TS Financial, Inc.

3 Mistakes Investors Make

2008-12-01T13:32:00.000-08:00

I'm constantly amazed at the power of propaganda and advertising. The return of the stock market over the last 10 years as measured by the S&P 500, is negative. Yes, you heard me right. Negative. As in less than zero.

Yet, there's not a day that goes by that I don't read a mutual fund manager or financial advisor saying “Don't sell your investments now, because all you'll do is lock in the loss!” OK, but why didn't you tell me to sell in December 2007, when I could have locked in some profits???

The reason is that mutual fund companies and those who sell them have a vested interest in you being in mutual funds. All the time. Good and bad markets. That's why they always advertise to be a “long-term” investor. I don't know about you, but to me 10 years IS a long-term.

The problem is we haven't been in a “buy and hold” market since 2000. And this secular bear market is likely to last another 10 years. To that end, here are 3 mistakes investors make and some possible solutions:

Mistake #1 – Being in the market all the time

It goes without saying that when investing, sometimes we should be on “Offense” and sometimes we should play “Defense”. This means there are times when we should be fully invested to build the portfolio and grow our wealth. But there are also times when we should either protect the profits we have or simply sit on the sidelines and wait. Remember, avoiding big losses is critical for consistent profits. There's always more opportunity, but not always more money to invest (especially if you're retired!).

Mistake #2 – Not knowing where you'll get out

We've all heard the saying “Buy low, sell high” and it's the only way to make profits in the market. However, the reality of investing is that sometimes you buy an investment “low” and it goes “lower”. It's important to your returns (and your emotions) to not let a small loss become a huge loss. Therefore, always know where your “ouch” point is on any investment. This is where you'll sell it and cut your losses. It could be a dollar amount (-$1,000) or a percentage (-5%). If an investment does go up enough, make your exit point higher than where you bought it. That way you'll at least guarantee a small profit. And remember, if you do sell an investment at your exit point, refer to Mistake #1.

Mistake #3 – Investing in mutual funds

It's not that I hate mutual funds, it's just that they are terrible for risk-management. You can't put a stop-loss order in for a mutual fund. But there are investments similar to mutual funds that are good for risk-management. They're called Exchange Traded Funds and they've been around since 1993. They are basically a basket of stocks like a mutual fund. But they trade on an exchange like a stock. This allows special orders types, like stop-loss orders, trailing stops (where the stop goes up if the ETF does, but never goes down), and others. Plus there's a whole line of ETFs which are designed to go up when the markets go down! Talk about a way to protect your profits!!!

Drop your mutual funds and replace them with a better choice like ETFs.

Financial pundits are always talking about diversifying your investments. But how about diversifying your strategies. “Buy and hold” is only one of several ways to invest. And many of the others have been profitable, even in this bear market. I hope all investors will review their strategies and see how they've done over the last 10 years. It can be very eye opening. Don't let the next decade pass without moving ahead.

And don't make the same mistakes again.

-----Tommy Sikes is a fee-only money manager based in Hillsborough, NC. He manages market risk for high net worth families who want to accumulate and preserve wealth. He can be reached at 919-644-0090 or by email: tommy@tsfinancial.info . His website is www.tsfinancial.info .

The Boomer Effect

2008-08-06T11:13:00.000-07:00

Starting in 2011, the largest demographic group in the history of the United States will begin hitting retirement age. This is also the group which controls the most wealth in the history of our country. We commonly refer to them as Baby Boomers, but let's discuss why they might also be called the Stock Market Busters.

Over the 20 year period from 1980-2000 our country saw many incredible advances in innovation and productivity. New business were created, new opportunities were found and the standard of living increased greatly. No doubt this had a positive effect on the stock markets.

This period also saw growth of the discretionary income of the Baby Boomer generation. And while much of that income found it's way into new cars, new houses and new toys, much of it found it's way into the stock market. This was primarily through 401k's, IRA's and brokerage accounts. Since there was a net addition to the markets, it makes sense that stock prices would generally rise. Of course there were the typical ups and downs, but the overall trend was positive.

Now let's fast forward to the last 9 years. We've been through a tech-bubble that burst in 2000, a terrorist attack that crippled the markets in 2001, accounting scandals and now a bubble in commodities. All of these events have put considerable strain on the market and also on the psychology of investors. Most investors are ready for the market to get back to it's march upwards, like in the 80's and 90's.

That's where the Boomers come in.

With the Boomers starting to retire, all that money that was flowing into the market will begin to flow back out of the market. With a net withdrawal, we'll likely see the returns of the market diminished greatly. This doesn't mean the market will go down for the next 10 to 20 years. It just means the 10%-20% returns of the previous bull market are probably a thing of the past. We may be lucky to average 3-7% going forward, just about in line with inflation.

So the choice becomes, should an investor keep buying a holding the same stocks and mutual funds and hope that we return to the glory days, or is it time to take a serious look at alternatives? Like strategies where you can profit in up, down or sideways markets.

I'd prefer to take action and find out what else is out there, rather than let time slip by and hope for a return of the old days.

