My Investment Lessons Learned in 2011

My investment portfolio, including 401k, IRAs, Roth IRAs and HSA, dropped ~10% last year. It was pretty bad compared with the returns of SP500.However, from investment strategy standpoint, I learned a lot last year and I think the prices of equities that I currently own will bounce back once the market aligns with the business fundamentals.

The part that I did right was that I followed the principle of value investment – invested in deep undervalued stocks, waited for their prices to reach fair values when I started to sell them. However, the parts that I did wrong were the bad trading tactics and the ignorance of effects of macro-economy and geopolitics on market.

Regarding trading management, Seth Klarman said in his book “Margin of Safety”:

” No book on investing would be complete without a discussion of trading and portfolio management. Trading – the process of buying and selling securities – can have a significant impact on one’s investment results. Good trading decisions can sometimes add to an investment’s profitability and other times can be the difference between executing a transaction and failing to do so. Portfolio management encompasses trading activity as well as the regular review of one’s holdings.”

Regarding the impact of view of economic condition on value investment, Howard Marks in 2001 wrote:

“There are a few things I dismiss and a few I believe in thoroughly. The former include economic forecasts, which I think don’t add value, and the list of the latter starts with cycles and the need to prepare for them. 

“Hey, ” you might say, “that’s contradictory. The best way to prepare for cycles is to predict them, and you just said it can’t be done.” That ’s absolutely true, but in my opinion by no means debilitating. All of investing consists of dealing  with the future . 

. . and the future is something we can’t know much about. But the limits on our foreknowledge needn’t doom us to failure as long as we acknowledge them and act accordingly.

In my opinion, the key to dealing with the future lies in knowing where you are, even if you can’t know precisely where you ’re going. Knowing where you are in a cycle and what that implies for the future is different from predicting the  timing, extent and shape of the cyclical move.”

I completed agree with Klarman and Marks, to be successful in value investment, we not only need to understand the individual business fundamentals, but also need to execute sound trading strategies and fully understand the possible consequences of macro-economy and geo-politics on the business cycles and market.

Here are the lesson learned that I had last year,

1.  I did not sell ADGF when its price jumped by 50% (90% of its fair price) in May 2011 and I was greedily waiting for it to reach 100% of its fair value. However, in August, its price dropped back to its original price. Since it is in my Roth IRA account and I do not need to pay capital gain, I should better sold it for profit and wait for it to drop again. I need to sell equity when it reaches 90% of its fair price. Do not be too greedy.

2.  In the beginning of July 2011 when SP500 was 15% above fair value, I did not sell my 401k even though there are two big market risks: (1) US to raise debt limit or not; (2) Europe crisis. Again, I was greedily hanging on for more gain in my 401k and hoped for the quarterly earnings would lift the stock market even higher. .. Even though the second quarter earnings were good as I expected, due to the uncertainty of macro outlook, stock price dropped by 15%. This event is similar to that of 2008 when congress planned to approve the rescue plan then market plumped by 40%. I need to learn to spot this kind of event and exit fast so to avoid loss. I believe to be in the market is like science, while to be out of the market is like art. I need to be good at this art.

In addition, when my ROR of my 401k dropped by 3%, and market uncertainty became larger and larger, I also should sell them all but I did not. Then my ROR dropped by 20%!!

3.  I bought HHC in a rush at ~$74 since I cannot see cash in my portfolio. I need to be more patient and wait for the fat pitch. Sit on the cash is not a bad thing but a GREAT thing – wait for the fat pitch!

4.  When market dropped by 6%, I rushed in and $11,000 HHC with $52.4/share so no more cash in my portfolio. However, the next day, the share price dropped again and then I have no more cash to invest. I need to invest in piece meal step by step instead of all in once. Same thing with BAC, I need to be patient. And always to lay cash aside to wait for the fat pitch.

5.  My portfolio has no cash or bond, I need to better allocate my portfolio to include bond, cash and stocks (Iarge, mid and small).

6.  I heard that Motorola was going to spin off Motorola Mobility 2 months before it was bought by Google. This is the exactly classic spin-off case recommended by Joel Greenblatt. However, I doubted about my ability for stock picking, so I did not spent time on it and missed this great opportunity.
In August, MMI’s stock price jumped by 60% due to the announcement of Google to buy MMI. It is a huge miss for me! I need to be more confident in myself.

7.  The thing that I did right was in addition to buying SP500 index fund, I bought small cap index fund when market dipped. The return from small cap index fund was about 1.5x out of that of SP500 index fund. However, I need to be aware of the 90 days 3 times in-and-out trading limit, I need to buy in small step piece meal but sell in larger step.

8.  I knew the European crisis woe long time ago, however, I did not foresee it have huge effects on US equity market. I need to learn how to sideline my portfolio (even with taking the small loss) when market starts to near collapse and then gradually get back when the market outlook becomes clearer.

9.  Do not take 100% of all the words and analyses from the Internet (such as Google finance and Bloomberg news), I need to have keen analyst eyes to dig deep in the hard data and try to come up with my rational conclusions or predictions.

In sum, despite the return of my portfolio in 2011 was worse than the market overall, I don’t feel bad at all about the results. I am confident that I have truly learned a lot from the past one year, and by smartly adjusting my investment strategies, I can greatly improve my return in 2012.