Tag: financial advice

Rental Property: Real Life Experiences

Rental Property: Real Life Experiences

Many people view residential rental property as a great investment.  I’ve never had any interestA charge for borrowing money, most often based on a percentage of the amount owed. More in committing the time I perceive is necessary.  I’ve also not made much money on 

Property and Casualty Insurance

Property and Casualty Insurance

Protection against loss is critical for everything you do, including running your own business or earning money from a side hustle.  The primary tool for mitigating business risks is property-casualty insurance.  There are many insurance policies within the realm of property-casualty insurance, each with its 

The Home Equity Fallacy

The Home Equity Fallacy

Building home equity can increase your financial security, but it isn’t necessarily the best way to maximize your net worth.  That is, building home equity quickly isn’t necessarily the right choice for everyone, not even those who have the financial wherewithal to do so.

I’ve frequently heard two statements relating to home ownership that hold true for some people, but I consider them to be fallacies when applied to everyone.

  1.  It is always better to own than rent.
  2.  If you own, you should pay off your mortgage as quickly as possible.

There are definitely people, including me, for whom one or both of these statements are true.  However, in the current mortgage interest rate environment, neither is true for people whose primary financial goal is to increase their net worth!

In this post, I’ll talk about the theory behind how rent is determined, provide a simple framework for comparing options for ownership and renting, and apply that framework under a number of different scenarios to see what happens to your net worth.

Your Priorities and Situation

Before digging into the analysis below, you’ll want to identify your priorities.  The analysis below assumes that your primary financial goal is to maximize your net worth.  It also assumes that you are indifferent between renting or owning from a lifestyle perspective. And, it assumes you have the ability to handle the risks of home ownership.  All of these considerations are discussed in more detail in this post.  You’ll need to consider the extent to which these assumptions apply to you before you use the findings below to inform your decisions.

In many situations, the analysis suggests that either renting or paying down your mortgage (i.e. building home equity) slowly will maximize your net worth.  However, many people, including me, prefer to have as large a home equity as possible.  Characteristics that might put you in the same category as me are that you are:

  • Living off your investments and a preference to eliminate a monthly mortgage payment from your cash expenses.
  • Averse to risk, leading you to not want to find that your investments have decreased in value at the same time you need to liquidate them to make mortgage payments.
  • Someone who likes the comfort of knowing that, in all but the most extreme scenarios, you have a place to live.

Because I have all three of the characteristics, and because my first few home purchases happened when mortgage interest rates were between 9% and 17%, I paid off my mortgages as quickly as possible.  I also paid cash for my most recent two residences with the proceeds of the sales of their predecessors.

Finances Rent vs. Owning, in Theory

In theory, the economic cost of renting should be more than economic cost of owning.  First, the owner needs to make a profit to cover opportunity cost of owning the property.  Second, the owner is taking on risk from the uncertainty in their ability to find renters and the cost and timing of repair costs for which the owner needs to be compensated.

An important consideration, though is the difference between the economic costs of ownership vs. renting and the cash flows of both options.  Specifically, your down payment and the portion of mortgage payments that go towards principal are not part of the economic cost of owning your home.  The principal portion is a transfer from cash to equity in your home.  As such, from a cash perspective (as opposed to an economic perspective), you will often need to pay more in cash to cover the costs of home ownership than to pay rent.

The economic cost of the equity in your residence is the opportunity cost of not being able to invest it elsewhere.  This amount differs from the amount of your down payment and mortgage payments.  The value of your home may increase, so your opportunity cost is the difference between the return you would earn if you invested your money in a different asset, such as the stock market, and the appreciation in the value of your home.

Appreciation from Ownership

When I was young, most people assumed that the price of houses went up every year.  Reality has shown that not to be the case, both when looking at regional and local conditions and also when looking at US nationwide housing price changes.  The chart below shows the average price changes by year from 1988 to 2019, the length of the period available for the Case-Schiller US National Home Price Index on the Federal Reserve website.

