are guilty ourselves) who put a sizable amount of money into one stock and sustained a catastrophic loss. The headlines, the story, and background of the business or idea sounded great, but at the end of the day the market decided you were wrong! Remember Netflix? We are all familiar with the DVD/Media Streaming service. This stock shot up like a spaceship to the moon based on the revolution of cheap rentals, going from $100 to $300, it almost seemed like you couldn’t lose money. Unfortunately this Cinderella story ended badly, take a look…

Trailing Stop Losses

I have a quick question for you, you don’t have to answer, it’s rhetoric. How many people do you know that have had some sort of asset (land, stocks, house, etc) and seen the value of that asset drop significantly only to hope and pray that it goes back up. Time and time again I witness this with family and friends like it’s a broken record. As investors and owners I know it is easy to get attached to your assets as you have spent a considerable amount of time and money acquiring them but the cold hard truth is not all assets are going to be profitable. Additionally when you “wait for things to turn around” you are causing more harm than good, the further into the hole you get the harder it is to climb out. Take a look at this chart that shows how your asset would have to perform in order to get back to break even after a significant loss.

What is a trailing stop?

Technical Definition - A stop loss order set at a percentage level below the market price for a long stock position. The trailing stop price is adjusted as the price fluctuates.

Practical Definition - A predetermined percentage below your entry price that you are willing to lose. This could be 10%, 15% or 25% whatever you determine this will be your “pack up your bags and move on” price point. In other words, if the price falls below this price point it will set off an automatic trigger to sell. However, we all hope that the price of the stock moves upwards and when/if it does your trailing stop moves upwards as well. This mechanism allows you to do three things:

It allows you to let profits run without selling your position too soon.

Allows you to cut your losses early to prevent catastrophic loss to your portfolio.

Literally takes all the emotion out of investing, which prevents you from making a drastic mistake.

Takeaway

A portfolio that utilizes both the tactics of proper asset allocation and trailing stops will have solid defense against stock market volatility. This will GUARANTEE that you never suffer significant loss to your portfolio. And yes I just guaranteed you that you can prevent significant loss to you portfolio. Here is how!

For this example assume you have a portfolio and at the moment it only holds $100,000 cash. There are two rules and they are absolutely non negotiable!

1. Do not place more than 5% of your capital into one position, PERIOD. No excuses

2. Emplace and adhere to a 25% trailing stop loss on ALL positions. No excuses

That is it, plain and simple.

“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle”

- Sun Tzu

Based on this example you would have 20 different positions of $5,000 each if you were fully invested. Since you are adhering to a trailing stop of 25% you can lose no more than $1,250 on a position. Before you invest a penny you already know that if are wrong (and it will happen) you will lose 1.25% of your portfolio. Now on the highly off chance that we have a catastrophic disaster and all of your positions were to hit their trailing stops after you initially purchased all 20 positions then you would lose 25% of your portfolio. That is the ABSOLUTE WORST that could happen, not a penny more.

Do you currently practice asset allocation in your portfolio? How about trailing stops? Do you think the stocks you choose is more important than proper asset allocation?

May 12, 2013

18 Comments

Wealth Build Bricks – Session #14

Ugh! Still working diligently hard on my other side project that I am desperately waiting to share with you guys. I will share one hard lesson learned with you this week though: My buddy and I hired a web developer off of Odesk to create this website. We “thought” we gave him all the information [...]

May 10, 2013

14 Comments

Strategic Attack – Fundamental Analysis

Art of War Chapter 3 Summary defines the source of strength as unity, not size, and the five components that you need to succeed in any war. Fundamental Stock Analysis As with any other craft it is imperative that one understand the fundamentals of stock investing prior to engaging in any other activity in relation to [...]

May 7, 2013

27 Comments

Waging War – Stock Direction

Art of War Chapter 2 Summary explains how to understand the economy of war and how unrivaled success requires making the winning decision. This requires limiting the cost of your competition and engagements. Translation for investors: Be very selective with the companies you decide to invest your hard earned capital Know the absolute worst outcome before [...]

May 6, 2013

35 Comments

Carnival of Retirement – Brick Building Edition!

It is my pleasure to host this week’s edition of the Carnival for Retirement. You’ll find a plethora of financial articles here that will assist you in building towards a successful retirement. For anyone interested in being included in these carnivals please visit the Blogger Carnival to submit your articles for consideration. Enjoy! Roger Wohlner [...]

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