Investoid

In my last post, I talked about why I think that most average investors should use a combination of index funds for the majority of their equity asset allocation. I went on and on about how most actively managed products available to regular investors provide inferior returns (compared to a relevant benchmark index) over time.

Given that, why does my investment philosophy talk about having a proportion of your portfolio in actively managed assets? There are a couple of reasons:

1. As I stated in my investment philosophy, I don’t believe that assets (stocks in particular) are always fairly priced. I do believe it can be hard to continually capitalize on mispricings though.
2. In my case for passive investing, I mentioned that there are investment products (and people) who can continually beat the market over the long term. These investments may also exhibit lower volatility, thus making them even more attractive on a risk/return basis.

Therefore, I think it’s reasonable to allocate some of your assets to actively managed investments, in order to attempt to achieve higher risk-adjusted returns as a core/satellite investment strategy. These investments could be managed by a professional or could be specific investments you want to make yourself (if you feel so inclined).

Why do this if you can likely achieve your investment objectives with passive investing? Well, I for one have two sets of investment objectives. The first one is my plan for my comfortable retirement. This one ensures I am well off during retirement and won’t be a burden on my family or the public social welfare system. I plan on being financially self sufficient for 40 or more years after retirement (the way life expectancy keeps increasing I may need it).

My second financial plan is if I am able to continually capture above market returns. Call it my ‘mad money’. I have some training and work experience in traditional equity analysis, advanced mathematical finance modeling, and know local investors who are reaping huge gains in the Alberta boom. I am placing 10-30% of my portfolio into various investments to see if I can have some very large returns that will propel me into another level at retiement. For some, this may mean getting another vacation house. For others, it could mean travelling around the world six months on the year. I haven’t decided what I want this to be for me, but this is why I allocate some money to active management: on the off chance I can generate significant returns, I will be very well off.

From a stock investment standpoint, here are some ways that regular investors can take advantage of what others are doing to beat the market:

• Look at the portfolios of the great investors (like Warren Buffet). Stockpickr has many of these portfolios available and are regularly updated with changes. You could either replicate one of their portfolios or you could choose a few stocks that are held by several of the leading investors out there. If you want to copy some of the best mutual fund managers, use GlobeFund’s filter and look for 10-15 year performance that exceeds the appropriate benchmark.
• Choose recurring top picks by managers. When a money manager goes on television, they usually trot out picks that they think can’t miss (especially if they’re due back on the show in 6-12 months) since their reputation and ego are on the line. If you see the same stock coming up from different managers in a short time frame (say for example, 3 times within two weeks), then it’s worth taking a close look at. I personally like reviewing ROBTV’s guest picks at least once a week to see if there are any that I like. If there are, I’ll usually watch the video clip on the top picks to see what the manager has to say about the stock.
• Buy into a good mutual fund with solid long term success. Usually these funds are not cheap (I’ve seen some that have MERs of 3% or higher as well as front end loads of up to 5%), but if the manager has been able to continually beat the market for 15 years or more, then they’ve got that rare ability to capitalize on mispricings consistently. Take a close look at management to ensure that there haven’t been any recent changes in whose running the show. I’d also look at how old the manager is, so you can estimate how much longer he’s going to be around. No sense getting into a fund with a huge sale charge (either up front for deferred over 5 or more years) if the manager’s 65 and might decide to start playing golf next year instead of picking stocks.

If you’re feeling ambitious and want to do some stock analysis yourself, then I’d recommend Fire Your Stock Analyst. I haven’t read through it completely, but it covers a lot of the details that I think are important for do-it-yourself investors. It covers how to analyse a stock from both a value and growth perspective.