Historical Housing Price Changes

As you can see, in most years, the price of houses went up.  However, in 1992 and from 2008 through 2012, the prices went down with the worst year, 2009, reporting a 12.6% decrease in home values.

Other Considerations

A comparison of the financial aspects of renting and owning also has to consider what you are willing to rent as compared to what you might buy.  The inferences above apply only if you are renting and buying the same residence.  If, on the other hand, you are willing to rent an apartment but are only willing to buy a house, the rental option can become much more attractive.  There are economies of scale gained from running an apartment complex that aren’t available to owners of single family homes.  Also, you might be willing to rent a residence that is smaller than one that you might buy.  Again, if that is the case, the rental option might be more attractive.

Rent vs. Own – Simple Illustration

To help you understand the finances of renting and owning your residence, I’ll start with a simple illustration.  In it, I compare three options:

  • Buy your residence
  • Rent the same residence
  • Rent a smaller property

Key Assumptions

Here are the key assumptions for the three options.

Buy Your Residence

I selected a 1,500 square foot house in Des Moines, Iowa for my illustration.  A typical house that size there has a current market value of about $240,000.  The countrywide annual average appreciation is 4% every year.  I have assumed that you pay 15% as a down payment and have a 30-year fixed-rate mortgage at 3%.

Utilities are assumed to be $200/month and property taxes and homeowner’s insurance total 1.5% of the market value each year.  In addition, I’ve included 2% per year for maintenance and repairs and 0.5% per year for updates.  These costs are assumed to increase with inflation at 3% per year.

I’ve assumed $1,000 of closing costs at both purchase and closing plus a 5% sales commission when you sell.  Last, I’ve assumed that you leave $10,000 in cash in an emergency fund at all times.

Rent the Same Property

The same house rents for about $1,400 a month, including utilities.  I’ve added renter’s insurance at $120 per year.  Both of these costs are assumed to increase at 3% a year for inflation.

Under this strategy, I assume that you invest the down payment plus emergency fund money at a 7% return per year.  The mortgage payments plus other costs of home ownership are more than rent and renters insurance, so I’ve assumed you also invest the difference at 7% per year.

Rent a Smaller Property

If, instead of a house, you choose to live in an 1,100 square foot apartment, your rent is only $1,100, including utilities, increasing with inflation.  As with the previous strategy, differences between the costs of home ownership and the cost of renting the smaller property are assumed to be invested at 7% per year.

Net Worth Comparison

This section contains a simple comparison of your net worth under the three options described above – own your home, rent a similar home or rent something smaller.  For this illustration, I’ve assumed you own your home for ten years.

Ownership Cash Flows

The chart below shows your annual cash flows using the assumptions above if you buy a home and sell it in ten years.

Ownership Cash Floww

The dark blue bar on the left is your down payment, buyers’ closing costs and the $10,000 of cash you set aside for an emergency fund.  The subsequent ten bars show your mortgage expense (orange), property taxes and homeowner’s insurance (gray), utilities (yellow) and maintenance, repairs and updates (light blue).

After ten years, under the simple assumptions, you can sell your home for $355,000.  From that, you pay 5% in real estate agent commissions and $1,000 in seller’s closing costs.  In addition, you don’t need the $10,000 in your emergency fund.  Thus, at the end of ten years, you get $346,000.  From that, you need to re-pay the remaining $150,000 of mortgage principal, so your net worth is $196,000.  Of that $196,000, $106,000 is from appreciation in the value of your home and $40,000 is from the principal portion of your mortgage payments.

Annual Cash Flow Comparison

The chart below compares the annual cash flows from the three options over the ten-year time period.

Buy vs Rent Cash Flow Comparison

The blue bars show the total of the cash flows in the previous chart from owning your home.  The yellow bars show your cash flows for renting the same home and the gray ones for renting a smaller residence.  These last two sets of bars include rent and renter’s insurance.  I note that the blue bars are taller than the yellow bars because they include your down payment and the principal portion of mortgage payments, both of which allow you to build equity in your home.

