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Podcast: Fluctuating Tides S1:E7 (permalink)
calendar icon 2021-09-29 00:00:00 +0000 UTC


Avoiding emotional investing with dollar cost averaging (DCA), the investor gap, adding to past positions.

Show Notes

Tickers mentioned in this show: None

Tidal River Investments positions the day after the first show airing:


Show Notes: Worksheet on calculating beta, using the covariance / variance historical method, Detailed definition of Beta from the Wikipedia

The Investor Gap, study from Morningstar

Dollar Cost Averaging:

Problems with Market Timing

Photography from Tidal River Investments can be purchased at tidalriverinvestments.com


Welcome to Fluctuating Tides, the Podcast, Episode 7. I’m your host, SomeCodingGuy, and let’s get right to it!

Last week was a difficult week for anybody with stocks in the tech sector, as tech sold off faster than the overall market. Given the stocks that I’ve selected in the past, Tidal River has quite a few of these, and despite being up overall against the market, I thought it would be useful to take a moment to step back from our normal stock analysis and look into some strategies for dealing with weeks like this past one.

So - we had one down week, should we sell everything and run for the hills and bury our money in gold? Is crypto the only way out? Should I have listened to all of the doubts that I had all along when I began investing? No! Since the first episode of this podcast, I’ve repeated every week in the closing comments, “Tides Fluctuate”. While tides themselves do actually fluctuate, most of the time I’m really talking about the stock market, calling back to what a wise investor once said, “markets will fluctuate”.

These weren’t idle words… While over the long run markets have risen, from a week-to-week perspective they can fluctuate wildly, running up or down based on whatever news happens to be breaking in the world. Sometimes that’s an oil crisis, sometimes that’s a new international trade agreement, sometimes that’s interest rates, sometimes that’s a large Chinese Real Estate company that may potentially paying its debts, but whatever the reason, over the short run markets bounce quite a lot, and that could be hard on investors. So how do we deal with this?

Well, with Tidal River, we’re in it for the long-term returns, so the first part of dealing with it is usually reminding ourselves, “this too shall pass”, and whatever happens to be going on in the given week, is probably temporary. If there’s too much fluctuation in a portfolio, much like a boat that’s rocking too much on the waves, we can add some ballast by introducing more stable value stocks that tend to move less with weekly market movements. Perhaps we took on too much risk with some of our high flyers, and they’re bouncing more than our comfort level. I haven’t seen any of these in the Tidal River portfolio, but it’s worth considering.

The next thing that I like to look at is whether or not I’m happy with my current set of investments. While short term news rarely has much long-term direct effect on most stocks that aren’t based on that short term news, it’s worth reviewing the positions we have, to see if any of our hypotheses may have changed based on current market situations. In the tech sell off, interest rate, and potential missed payment situation that arose last week, I don’t see any of the portfolio having undue exposure to any of these factors, other than possibly some sensitivity to increases in interest rates on borrowing, but all of these businesses should work just fine with higher rates after repositioning.

So if nothing changed in our fundamental hypotheses, how should we think about the recent stock pullbacks? Well the first thing that I love to do is to start going bargain shopping, since this usually provides an opportunity to enter a position that may have been too expensive previously at a lower price. If I don’t see anything particularly interesting, then often I will add to positions that have pulled back, since if I loved it at a $100, I love it even more at $90. A more formal version of this is called dollar cost averaging, aimed at getting the average price of a stock over a given period.

As far as I’m aware, none of us actually knows the future, which makes stock investing, like anything else, inherently risky. Now there’s a distinction between good risks and bad risks, and based on the analysis I’ve been doing so far, we try to spend as much time as we can over in the good risk category. Granted, when picking up a new stock, we never know if we’re at a low point or a high point, but our fundamental investing assumption is that when we find stock, we’re hoping that over the long run it’s price is going to be somewhat higher than where we bought it, and in particular that that growth happens faster than the S&P 500 does, because as we discussed it episode one, if we’re not beating the S&P 500, we can just take a position in the S&P 500 itself, using an ETF or a mutual fund. There are, however, some techniques that we can use to reduce our sensitivity to whatever the price of a stock happens to be on the day that we begin trading it - one common technique is to split up our trade into a series of smaller trades that happen at regular intervals, or to leave a little cash on the side to opportunistically invest whenever the market happens to pull back.

Regularly investing the same amount of money periodically is called dollar cost averaging, because in the end we end up with the average dollar cost for a given stock over the period that we applied the technique. It isn’t one size fits all, since we have to choose how many investments we make, how big each of them should be, how often we do the trades, what the fees on those trades are, and how much we may or may not be missing out on if we’d just invested the whole amount up front, and the research on it is all over the map.

