There’s more than one way to Skin the Cat

There's more than one way to Skin the Cat We held an education day the other day and one thing became clear. A lot of self-directed investors have become trapped by habit. Sometimes you just need to stop and ask. “Am I doing the right thing?”. This article is for you. There are a few ways to manage your own investments depending on how much activity, passion and stress you are prepared to put in. Let me shed some light on your options. There are many ways to skin this cat. Here they are, from safest to most risky.  SKIM THE SURFACE
  • Option One. The lowest risk option. Balanced investing. Just sit in ‘the market’ all the time. You can do that through an industry fund or a retail fund. These large funds can expose you to a very balanced (boring) investment mix that holds a number of asset classes and achieves the ‘average’ return. You do well in good years. You do badly in bad years. The good news is that thanks to their expensive websites developed over the last few years you can now manipulate the mix of asset classes yourself, in some cases, from your mobile phone. The different mixtures of assets are called things like balanced, conservative, aggressive or cash, all of which are simply descriptions for different percentages in each asset class. It’s not rocket science, it well administered, there not a lot of value add and there’s a low level of activity, risk and involvement. As a reasonably high risk investor, if I was in an industry fund I’d sit almost all the time in their most aggressive option, which, to an equities investor, isn’t aggressive, and just occasionally, when the stock market made it to the front of the weekend tabloid newspaper for the wrong reasons, I’d hit whatever their most conservative option was. The game is to catch the bull markets which run for 80% of the time, and hit ‘cash’ to avoid the worst moments (pandemic, GFC, taper tantrum). This is the easy way to invest. No paperwork, a website to log into, a mobile app that gives you the ability to change your asset mix over a coffee on Saturday (it takes a few days to actually happen). All with higher than normal fees, lower than normal stress and the lowest level of personal activity.
  • Option two. Investing in Markets through market exposed exchange traded funds or ETFs. This is another way to invest in an essentially passive exposure to the markets. I’d say managed funds or listed investment companies (LICs) but you can’t trade managed funds and both managed funds and LICs are ‘active’ and more expensive. You want passive exposures which means no one is buggering about being clever. That means identifying passive ETFs, the ones with an algorithm running things and no employees. You can get a very hard to beat compounding exposure to the Australian market through a number of ETFs. You can also easily mix things up with exposures to international markets through passive ETFs. It will bore you, but you do avoid the other very dull asset classes (property, cash, fixed interest) and you retain the ability to time the market a bit more acutely and you can do it yourself on the ASX through any dealing platform. Most of the time you sit quietly in the market, but the main reason to do it like this would be to trade the market(s) occasionally, either to exploit the 5-10% market moves a few times a year, or to avoid the bigger 10-25% drops or the once in a lifetime 50% drops (which happen ten times a lifetime). They sound complicated, but really they’re not. A lot of investors now use ETFs to manage their own investments. The other beauty of it is that it is low cost and it avoids all the individual stock risk that now plagues individual stock pickers. We do this in our Strategy Portfolio.
  • Option Three. Now we’re a bit more risky and active. Option three involves low volatility investing in themes and sectors. The main issue here is, once again, avoiding individual stock risk. You do this by investing in themes and sector trends, again by using ETFs. We have recently bought a resources sector exposure through an ETF called OZR for instance. Type “OZR ETF” in google and you’ll find it. There are a host of themed passive ETFs that allow you to time sectors and themes. Again, avoid the active ones. You want passive ones that use an algorithm to generate an exposure to an index without brains involved. Investing in sectors and thematic ETFs allows you to be a bit more active by timing sectors and themes. It is still a bit boring but is a lot less risk and activity and there is a lot less admin involved than you will experience trading a portfolio of individual stocks. We also do this in our Strategy Portfolio.

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OR YOU CAN TAKE ON STOCK PICKING Diving into stocks – Now you dive under the surface of the market. After those three options things your next step is to pick stocks. Up until now you have been swimming on the surface taking advantage of the tides. Your costs, risk, volatility and level of activity have been low. The next step is to duck dive into deep water looking for gold. There are a few ways to do that. Here are the most obvious approaches.
  • Holding a Big 20 stock portfolio. A lot of you probably do this by default. This is where most of you get trapped. Holding around 20, mostly big, mostly obvious stocks. You trust them by virtue of their size and brand but don’t know them in detail. This is often more a more risky approach than it looks because of your lack of research and engagement. You can get trapped into this approach by capital gains (“I can’t sell”) which is understandable but not ideal. It may seem normal and sensible, but the truth is that if you’re going to do this ‘Moron Portfolio’ thing you’d be better saving yourself from a lot of admin, activity and lost evenings and weekends by just buying market ETFs and timing them. But if you inherited the portfolio or have the CBA from issue, you’re trapped. Just don’t pretend it’s ‘clever’. It’s lazy. Think about options one to three. This is what we do in our Long Term Portfolio.
  • Holding a Big 20 Income portfolio. Unlike holding a portfolio of twenty big stocks just because they’re big, picking twenty stocks for yield is a sensible use of your time. There’s a bit of brain needed here picking out the low volatility high yielding stocks that are reliable and dependable rather than cyclical. There are income stocks and there are income stocks. Banks are income stocks, they are boring, safe, have high pay-out ratios and few ambitions. They understand the importance of their dividends to shareholders and will pay them come high water although they cut them when its hell (Banking Royal Commission, GFC). Resources on the other hand are cyclical, they offer high yields in the good times but as we found out from RIO at the last results, not all the time. This is what we do in our Income Portfolio.
  • Stock picking a few good stocks. This is where I would be if I was out in the wilderness looking after my own Super. Five to ten stocks max. You know them well, get to understand how they trade, what they do, when to buy them and when to sell them. You get used to them. Then you quietly trade them. You want bottom left to top right stocks in the long term but you develop an edge and are able to pick the eyes out of them by unaggressive trading them. One a year, maybe three or four times a year? Its a pretty safe way to do stock picking that takes a combination of fundamentals (picking the right stock in the long term) and technical (trading the peaks and troughs). This is probably the most ‘fun’ and intellectual yet least guesswork way to make money out of stocks. The trick is to keep the list short so you know the stocks. Five would be a good number. Just trading one stock alone and doing it well (BHP?) would also be a fabulous low risk way to ‘Invest’ (make money in stocks) but thanks to the mantra of diversification, I can’t suggest that. The principle is that holding 5 stocks you know really well is less risky than holding 20 stocks you don’t know well.
  • Stock picking everything. Now we get to a place a lot of beginners get trapped without knowing its not normal. Trading everything and anything. It involves tips and it invites a lot of volatility, risk and reward. It is for people who don’t have a heart condition. This is riding the stormy seas. Its about timing fads, finding diamonds in the rough, spotting change. It’s for those of you with the time and energy and risk profile to attempt transformation. It is also, in my humble opinion, a bull market activity. Stocks with no earnings die in the cold. Trading loses money when it goes cold. Trading is an activity to do when the sun comes out. See Henry's Take.
Hope that’s useful. Reading this framework you might realise you have been trapped in an assumption about how the stock market is done when there are other alternatives. This explanation might allow you to choose how active, stressed, open to risk you want to be. Maybe what you’re doing (individual stock picking) is too risky and active. You have a choice not to do that. There is more than one way to skin this cat.
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More about the author – Marcus Padley

Marcus Padley is a highly-recognised stockbroker and business media personality. He founded Marcus Today Stock Market Newsletter in 1998. The business has built a community of like-minded investors who want to survive and thrive in the stock market. We achieve that through a combination of daily stock market education, ideas and activities.

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