Net Worth Comparison

If you own your home, your net worth increases from the appreciation in the value of your residence.  Because you have borrowed some of the money to pay for your house, your percentage growth rate of your home equity is higher than the appreciation rate of the house itself.  This result is called leveraging, as you get the dollar value appreciation of your house while investing only a portion of it yourself.

If you don’t own your home, you can invest the difference between the cash flows represented by the blue bars and those represented by either the yellow or gray bars.  For this simple example, I’ll assume that you earn a 7% annual average return on your money by investing it in the stock market.  To further keep the example simple, I ignore income taxes.

The chart below compares your net worth under the three strategies at the end of ten years.  In the Buy Your Home option, your net worth is equal to your home equity after you sell.

Home Equity & Net Worth Comparison

In this illustration, you have a higher net worth if you buy your home than if you rent the same home. However, your net worth is much higher if you rent the smaller apartment than if you buy your home.

Rent vs. Own – More Realistic Illustration

In the simple illustration, I ignored risk.  All four of mortgage rates, inflation, home appreciation and stock market returns vary widely from year to year.  In the more realistic illustrations, I use the actual values of these economic variables for each period starting in 1987 and ending in 2019 to introduce volatility.  I’ve looked at this time period because 1987 is the oldest year for which I could find home appreciation values.  Had I used even older time periods, mortgage interest rates would have been outside the range of what is shown here, so the probabilities should not be considered representative of all possible results.

I show four sets of comparisons to increase the likelihood that one of them is close to your situation.  In the first comparison, I use the same assumptions as in the simple illustration other than the economic variables.  I increase your down payment from 15% to 50% and 100% of the purchase price in the second and third comparisons.  In the fourth comparison, I retain the 15% down payment assumption but change only the time period you own the home from ten years to two years.

10 Years; 15% Down

The box and whisker plot (described in this post in case you aren’t familiar with reading one) below compares the simulated values of your net worth (i.e., your home equity) after you sell your home if, under the Buy Home strategy, you own it for ten years and put 15% down.

Home Equity & Net Worth Comparison - 10 Years

Because I used ten years of inflation and stock market return data, the data used in the graph include 23 ten-year periods, those starting in each year from 1987 through 2009.  The boxes represent the range from the 25th percentile to the 75th percentile of your net worth under each strategy.  The line in the middle of the box is your average net worth.  The whiskers that stick out of the boxes range from the 5th to the 95th percentiles.

Using these assumptions, the range of ending net worth values from renting the apartment (gray box) are almost always higher than either of the other two strategies.  At the average (solid line in the middle of each box), you have a very slightly higher net worth if you buy your home (blue) than if you rent the same home (orange).  The range of your net worth is wider if you rent the house and has a higher upper end, due to the possibility of attaining high investment results.  Over a ten-year period, the average return on an investment in the S&P 500 is very rarely negative, so you never have a lower net worth from renting as compared to buying the same home based on this time period.

10 Years; 50% & 100% Down

The higher your down payment, and therefore the higher your equity in your home, the higher your net wroth from renting as compared to buying, as shown in the two charts below.

Home Equity & Net Worth Comparison - 10 Years

Home Equity & Net Worth Comparison - 10 Years

The higher ending net worth values when you rent in the comparisons with bigger down payments emanate from the larger amounts that you have available to invest.  That is, if you are comparing your net worth after renting to the option in which you pay for your house in one lump sum of $240,000, you have the full $240,000 available to invest for the entire ten years.  But, when your down payment was 15%, you had only $ $36,000 (15% of $240,000) to invest for the full period plus the amounts that you paid in principal each month.

2 Years; 15% Down

Another scenario in which your net worth will be higher from renting than from buying is if you plan to own your home for a very short period of time.  For illustration, the chart below compares your net worth if you own your home for only two years and put 15% down.

Home Equity & Net Worth Comparison - 2 Years

Your ending net worth is generally higher under the two rental options than the buy your home option.  However, the difference is not as clear as when you pay cash for your house.  There is much more volatility in stock market returns when looking at only two-year periods as compared to ten-year periods, so the range of results under both rental options (in which you are investing your extra cash) is much wider than in the ten-year scenarios.