But often individual investors are their own worst enemy, trading based on emotions from current market ups and downs, leading to sub-par returns. In a study known as the Investor Gap, Morningstar compared the returns of mutual funds to the returns of investors that actually invested in those mutual funds, tracing the inflows and outflows of money to those funds, to analyze what actual returns investors really had as opposed to just what the funds stated. Consistently they found that investors underperformed the funds themselves, the difference being what they called the “Investor Gap”, or the difference between actual investor returns and the fund’s returns. This is often held up as relevant evidence that using dollar cost averaging will lead you to a smaller Investor Gap rather than trying to trade on a more casual basis, and I’ll include these links in the show notes. On the flip side, it’s also worth pointing out that if you absolutely know that a stock is only going to go up over time, dollar cost averaging will lose to just a single lump sum upfront investment in the same stock, but reducing the emotional involvement in the actual process of investing is a good thing in my book, so I generally take dollar cost averaging as a win on that basis alone. By the way, if you do know what markets are going to do, feel free to contact me and let me know…

“Beta” is another interesting item that comes up in these discussions, something you may or may not have seen before on quote sites. “Beta”, or more formally “the beta coefficient” from markets, is often used as one of the ways to gauge risk on an individual stock. While this number is usually just presented to us with no further explanation, I took a moment to work a few beta calculations manually, which I link to in the show notes, so that you can see one of the ways to calculate it. At a high level, it works by estimating how much a given stock moves with regard to the broader market index, but there’s some disagreement on exactly how to calculate it - I use a method simple to do in a spreadsheet in the link - but regardless how you calculated it, it should give you some idea of how much the stock you’re looking at moves with respect to market movements. Normally a Beta of one means that the stock moves in perfect lockstep with the market, 0 that it doesn’t move at all in relation to the market, or for numbers larger than one that the stock tends to swing more than the market does, which gives us a rough single number for how risky a stock is, with caveats.

What other sort of measurements could we make to try to figure out the risk involved in any given stock? Well, I haven’t seen any “risk units” invented yet, perhaps we can invent one called the “risky”; in the meantime, risk is usually measured relative to something else that we understand better, such as the market as a whole through an index. We could also measure risk in terms of correlation or, more loosely, relatedness, since if everything in our basket of stocks moved in lockstep, we’d have put all of our eggs in one basket.

Diversification is concerned with this problem, with numerous studies pointing out that a balance between asset classes to invest in that aren’t all strongly related to each other, namely stocks, bonds, cash, and alternatives, is a good thing. Given my own risk preferences, I tend to allocate more to stocks than the other classes, and the Tidal River portfolio is nearly all stocks given its focus, but this is the sort of thing that a financial advisor could really help you determine the right mix for yourself. Personally, if I’m not sleeping well at night or if I catch myself checking stock prices too often, I probably have too much risk in my portfolio, and I’ll take some time to to balance it out.

We also could look at how much our stocks tend to move with regard to each other, instead of with respect to just the market, giving us an idea of how much investment diversity we may have in our portfolio at a given moment. I’ll probably spend a little more time in future shows looking for less tech-related shares, a bias that I tend to have given my tech background, but not necessarily a good thing for building a portfolio design for more stable long-term growth. In the meantime, however, given the goals that Tidal River has, I’m okay with taking on a little more risk than I may in my own individual portfolio.

For this week I’m going to add to existing positions, focusing on those that pulled back, to aim for a lower average price for those positions. Buying opportunities do show up occasionally in markets, and while I don’t want to just invest funds solely in the stocks that I’ve picked to date, given how expensive some of the other stocks that I looked at were, I think for right now it pays to shore up some of the positions that I’ve already taken. I also spent some time looking into water stocks, a utility that I’ve enjoyed investing in in the past, mainly due to its importance to all of us; however, after screening a bit in the industry, most of the water stocks that I saw looked very expensive, priced to such a level that they would need to grow perfectly over the next 5 to 10 years. It’s not to say that they’re bad Investments, and I’m sure that they are fairly unrelated to the existing tech shares already in the portfolio, but I just didn’t see any deals that I was particularly comfortable with, so I’ll do some more research on some other assets for next week.

Given all of this, Tidal River is going to stick with the positions that it had before, and add to some of them with the regular 100 bucks added for each podcast.

If you like the podcast and want to see more content like this get created feel free to subscribe on your favorite podcast app, or buy a photo from https://tidalriverinvestments.com - money earned on the photos gets deposited in the investment account. As always Tidal River Investments and I are not financial advisors, market analysts, or otherwise in any way offering advice for or against any of the securities discussed - meet with a financial advisor for that information. Stocks and funds may not be good investments for you, depending on your financial situation.

We’re here for learning, not advice, and I wish you the best on your financial journey, and remember, tides fluctuate!