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Tuesday, July 17, 2007


Cortland, NY; Investments Part III

Cortland, NY is one of those small towns in central NY where the summers are beautiful and the rest of the year is frigid. We took our daughter there for orientation this week, which was less than scintillating since they spent most of the time reassuring the parents that they will in fact look after our kids a little and college will not amount to a 4 year beer fest. Frankly, if I was an incoming freshman, that is not the message that I want to focus on.

Best line of the week came from an incoming student: "This is as bad as school, or even worse!"


First, some definitions you need to have to understand the formula:

Buy/ Hold list - the stocks I determine that I am willing to buy and hold as part of my portfolio;

Zero buy - Buying a stock that is the smallest position in my buy / hold portfolio.

Value Buy - Buying the stock that is the smallest position in my buy/hold portfolio that meets my book value and debt/equity ratio criteria.

Cash allocation - cash divided by the total assets in my portfolio. I target 20%.

The formula is fairly simple to operate. The idea is to keep a 20% cash allocation. I am likely to raise that target allocation as I get older. The portfolio that constitutes my divisor consists of my taxable E-Trade account, my IRA E-Trade account, my full service brokerage account, and my municipal bond fund account. Treasuries and money market funds count as cash.

The next thing to determine is how often to trade. The bigger the account value, the more often I execute a transaction. For me, I like to use $500,000 as a benchmark for a transaction for every two week period. So if I had a portfolio that was less than $500,000, I would execute a transaction every two weeks. Between $500,000 and a million, I would execute a transaction each week, and so on. Once you determine when to transact, the next question is whether it is a buy or a sell. That depends on the cash allocation you are targeting. I target 20 % for me. For a younger person, I would target a lower cash allocation. If I have over 20% cash, i will buy. If lower, I will sell.

Currently I am transacting every other day (life is good). If it is a transaction day, the first thing to determine is which stocks will not be transacted. Those are whatever stocks were the subject of my last three transactions, and any stocks where I might be considered an insider (like the company I work for). The next thing is to determine if it is a buy or a sell, based on where I am versus my cash allocation target. If it is a sell, it is fairly cut and dried. I sell the stock which constitutes my largest position (in terms of dollar value), that is also not in the last three transactions. I sell a round lot (100 shares), as long as that will amount to $2000 or more, my minimum trade. If the stock were selling at 4, I would sell 500 shares. If I only have 100 shares left, (let's say I owned Berkshire Hathaway) I sell half of those shares instead of a round lot. I am not closing out the position. I only do that when I remove the stock from my buy/hold portfolio.

If it is a buy, I determine whether it is time for a zero buy or a value buy. If I have had a zero buy in my last three transactions, it will be a value buy. For a stock to be a value buy, it must have a price to book ratio of less than 2 and a debt to equity ratio of less than 1. Alternatively, it will be a value buy if the sum of those two ratios is 2.50 or less. Then I buy a round lot of a minimum of $2,000.

If there has been no zero buy in the last three transactions, the transaction is simply to buy a round lot (equaling a minimum of $2,000) in my smallest position. If I have a few stocks on my buy list where I own no shares, I'll sum the two ratios I use in the value buy calculation, and buy the stock with the lowest sum.

If I determine to buy or sell in the full service brokerage, for whatever reason, I'll use $4,000 as the minimum.

So that's all there is. I am constantly determining how often to trade by keeping tabs on the value of the whole portfolio (I use Microsoft Money and E-Trade). Then I determine whether I have a buy or sell and act accordingly, referencing my portfolios in Yahoo Finance. The following rules keep me in line:

Maintain the chosen cash allocation;

Don't trade the same company twice within four transactions;

If it's a buy, most on-line brokers will not let you trade stocks on-line that trade for less than a dollar; So I move on to the next stock if that one comes up.

Here's what the formula does for me:

it takes the emotion out of the equation;

it tends to direct me to buy stocks low and sell high;

it makes the sell decision much easier;

it still allows for sufficient creativity in terms of what goes on the buy/hold list.

it gradually improves the quality of the portfolio.

It keeps the portfolio diversified.

The next post will complete the puzzle by illustrating some situations where the absence of a formula caused pain (the famous Dell Computer case) and where the formula has helped me succeed.

Remember, this portfolio works for me, but it is not that likely to work as is for most others. However, having some formula you derive from your experiences is likely to be valuable if it logically helps you accomplish your goals and removes the emotion from decision making, especially the difficult sell decision.


On Monday, I sold another 200 of Conrad (CNRD) at 13.65. 100 of these were the last of the 11/2/04 purchase at 1.95, the other 100 were purchased at 2.25 on 2/9/05.


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