Conclusion

These analysis show that, in many cases, your net worth will be higher if you rent than if you own.  However, as noted above, maximizing your net worth is not everyone’s priority when it comes to their residence.  As such, you’ll want to consider your priorities and preferences along with these findings in making your decision to buy or rent.

Flex or Fix in Buy vs. Rent

Flex or Fix in Buy vs. Rent

Your residence is likely one of your biggest expenses.  The most common options for residences are renting and purchasing.  There are costs and benefits to both approaches, some of which depend on your lifestyle and goals and some of which depend on your finances.  In 

Holidays on a Budget

Holidays on a Budget

Even in normal circumstances, the holidays can be stressful.  With the concerns about travel and the impact on many people’s income from COVID-19, the 2020 holidays are likely to be even more challenging.  In this post, I’ll provide ideas that might help alleviate some of 

The Case for a Few Good Stock Runners

The Case for a Few Good Stock Runners

Many investors limit the amount of their investments in individual companies to manage the risk in their portfolios.  Others advocate holding on to stocks whose prices increase faster than the rest of your portfolio (which I’ll call stock runners) as long as the reason you bought the stock in the first place continues to hold true.  I’ve taken the latter approach with my portfolio with some success.

In this post, I’ll talk about how many stocks you might want to hold in your portfolio to maintain diversification.  I’ll then explain both strategies for dealing with stock runners in more detail.  I’ll close with an explanation of how the strategy of holding on to stock runners worked for me and provide examples of when it wouldn’t have worked.

How Many Stocks to Hold

If you plan to invest only in individual stocks (as opposed to including mutual or exchange-traded funds in your portfolio), many advisors recommend that you make investments in at least 10 companies.  Ten provides a balance between the amount of time needed to research a possibly longer list of companies to make an informed decision and creating diversification.

A Poor Performer

The goal of diversification is to reduce the impact of the poor performance of one stock on your total portfolio returns.  In my post on diversification and investing, I used PG&E as an illustration.  The chart below shows PG&E’s daily stock price over the 12 months prior to PG&E declaring bankruptcy in early 2019.

In the twelve months ending January 26, 2019, PG&E’s stock price dropped by 72%.  From its peak in early November 2018 to its low in January 2019, it dropped by 87%.

 The Benefit of More Stocks

Although diversification can’t completely protect you from such large losses, it can reduce their impact especially if you invest in companies in different industries.   If the only company in which you owned stock was PG&E, you would have lost 72% of your investments in one year.  If, on the other hand, you had owned an equal amount of a second stock that performed the same as the Dow Jones Industrial Average over the same time period (-6%), you would have lost 39%.  The graph below shows how much you would have lost for different numbers of other companies in your portfolio.

Portfolio returns by number of stocks

This graph shows how quickly the adverse impact of one stock can be offset by including other companies in a portfolio.  In a portfolio of five stocks (PG&E and four others that performed the same as the Dow), the 72% loss is reduced to about a 20% loss.  With 10 stocks (circled in red), the loss is reduced to 12.6% which isn’t much worse than the 6% loss for the Dow Jones Industrial Average.

The curve starts to flatten out quickly at about 10 stocks, supporting the common rule of thumb that a portfolio of only individual stocks should have representation from at least 10 companies.

Options When You Own Stock Runners

There are two schools of thought about how to treat stock runners.

  • One is that you should sell a portion of your holdings so that the value of your holdings in any one company is no more than 10% (one-tenth) of your total portfolio.
  • The other is that you should let your winners run. The latter view is consistent with the advice of Peter Lynch, one of the most successful mutual fund managers ever, who advocates looking to buy stocks that could become ten-baggers (worth 10 times what you paid for them).

When Holding on to Stock Runners Works

I have taken the latter approach and will use two of the stocks that have been in my portfolio for close to 30 years to illustrate.  Let’s say I had $100,000 to invest in 1992.  I put 10% of it in each of Boeing (BA) and Neogen (NEOG) stock.  I put the rest in an S&P 500 index fund.  (That’s not really what I did or the amount of money I had, but the changes make the example simpler.)

