You Must Have a Goal to Achieve a Goal
Let's assume you're training to run fast in a foot race. What type of training are you going to do? Are you going to run sprints up hills? Are you going to start with a 3-mile jog and gradually increase your distance each day? Are you going run with a partner? Are you going to do some combination of everything?
The answer to that question obviously depends on what type of foot race you're trying to win. If it's a 100 meter sprint, you're going to focus on build up an explosive burst. If it's a marathon, you're doing to do a lot of distance training. Either way, the training regimen you design to achieve your goal is based explicitly on what you goal is. If you didn't have a goal, you wouldn't be able to design an effective training regimen.
So it goes, too, in investing.
Here's what I mean by that
I mentioned in a recent post that I'd caught some flak from a hanful of Global Gains members for issuing two valuation-based sell recommendations. But I did so because my analysis told me the risk/reward trade-off for those two stocks was not attractive, particularly as compared to a few other stocks on our scorecard.
Similarly, I received some questions via email about a comment I made in the "Is Buy and Hold Dead?" roundtable that many of you signed up to receive from Fool.com. The gist of that comment was that I would back up the truck on TIPS that offered a before inflation rate of return of 5% to 6%. You wanted to know if I meant that and if I'd really be happy with that.
My favorite part of my job is finding obscure Chinese micro cap winners. I love doing the research, the background checks, and the valuations. Most of all, however, I love when we catch one that rockets up. And while I'd love to earn 35% annually, I recognize the fact that there are a finite number of stocks that can offer that type of return and that I can't expect to bat 1.000 and find every single one of them.
So I ask myself: What is my goal? What am I training for?
Obviously, if I'm taking risk in stocks, I'd like to beat the market. That means something greater than 6% annually in real terms. But if you can get 6% annually in real terms with no risk, why would you pass that up? We have to assume bull markets will revert to their mean, and if you can get a long-term index fund return with no risk, I think that's a smart move.
Now, risk-free returns today are miniscule, so you need to do other things. And when it comes to emerging markets stocks, I tend to demand between 14% and 16% annual returns to make it worthwhile to hold them. That's because there's so much that can go wrong. Once my expected return drops below that, I'll seek out a similar return from a security with better business quality. Here's the key, though, if you can't find that, don't move the goal posts. Opportunities always come back.
And that's the lesson
The reason why you might be able to get 6% TIPS in a raging bull market, is because everyone is chasing 20%+ annual returns in equities. But if your goal is 6%, you can ignore the chasing and get the risk-free security. If you don't have a goal, you're liable to keep chasing the highest possible return, which will expose you to maximum risk.
Now, if your goal is higher than 6% real returns, you probably have to augment your portfolio since I wouldn't expect TIPS to get any higher than that. But you can do the math much easier to determine your proper risk-adjusted portfolio allocation plans as long as you know what the goal is on the other side of the equal sign. (Note that the farther your goal is away from zero, the greater volatility you have to accept in down years.)
So, do you know what your goal in investing is? Or are you chasing the highest possible return?