Jack Lee, a retired engineer, worked at IBM for 28 years. He has traveled all over the world and has been an active investor for 10 years.
In 2016, the interest rate is near zero. The economy is stagnant with less than 2% GDP growth. The world is in turmoil. Energy is in oversupply. What is an investor to do?
Types of Assets
Here is a basic list of asset classes:
- a savings account in a bank
- stocks and bonds
- gold and precious metals
- mutual funds
- ETF (exchange-traded funds)
- index funds
In the current climate, with interest rates near zero, what are some investment strategies?
The goal of any long-term investment strategy is to preserve capital and hopefully gain profits over and above inflation rates. My investment target is to achieve at minimum 3% above the inflation rate.
For people near retirement or retired, investing is a way to protect their accumulated life savings. What are some options?
- You can keep cash under your mattress. This is one way to preserve capital but you risk losing all of it in a fire and a small portion each year due to inflation. Not a viable solution.
- You can keep it in a savings account at a bank. Currently, it pays an interest rate of only 0.01%. In fact, interest rate has been near zero for the past 10 years, while inflation has been running on average at 2% per year. Again, not a good way to save.
- You can purchase an annuity that will guarantee a monthly payment till your death. This is almost like an insurance policy. However, the down side is that you pay a front-loaded fee of 8% and your monthly benefits are fixed. No adjustments for future inflation.
- You can invest in an index fund. This is the simplest way to invest and requires no time or skill. You are basically investing in the average of a large number of companies. Index funds have low fees and rise and fall with the stock market. A simple strategy that works in the long run.
- You can invest in individual stocks of publicly traded companies. This involves knowing which stocks to choose and monitoring them periodically. Buying and selling of stocks will incur a fee for each transaction.
- You can invest in mutual funds. There are fees, of various degrees, and you cannot trade during the day. The value is set at the end of each trading day.
- You can invest in ETF, or exchange traded funds. These act just like stocks and can be traded just as any stocks.
My Hybrid Strategy of Investing
One key to investing is diversification. Never put all your eggs in one basket. The goal is to grow the pot over time.
Here are my 10 ideas:
- Pick good stocks and buy and hold.
- invest in stocks that pay good dividends (with steady returns above 3%).
- Invest a portion in mutual funds (30%).
- Invest in SPY.
- Invest a small portion on new speculative stocks that have potential (5-10%).
- Apply some hedging using SPY and SPXU (10%). Explained in detail below.
- Invest in some ETF (gold and silver and oil).
- Keep some in cash always (10% of portfolio).
- Invest in individual stocks that show promise and have good track records.
- Buy low, sell high.
Don't be greedy. When a stock reaches a 10% gain, sell and take the gain.
Once a year, re-balance your portfolio and adjust strategy based on actual results. In other times, consider changes only if major financial factors come into view, for example increased interest rates by the Federal Reserve.
How Does Hedging Work—A Simple Example
Assume that the DOW is 18,000 and you own 35K of SPY and 15K of SPXU at the start for a total of 50K.
Assume the DOW climbs to 19,000, a gain of 5%. You sell 12K of SPY and buy SPXU simultaneously.
If the SPY tracks the DOW and the SPXU is inversely affected by a factor of 3, as it averages on a given day, the net effect would be SPY at 36.75K and SPXU at 12.75K. A gain of .5K.
After the sale of 12K, the SPY will be 24.75K and the purchase of SPXU will be 24.75K.
Assume on another trading day, the DOW drops back to 18,000, a loss of 5%.The SPY will be 23.5K while the SPXU will rise to 28.5K. A total value of 52K. A net gain of 2K minus the cost of the trades.
For a more dramatic case, assume the DOW is at 20,000 and you own 35K of SPY and 15K of SPXU.
A major correction hits and the DOW dropped to 16,000 in one day, a drop of 20%. Your balance will be 28K of SPY and 24K of SPXU, a balance of 52K. An actual gain of 2K.
Assume on that correction day, you sell 10K of SPXU and simultaneously buy 10K of SPY.
You will have 38K of SPY and 14K of SPXU. On subesquent days or even weeks, the DOW recovers 10 percent to 17,600.
Your balance will be 41.8K of SPY and 9.8K of SPXU, a total of 51.6K.
Why Does Hedging Work?
In the three simple cases above, you can see how one can use hedging to reduce the impact of a major correction. This does not come without a price. You are reducing the down side of a correction, but you are also limiting the gains on the upside. They go hand in hand. There is no free lunch in investing.
The reason this simple strategy works is the opposite relations between SPY and SPXU. When SPY goes up, SPXU goes down by a factor of 3 and conversely, when the SPY goes down, SPXU will rise by a factor of 3.
Political Shifts (Nov. 22, 2016)
After the surprise election of Mr. trump, there is a major shift in business and wall street. Therefore, a new revised strategy is in play. For example, Trump is from the climate change skeptics side of the political spectrum. As such, the election already has seen big shifts in various sectors. In specific, solar, coal and energy sector.
In the weeks after the election, the DOW has reached a new high of 19000, contrary to experts who had predicted the opposit.
Solar companies and renewables have seen a huge drop in value. Meanwhile, coal companies and oil companies have seen an up swing.
As a private investor, I have sold my stock in Solar and added more of coal companies.
In addition, I expect interest rates will begin to rise as the Federal Reserve will change leadership.
DOW vs. SPY Chart History
When it comes to personal investing, it doesn't have to be complicated. You will sleep better if you just follow a few basics.
- Don't panic sell.
- Keep a cash reserve.
- Invest in index funds for the least effort and low fees.
- Don't try to time the market.
- Don't be greedy
- There is no sure thing.
You don't have to be right 100% of the time. You will gain even with a 60/40 record.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2016 Jack Lee