Neogen performed very well between May 1992 and August 1, 2020.  $1 invested in Neogen on May 1, 1992 was worth $169 on August 1, 2020!   By comparison, $1 invested in 1992 in the S&P 500 was worth $8 in 2020 and $1 invested in Boeing stock in 1992 was worth $16 in 2020.

The Two Strategies

The chart below shows what would have happened if I had managed this portfolio since May 2, 1992 under the two different strategies.  The purple line shows the strategy I use – buy and hold or let stock runners run.  The green line shows what would have happened to the value of the portfolio if I had trimmed my positions in Neogen and Boeing once a year so that the mix was 10% in each of Neogen and Boeing and 80% in the S&P 500.

Net Worth comparison including Boeing and Neogen as stock runners

The Benefit of Keeping Stock Runners

From 1992 until mid-2008, there really wasn’t much difference in the results of the two portfolios.  Since then, both Boeing and Neogen have significantly outperformed the S&P 500.  The purple line therefore moved above the green line and has consistently stayed higher.  On August 1, 2020, the purple line shows that the buy-and-hold portfolio had a value of $2.5 million.  The trimmed portfolio (green line) had a value of just over $1.5 million on the same date or only 60% as much.

Boeing had particularly poor results in the 10 months starting in October 2019.  Its price on August 1, 2020 was only slightly more than half of what it was on October 1, 2019.  Similarly, Neogen hit a high of 200 times its May 1, 1992 price in April 2018.  You can see these peaks in the purple line in the chart.  Even with these significant declines in Boeing’s and Neogen’s prices recently, the buy-and-hold strategy produced 66% higher returns.  If I had been able to anticipate these decreases and thinned my positions in these two companies in 2018 or 2019, my net worth on August 1, 2020 would have been even higher.

I caution that this example is somewhat extreme.  There are very few stocks, such as Neogen, that have produced such consistently high returns.  Nonetheless, the illustration highlights the benefits and risks of letting your stock runners run.

When Trimming Your Positions is Better

Before you get too excited about the buy-and-hold strategy, you should know that you can’t use it blindly.  I’ll use the examples of General Electric (GE) and Pacific Gas & Electric (PG&E).  I owned GE for a while and have a family member who owned PG&E, so am familiar with both companies.  From May 1, 1992 through early 2017, GE significantly outperformed the S&P 500 (increasing in price by a factor of 30 vs. 5.5) and PG&E produced roughly market returns, but was considered a reliable stock with a generous dividend.  Starting in 2017, both companies encountered financial difficulties and lost substantial portions of their market value.

The chart below shows the same comparison as above – buy-and-hold vs. trimming your positions – using GE and PG&E in place of Neogen and Boeing.

Net Worth comparison including GE and PG&E as stock runners

While the companies were doing well (up to the 2008 financial crisis), the buy-and-hold strategy produced better returns.   For the next 8 or 10 years, the two portfolios performed similarly.  Once the two companies encountered difficulties, though, in 2017, the annual trimming strategy started to outperform.

Conclusion

The conclusion that I draw from these illustrations is that, as long as you think a company can outperform the market, you will likely be better off letting your stock runners run.  However, if something changes at the company, you will likely be better off trimming the larger positions in your portfolio, at a minimum, or selling all of your stock in the company.  This conclusion reinforces the points Peter Lynch made in his book, One Up on Wall Street, that you should know the story behind every stock you own.  Brandon Smith makes a similar recommendation in his guest post for me that changes in a company’s management, market or financial position can be important sell signals.