Market-Neutral Investing

2008-06-23T07:24:00.000-07:00

Where will the stock market be in 20 years? Higher, lower, or about the same?

How about in 5 years?

What about 1 month from now?

If I polled retail investors I'd bet that a great majority would say that the market will be higher in 20 years. For the 5 year timeframe I'd guess that most would say higher, but the percentage would drop. For one month, the number of people saying higher might drop to close to 50%.

When we invest with a market-neutral strategy we're not saying that the market is not going to move at all. We're simply saying we have no idea what DIRECTION the market will move.

So how do we do this? And more importantly, how can we make money?

I start by looking for diversified, liquid indexes that should track the overall market. My favorites are the SPX (S&P 500 index), NDX (Nasdaq 100 index) and the RUT (Russell 2000 index). These are all optionable and frequently traded.

Without getting too technical, there are two basic option strategies we employ to create our market-neutral portfolio. One is a credit spread and the other is a calendar spread. These are both risk-defined strategies, so we can know what our max gain and loss is from day one. We put these trades on every month in a consistent fashion. With good risk-management, we can get an edge on the market.

What these option spreads allow us to do is to define a range within which we can profit. The benefit is that every day that goes by with the index in our range, we make money. I don't know of any other investment where you can get paid for the market doing nothing!

So what's the catch, Tommy? It can't be that easy!

You're right. Remember, the index needs to stay in our range for us to make money. But what if the market really moves in one direction or the other? That's where the risk-management plan come into effect. Just because we know what our max loss is doesn't mean we want to get there!!!

The beauty of using these liquid options is the ability to make adjustments when necessary. It's like playing roulette, but being able to change your bet right up until the ball stops moving. When the market gets to one of our pre-determined points, we simply adjust our range out farther, or take the trade off for a smaller profit.

We also have to know that we won't win every time. This is the stock market we're talking about. Don't let the need to be right get in the way of making good profits.

Given the market we're in, I think this type of neutral strategy is a great way to generate profits and control risk. I like being able to make money whether the market goes up, down or stays the same.

So next time someone asks you "Where do you think the market is heading?" you can say "I don't have any idea, but I can still make money!"

Tommy Sikes

Absolute vs. Relative Returns

2008-05-23T10:00:00.000-07:00

Anyone who's attended my classes or speaking engagements has heard me refer to "absolute" returns and "relative" returns. Let's talk about what they are and why they're important.

Have you ever seen a mutual fund advertisement or prospectus? In the performance section you'll often see the returns listed on a 1yr, 3yr, 5yr and 10yr basis. Often there will also be a comparison of the mutual fund to an index, like the S&P 500. Or it may compare the fund to the average of all it's "peer" funds, which are in a similar category, like Large Cap Value.

So you may see something like this:

Fund XYZ 3yr 6.3% (+1.3% vs. S&P500) and 5yr 7.9% (-2.7% vs. S&P500)

What this is saying is that over the last 3 years and 5 years, Fund XYZ has averaged 6.3% and 7.9% per year, respectively. The part in parentheses means that those returns were on average 1.3% better than the S&P 500 over the last 3yrs and 2.7% worse than the S&P 500 over the last 5 years. In other words, the performance RELATIVE to the S&P500.

So what does this mean Tommy?

It means that this fund and the fund manager are measured or "benchmarked" against the S&P500. In other words, any performance incentives are likely tied to beating the market or benchmark, not necessarily providing good returns. If the S&P 500 lost 22.3% in a year (like in 2002) and this fund returned -19.9%, that would be a big win for the portfolio manager (+2.4% vs. S&P 500).

I don't know about you, but I'd be upset if a portfolio manager got a bonus for losing 19.9% of my money!!!

ABSOLUTE returns on the other hand, means positive returns regardless of what the S&P 500 did or any other measure. It means moving forward in any market environment, interest rate level or inflation period.

But Tommy, you can't have positive returns every year! That's crazy! You have to suffer through some losing years. That's why you diversify and invest for the "long-term"!

Believe that if you want, but there are literally thousands of funds out there that produce solid positive returns each and every year. Some are focused on the U.S. markets, some on international markets. Some are invested in stocks only, while others diversify into commodities or private equity.

Tommy, why haven't I read about these mutual funds before?

Because they're not mutual funds, they're hedge funds.

Let me tell you why I think hedge funds are perhaps the best investment vehicles out there. First, true hedge funds are all about risk management. Without the limits imposed on mutual funds, hedge funds are able to actively manage risks by diversifying their strategies and using alternative investments, like options and futures. With these tools managers can set up scenarios where they profit from up, down or sideways markets.

Secondly, the performance bonuses paid to hedge fund managers are based entirely on the amount of net positive returns. And this doesn't reset each year like mutual funds. The positive returns have to be above any previous high-water mark! Unless the manager controls risk in volatile markets and takes advantage of opportunities (long and short) there's no bonus paid.

That's why we use many of the same techniques at TS Financial. We figure the reason people pay us is to make them real money, not relative money.

Don't you want someone who's interests are the same as yours, not losing money and making money each year?

Absolutely.