Thursday, October 17, 2013

The Accumulation process

Eleven years into investing and I have learnt very valuable lessons regarding how not to lose money. Not that I have by any means perfected the art of not losing money, but I have become more careful in my investments to avoid obvious risks to the downside. 

One such strategy has been to move from a bulk buy model to an accumulation model. In the early years, I would invest in lots of 100 or greater there by forcing a rather significant size of a capital on a thesis that I have just come up with and am not terrible sure about. Any additions to the position would also be in lots of 100 and greater and before I know it I would have invested over 10-15 thousand dollars on an investment that could very well be based on an incorrect thesis. The argument for the lot size was also influenced by the brokerage fees that would form a significant percentage of the invested capital if the lot was not significantly large enough.

Enter 2005, when I first got wind of the offer from one of my banks that a certain balance in my bank account would make me eligible for a set number of free trades. With that I have never looked back and have always fallen back on the accumulation process. Here I state some of the great advantages of the accumulation process:

1.      Allows you to enter an investment without significant capital and in case of large share price, the ability to enter into an investment
2.      The first lot forces you to start tracking the investment on a regular basis
3.      Invest based on a thesis rather than on momentum. This is very important because, it is not always that you are confident of your thesis and you would like to see the thesis show signs of playing out before you commit more capital
4.      Dollar cost averaging, in case you did not catch the bottom or you are going through a challenging macro market event
5.      Adjust your price of investment to reflect the right yield you want from the investment in terms of dividends. This is similar to dollar cost averaging except the goal of this is to increase effective yield on your overall investment

The obvious downside to this strategy is the cost of buy orders which is why it is important to use a low cost brokerage firm or a free trading platform as I indicated earlier. You do not want the brokerage fee to eat into the yield/appreciation that you have achieved through patient investing.

Having said all this, I still am looking for some ideas on how to accumulate the right way. Here are some thoughts I have:

Find the stock use a stock screener that meets your valuation requirements. I generally use one from one of the brokerage firms that I have an account. Check the trend line over the past year to see what the market has been doing to it. If the trend line is downwards over a significant amount of time like a few months, it is advisable to monitor the stock for a few weeks to see if it continues on the downward trend or bottoms out. If the stock pops right back up, no worries. There is no rule that you need to get it right at the bottom. It is more important that you don’t grab it while the market it working the stock down to its bottom. If you see a significant volume based upside for a couple of days, it might be a good time to open a position. When you do this you have to be chronically aware of a few things.

1.      The lowest price you are willing to buy the stock at after which you cannot bear the pain anymore
2.      The yield that you are getting at the current invested capital (Not the yield on the current stock price) and your target yield for the investment
3.      The highest price you are willing to pay based on fundamentals (and target yield) for the stock – This needs to be revisited on an annual basis to see if the fundamentals have changed.

In a investment thesis, patience is paramount because it is not necessary that your thesis would play out in a short period of time. And with accumulation it allows you to add to your position as you build confidence in your thesis rather that going all in right on day 1 and then regretting it for a long period of time as the market outperforms. As this waiting can get excruciating, a significant yield at your entry and accumulation points would dull the pain of waiting for the day of reckoning when your thesis actually plays out. On the off chance that you were wrong, at least your investment yielded a decent return and you can exit with head held high.