 

Why I Chose Patience over Re-balancing

Why I Chose Patience over Re-balancing

Many financial advisors recommend re-balancing your portfolioA group of financial instruments. More no less often than annually to ensure the asset allocation is consistent with your risk tolerancePersonal preference indicating how much risk you are willing to take to achieve a higher return. More, as 

What is Bitcoin: The Short and Long Answers

What is Bitcoin: The Short and Long Answers

The phrase “what is Bitcoin” is currently getting between ten and one hundred thousand search queries in Google per month. There is a broad spectrum of answers out there. In this exposition we’ll give an accessible answer that will help you decide if cryptocurrency is 

7 Must-Know Stock Market Sell Signals

7 Must-Know Stock Market Sell Signals

Before we talk about the specific indicators that would signify stock market sell signals, we must understand why we bought each stock in the first place. The simple theory of ‘buy low, sell high’ seems practically very easy, but the reality of the situation is much more complex. When investors look to spend their hard earned cash on stock market investments, it is absolutely necessary that they buy stocks when they are relatively undervalued in comparison to the company or market as a whole. What investors need to assume is the fact that you make money at the price you buy at, not the price you sell. It is imperative as an investor that you understand both sides of the coin when it comes to buying and selling stocks. A breadth of knowledge in technical, fundamental, and psychological factors that affect stock prices will give you an edge.

How You Buy a Stock

Many factors can be used to help look for and find buying opportunities. When buying stocks, look for low price-to-earnings or P/E ratios relative to the industry average or a P/E ratio that is near the low of its five-year range. Find companies with strong earnings and ones that have an economic moat that will protect said earnings. Use short-, medium-, and long-term charts to identify if the stock has a history of growth.  You’ll be surprised how many companies don’t make money or make less than before, and the stock chart usually reflects that. Finally look at the business you are interested in from afar. Is it growing? Does it change the world we live in positively? How does its competition look? Utilize everything you can when looking to buy stocks.  Trades should be based on calculated risk. Without that, you are gambling.

Stock Market Sell Signals

Now that we’ve discussed why we would buy a stock, let’s dive into why you should sell a stock. As the market moves, it’s important to keep an eye on how your company looks from a financial standpoint. Below we will discuss in detail some key fundamental metrics that could be used to signal that a stock is overvalued, also known as stock market sell signals.

Price-to-earnings (P/E)

The P/E ratio is used to show how expensive a stock is relative to the money it earns. The first check you can perform on any stock is to compare the stock in question’s P/E with the sector average. If the stock’s P/E is higher than the sector average, then the stock is relatively more expensive than the sector’s average and can be considered a sell signal. Some companies (typically tech companies) carry a high P/E due to the public pricing of future earnings. This is why the next step would be to compare the stocks P/E within a five-year range of its own P/E. If the stock is near the top of the five-year range, then it’s more overvalued than it has been in the last five years, which could be an indication to sell.

Next, with a word of caution we can look at the Forward P/E. I say with a word of caution because this is based on analysts’ expectations and guidance set by the company. Don’t forget these are educated guesses – they can be spot on or miss the mark completely. Typically, when the Forward P/E is higher next year than the current P/E, there is a projection of lower earnings. Most, if not all, investors should invest in companies projected to make more money quarter over quarter and year over year. This too could be used as a signal for when it’s time to sell a stock. With some simple yet advanced tactics, you can even project the stock price in a range for the next year. Want to learn how to do this? Click here: https://launchpadyourlife.com/learn-earn-retire-early-portfolio-builder/

Price-to-Book (P/B) Ratio

The price-to-book (P/B) ratio is a comparison between the market valuation and the book value of the company. A good buy point for any stock is a P/B under 1. But, when a stock’s P/B is higher than the sector average, then it’s relatively expensive. This comparison could be used to signal when to buy or sell depending on what the P/B is at, as well as how to compares to the industry average. Another word of caution – use this as a checkpoint and not a definitive buy/sell signal. Sometimes companies can window dress book value causing the P/B to appear lower than it really is, so again be cautious.

Earnings Per Share (EPS) Growth Next Year and Next 5 Years

Earnings per share (EPS) growth uses projected earnings to give us a glimpse into what may happen next year. This can also be used to understand trends. Is the company constantly growing its earnings? Is it stable, consistent growth? If the answer differs from its history, it could be one of our stock market sell signals. The importance of earnings growth is that the stock price inevitably follows earnings. Some newer companies could have growth based on expected future earnings, but the stock price generally reverts to the mean at some point – all based on the company’s actual earnings.

