The benefits of an adaptable investment strategy

A few weeks ago, I published some new cornerstone content on the site – part of which was around my investment principles. I’ve also published a number of articles about my investment strategy. The recent plunge in markets has made me examine these and reconsider how useful they’ve been in the current environment.

The most obvious issue I identified is my position as a long-term buyer of stocks. The recent bear market has forced me to look at the value of my holdings, many of which are facing significant hits to earnings per share and a couple of which have suspend dividends. This has made me more cautious about adding new positions – I’m happy to hold existing companies in my portfolio but I honestly believe many companies I’m analysing deserve to be cheaper right now based on the global economic shutdown.

I’ve always been fairly stringent and cautious with risk management; it’s one thing to say this in a bull market, but I found that even as things have turned less rosy, my mental state hasn’t really suffered when it comes to my investments. If the currency collapses, the government fails, and we all end up in a state of dystopian anarchy, then I’d still be happy in the way I handled my investments with the knowledge I had. There would be absolutely no reason to sell to cash (after all, we’d be in a dystopian nightmare and cash would be worthless too).

I don’t believe that is what will happen, but even if it did, then I don’t see what I can do about it. Selling my investments won’t protect me and my family from it.

I’m not entirely sure, however, that the average investor is quite as sanguine. A friend of mine had a huge position in a major UK bank (one which I’m also invested in) and as a consequence is facing a loss on that single position which on its own significantly dwarfed the draw-down on my entire portfolio. Their huge overweighting to a single company seems like a ‘no brainer’ to him, but to me, I would be absolutely in pieces if I was facing such a huge loss on a single position. My diversification means that although we both share an investment in the same firm, my paper loss is less than 15% of his – it also means that if we’re right on that position and it ends up hitting my price target, he will make seven times as much profit as me (roughly speaking – I’ve not taken into account average buy prices or dividends!).

To me, the diversification within my portfolio is absolutely essential to enabling me to sleep at night and prevent sheer panic at a time like this. By having a strategic plan, I remained calm as the markets fell and was able to watch it with more of an academic interest than thinking “OH MY GOD, I’M DOOMED, I’VE LOST SO MUCH MONEY!!!!”. If one or two companies suspend their dividends or face outsized challenges, I’m comfortable that my overall portfolio will thrive over time.

Despite having developed a strategic plan, even I have become less certain about the best course of action. Once or twice I’ve considered buying some positions, then a few days later considered selling others. I’ve wondered deploying a much larger chunk of capital than I had scheduled – then decided not to, and then wondered if I’ve missed an opportunity. To me, this is a clear sign of the confusion inherent in the markets right now. The recent bounce makes no sense at all; we’re all still in lockdown, have been for weeks already, individuals are facing a prolonged period of financial distress and companies and governments have never been more indebted.

As a long-term investor, my ultimate move has been to stick to my plan. I moved out of some positions at the beginning of the year as part of my strategy to strengthen my portfolio and redeployed it into other positions. I’m not dumping positions wholesale and I’m not scrambling to buy into a collapsing market. Broadly speaking, I’ve paused my purchases; there are a few companies I’m looking at but I’m content to keep looking. I usually make between 12-20 trades in a year, excluding top-ups, and I try to keep them equally spaced with one or two trades a month. According to my plan, I therefore should have made four to eight trades so far this year, and I’m on target with six sales and two purchases. Usually, this would be equally weighted between purchases and sales, but with market conditions looking a little toppy, I was taking the opportunity to strengthen my portfolio.

Having this flexibility to ‘adapt’ my strategy has been key – it seems crazy to me to keep blindly following a plan developed in a bull market when the situation is so obviously different now. I have never lived through a pandemic – I’m not sure anyone alive has to be honest – so I have no prior experience against which to judge the situation. By giving myself licence to ‘wait’ on purchases or sales rather than insisting on making trades, I feel much more comfortable that I can limit the damage to my portfolio from the pandemic.

It seems strange to be doing this, as 2019 was a fantastic year for my portfolio and I had such high hopes heading into 2020. I was excited about the opportunity to add fresh capital to my ISA and was eagerly discussing new opportunities with investor friends. It didn’t take long for the wheels to come off but thanks to me constant focus on quality and reasonable valuations, I feel quite comfortable that over the next five to ten years, my portfolio will return to growth. I simply have to nurture it through the current markets to get there.

My Bear Market Strategy

  1. DON’T PANIC! Absolutely do not panic, flail, thrash, writhe or otherwise take short-sighted, panicked actions which will damage the portfolio. If unsure, wait and think about things.
  2. Be cautious on valuations. Do prices reflect currently EPS and historic growth levels? How much lower could these get – what if they become negative? Better to be overly cautious than overly optimistic in a bear market.
  3. Don’t be afraid to hold cash. Cash gives you options – it won’t lose value like a share and can enable you to access future opportunities.
  4. Prefer current companies over new positions. You’ve done the research on the companies you already hold; can you say the same for new ones? Sometimes it’s better to dance with the devil you know than the one you don’t.
  5. Watch the charts. You’re not Warren Buffet, no matter how many times you read The Snowball. Now is not the time to pretend you always know better than the millions of individual investors that make up The Market.
  6. Curb your consumption of Mainstream Fear. Traditional and social media will be packed to the gills with screaming, panicking, headless chickens. Thousands of voices bleating doom and destruction.
  7. Follow facts, not opinions. Facts are few and far between at the best of times but in a bear market, opinions can be lethal. They be identified through phrases such as ‘I believe’ and ‘in my experience’. Avoid them unless trusted.