CINCINNATI BUSINESS COURIER
June 12-18, 1989
Investments
By Charles D. Vaughan
The smartest dogs leave fast track to greyhounds
SKIPPER WAS A GOOD OLD DOG, but he had a big problem. He liked to chase cars. Try as we might, we couldn’t convince him it was a bad idea. Not only was it unproductive, it was downright dangerous.
A lot of investors seem to have picked up the same bad habit. I don’t mean chasing cars, but chasing markets. In fact, there may be a little bit of Skipper in all of us when it comes to investing. Nobody wants to miss a big chance to make lots of money. Unfortunately, most of us don’t get the urge to run until we see the market going by.
Studies have shown some interesting facts about fasttrack investing. The most important ideas have to do with risk aversion. Oddly enough, the most riskaverse investors are the worst performers. The reason for that is found in basic personality traits.
Greyhounds are built for speed. They are lean and mean and can maneuver quickly. In the volatile markets, the greyhounds have the edge. The most likely winners are those who are willing to assume a risk position at the first sign of potential. They do so because they are also willing to change direction quickly if their position seems doubtful. They are very low on the risk aversion scale and don’t mind being wrong a few times to get in the right position. They are willing to cut losses quickly and will ride a winner until it starts to falter.
Bassets are built for comfort. They are slower moving and need to be more deliberate in their actions. They are very high on the risk aversion scale and want to be certain they are right before making a commitment. For the most part, they avoid the fast track. They know their limitations and need a lot of convincing to commit to the chase. That is the trouble. Markets top out (or bottom out) when the most risk averse (hardest to convince) player finally decides he has enough information to make a decision.
That’s why some people claim that they always buy high and sell low. They do! They are always mystified because “everything said prices were going higher.” Right; so who was left to buy at higher prices?
Most of us are not greyhounds (including most players on the fast track). Neither are we bassets. We are more like Skipper, just a blend. But, we are subject to the tendency to get just the right amount of information to convince us to take the plunge at the wrong time. So, how can we avoid the temptation to make the same old mistakes again?
I have found two methods that work pretty well for all but the most hopeless cases. The first is simple dollar cost averaging and the second is asset allocation. Both approaches require that you have the discipline of planned investment policy.
Dollar cost averaging is a technique for investing a set amount of dollars into a given investment on a regular basis. This is most useful for those who do not have a large portfolio and want to build for the future. Many people invest in one stock (usually in a company plan). Others invest in a diversified portfolio of stocks through a mutual fund. The advantage is that using the same dollar investment buys fewer shares when prices are high and more when prices are low. This makes the average cost always lower than the average purchase price. It is a good longterm strategy when combined with other investments.
The second approach is better suited to those with larger investment portfolios. It used to be called portfolio mix, but is now called asset allocation. This method calls for establishing percentages of the total dollar holdings to be placed in various asset categories. For example, one might put 50 percent of available funds into fixedincome investments and the other 50 percent into equities such as stocks. Some managers would then strive to maintain that balance by shifting dollars from stocks as they rose into bonds or vice versa.
Most professional managers now use more asset classes to provide greater balance and diversification to spread risks. The purpose of this approach is to achieve a good return at the least risk. When properly managed, it calls for minimal shifting of funds which keeps transaction costs down. Some managers change the percentages on a regular basis such as quarterly. This is mostly selfdefeating because it institutionalizes market chasing.
Old Skipper never caught a car. I don’t know what his plan was if he ever had. But, one caught him much to our sorrow. I wish he’d left the fast track to the greyhounds. Maybe we can learn from his mistakes.