Elements of Skill

Here are several elements of skill that you can adopt as your own.

Threshold Distortion

How many articles have you read in which mutual fund managers were selected from the top of the pack? Too many, no doubt.

The selection method is good. The follow up is horrible.

Never buy those funds when they are at the top of the pack. That would be buying high. Wait instead for their prices to come down. Allow up to five years. Buy them when their prices are low.

A few good funds will get away, but not many.

This works with stocks as well.

Dividend Indifference Fantasy

The dividend payout should not make a difference. Money that a company reinvests should add to growth.

The fact is: it doesn’t work that way.

Dividends help you identify quality companies that treat shareholders right.

Choose from the top third of dividend payers. Avoid non payers. Make sure that smoothed earnings (five to ten years) are growing and support the dividend payout. Expect single year earnings to fluctuate.

Avoid Rebalancing

Rebalancing works, in theory, if all investments have equal expected returns. Rebalancing fails, if fact, because inferior investments drag down overall returns.

Rebalancing still works, in theory, because it controls the risk to reward ratio. If fails, in fact, because it is possible to measure relative risk. Adjusting allocations according to valuations does far better than any fixed allocation.

Play with the Scenario Surfer (button on the left). See the difference for yourself.

Avoid Liquidation

Early investigations into Safe Withdrawal Rates allowed for a complete liquidation of a portfolio. These days, I advocate income management. Never sell any shares. Your portfolio will last forever. Your income will rise at least as fast as inflation.

I advocate a Dividend Blend strategy. Start with a combination of a high yielding portfolio, possibly with declining value, and a lower yielding portfolio that grows its dividend rapidly. Use TIPS for cash management.

Use the Automatic Allocator (available at my Yahoo Briefcase) to optimize allocations. Otherwise, start out with a 50%-50% allocation (with zero in the TIPS account initially).

You can easily reach a continuing withdrawal rate exceeding 5% of your initial investment that grows fast enough to match inflation.

Have fun.

John Walter Russell
December 1, 2007

Yahoo Briefcase