Debt Load Management

If a stock has a debt load, it is important to assess how management is handling it. Is management letting debt grow or paying it down faster than expected? The answer is important because a building debt load increases the interest expenses the company will have and therefore affect the bottom line.

We want to focus on year-over-year changes in the debt/equity ratio as well as the long-term debt/equity ratio. We want these ratios to either be a low stable number relative to the industry average or we want to see that management is actively paying it down. In doing so, shareholders equity or the value of the shares you currently own will increase. When the opposite is happening, such as erratic or increasing debt loads, we should be concerned and possibly ready to sell. If you want to look at a year-over-year trend of these statistics, Charles Schwab has some great tools that come with its account. Below we can see the five-year trend in graphical form to the left, a definition of the ratio in the middle area, and the current value of the ratio to the right for a sample company.

Debt to Capital Ratios

Do you want to open a Charles Schwab account to access these awesome features? Click this link to sign up, it only takes minutes! http://www.schwab.com/public/schwab/nn/refer-prospect.html?refrid={REFID}

The Big Picture

Sometimes the best way to tell if it is time to sell a stock is to see if the story has changed.

Changes in Business

Before you ever invest in a company, it is imperative that you look at the business from every angle. It is necessary as an investor to know what you are buying and why you are buying it. You would not buy a car without test driving it, would you? Typically, you look at Consumer Reports, talk to people who have owned that car model, and look at safety ratings and mechanical flaws or misnomers. The same can be said for stocks – look for changes in the income statement, balance sheet, and statement of cashflows. When these things begin to change from your initial thesis, it may be a stock market sell signal.

Changes in Management

When management changes, it may be time to sell. Typically, stock prices fall when new management is announced because a different mindset is at the helm of the company. People may have the same goal, but different paths to reach said goal. The story can change on a multitude of levels. Even if the financials are still intact, if the story about who it is as a company or what it does has changed, it may be one of our stock market sell signals.

An example of this is the Chinese company, Lukin Coffee, which, from its financials, was poised to be the next Starbucks. It was later realized that the earnings were not as they seemed and they were forging financial documents. The stock tanked and has since been delisted from the NASDAQ. Sometimes you can see the smoke before the fire and get out of a stock, and sometimes you will have to get out while down to prevent a total loss.  As a caution, though, a decrease in a stock price isn’t always a sell indicator.  In fact, in some cases it may be a chance to buy more of the company’s stock.  So, you’ll want to be sure to understand why the stock price has decreased.

Sector Rotation

The stock market moves in and out of sectors like the tides in the ocean based on the current point of the economic cycle. Understanding where money is moving in and out of could be used as a signal for when to sell a stock. The best way to grasp this concept is to take a step back and look at the overall economy. During times of fear, the best investments tend to be non-cyclical defensive positions like grocery stores and household goods.  In a depression or economic contraction, you may not buy a new iPhone, but you will still buy bread and toothpaste for your family.

Many graphics can be found by googling ‘sector rotation’ to give you a better idea as to what are the best sectors to invest in based on the economic picture at hand. Trying to time the market tends to not be a successful strategy. The old saying goes, ‘time in the market is better than trying to time the market.  Use sector rotation to either sell at right time or buy on the dips when the sectors rotate.

Portfolio Rebalancing/Profit taking

As you build your portfolio, if you invest in great companies, then eventually the underlying stock prices should rise. As those stock prices rise, the overall percentage that it takes up of your portfolio rises as well. For most passive investors, any one stock should not take up more than 3-5% of your overall portfolio to avoid company specific risk.

Closing Thoughts.

Now you have some stock market sell signals!  Remember that you should only invest in what you know.  When things start to change, do whatever you have to in order to protect your money and continue to grow your wealth. Good luck investing!

Don’t Make these Financial Mistakes

Don’t Make these Financial Mistakes

The world is going through a very difficult phase. Everywhere we are hearing that we need to get adjusted to the ‘new normal’. Nothing is normal as it used to be. Children are not able to go to schools.   Most people are working from home.