Why the Best-Laid Investment Plans Usually Go Wrong...

[koekebakker]

Why the Best-Laid Investment Plans Usually Go Wrong (except your Variable Portfolio apparently)

H.B's advice about a separate Variable portfolio always confuses me. It seems to contradict the 'anything can happen, nothing has to happen/beating the market is a losing strategy' fundamentals of the PP.

Why would you keep a VP if speculation is futile? If you just like to speculate, why not just take some cash and consider it 'fun-money'? And if you want to tilt, you can just slightly alter the allocation percentages within the PP. Holding a VP seems dangerous advice for most investors as it leaves a lot of room to make all the classic investment mistakes.

What are your reasons to keep separate VP?

[Pointedstick]

Holding a VP seems dangerous advice for most investors as it leaves a lot of room to make all the classic investment mistakes.

That's probably true. But keep in mind that Harry Browne was a successful speculator, and the PP arose out of his desire to consolidate into something safe.

There are many VP choices that I think can make plenty of sense without you having to bet the farm on Indonesian junk bonds. For example, the PP produces a relatively small income stream and most of its returns are capital gains; a bond-heavy or dividend growth VP could make sense if you have the fortitude to only care about income, not the capital value of your income-producing investments.

[AdamA]

The way HB's writings on having a VP have always read to me is, "If you must speculate, do so in a separate portfolio, and don't expect to be successful."

He basically came up with the idea so that those of us with a strong need to gamble could do so without going broke.

[Alanw]

Holding a VP seems dangerous advice for most investors as it leaves a lot of room to make all the classic investment mistakes.

That's probably true. But keep in mind that Harry Browne was a successful speculator, and the PP arose out of his desire to consolidate into something safe.

There are many VP choices that I think can make plenty of sense without you having to be the farm on Indonesian junk bonds. For example, the PP produces a relatively small income stream and most of its returns are capital gains; a bond-heavy or dividend growth VP could make sense if you have the fortitude to care only about income, not the capital value of your income-producing investments.

My VP consists of 100% Vanguard Wellesley.  The fund holds large cap, blue chip dividend producing stocks, high grade corporate bonds with a smattering of treasuries, and produces a dividend yield of nearly 3%.  This is held separately from my PP and gives a total portfolio allocation of roughly 28% stock, 32% bonds, 20% gold and 20% cash.  I don't consider Wellesley a speculative holding; although, it did get whacked pretty good this week along with everything else.  Speculative VP,s can be used for gambling.

[iwealth]

Why the Best-Laid Investment Plans Usually Go Wrong (except your Variable Portfolio apparently)

H.B's advice about a separate Variable portfolio always confuses me. It seems to contradict the 'anything can happen, nothing has to happen/beating the market is a losing strategy' fundamentals of the PP.

Why would you keep a VP if speculation is futile? If you just like to speculate, why not just take some cash and consider it 'fun-money'? And if you want to tilt, you can just slightly alter the allocation percentages within the PP. Holding a VP seems dangerous advice for most investors as it leaves a lot of room to make all the classic investment mistakes.

What are your reasons to keep separate VP?

I've asked a similar question here before. I think it's mostly a mental thing. It allows for a gamble, acting on a gut feeling, etc., with money one can "afford to lose."  But if 80% of your money is in the PP and 20% in dividend paying stocks in a VP, really you're just a person holding a 40/20/20/20 portfolio with a different set of rebalancing rules assuming you don't want to "mix" the two.

[MediumTex]

A properly designed VP is based upon the same principles as the VP, but with more risk.  The principle is that a volatile asset can easily see gains far in excess of 100%, but can never see a loss of more than 100% (assuming no leverage is being used).

A well conceived VP speculation should be one in which the upside is at least 300-400%, while the downside is obviously not more than 100% (assuming no leverage).  In other words, the potential benefit is far greater than the potential loss.

If you feel really good about a speculative play and can afford the loss if it doesn't turn out well, when properly understood the risk/benefit balance is actually very much in the investor's favor is he chooses high quality speculative plays.  By "high quality speculative plays" I mean speculations in which you actually know something about the underlying business and you aren't just being taken advantage of by someone who is doing a pump and dump or otherwise selling you junk.

One setup I really like for a speculative play is when a company with good earnings and a lot of insider ownership is getting really beat up by the market and the board adopts a "poison pill" arrangement to help prevent an attempted takeover of the company.  This tells me that the board feels pretty good about the company's prospects and is usually pissed that the market is treating it so poorly.  You've really got to pay close attention to SEC filings to pick up on this sort of thing, though. 

[MediumTex]

One setup I really like for a speculative play is when a company with good earnings and a lot of insider ownership is getting really beat up by the market and the board adopts a "poison pill" arrangement to help prevent an attempted takeover of the company.  This tells me that the board feels pretty good about the company's prospects and is usually pissed that the market is treating it so poorly.  You've really got to pay close attention to SEC filings to pick up on this sort of thing, though.

Out of curiosity, have you been able to identify any such companies in your VP history?  How well (or poorly, as the case may be) has it worked out for you?  Could you cite past examples?

DrilQuip is the company I was thinking of in particular.  DRQ provides equipment for offshore drilling in harsh conditions.  Its earnings are strong and consistent, it's well-managed, good market position, etc.  A quality company from top to bottom.  It has three founders who own a lot of stock (one died a few years back I think).  I began following this stock closely around 2006 when it was trading in the $40-$60 range as I recall. 

When 2008 hit it traded down to the mid teens and it was during this period that the board adopted the poison pill.  When I saw that I bought 1,000 shares.  The problem, of course, is that I sold 900 of those shares when it got in the low 20s a few months later and I couldn't resist.

Today is is trading in the high 80s.

If I had simply stuck to my thesis, I could have turned a $15,000 investment into an $88,000 investment in five years, which is pretty darn good.  The way things turned out I still did well, but not nearly as well as I could have done.

The point, though, is that I didn't feel like I was buying a lottery ticket on a company that I didn't know anything about.  It was truly a bargain when I bought it and it was a sound VP play.  My downside was a $15,000 loss, but my upside was far greater.

[Pointedstick]

Very few of us really have what it takes to be a speculator. Even in the event you have a great edge and enter at the right time, when do you exit the position? That's always the killer question for me. I made a bunch of money off my own fruit company investment but was too conservative and only sold half near its peak. Now what I have left is way down and a potential 100% gain has been eaten down to "only" 25% were I to sell off the rest today.

[AdamA]

Very few of us really have what it takes to be a speculator. Even in the event you have a great edge and enter at the right time, when you you exit the position? That's always the killer question to me.

Me too.

I think more mechanical VPs are the only things I can handle.  The problem is, I can't really think of that many. 

[smurff]

In addition to all the speculation uses already mentioned, I think of the VP for assets that don't fit the big four that you acquire as a non-PP investment.  Residential real estate, municipals, corporate bonds, etc. 

As for speculation:  Humans simply love to placing bets and making gambles.  If it's not the stock market, then it's the lottery, the horses, black jack, or Bingo.  I think the VP, which is a brilliant idea, was HB's way of supporting investors, who will naturally have this tendency, who want to keep their betting and gambling close to the financial markets.  (In the USA, despite occasional lotteries, casinos, horse racing, and dog racing, in some states, there was no widely available gambling method back in the 1970s/1980s.  Only the stock market, which technically is not gambling, however it was largely reserved for wealthy players.)

[Pointedstick]

(In the USA, despite occasional lotteries, casinos, horse racing, and dog racing, in some states, there was no widely available gambling method back in the 1970s/1980s.  Only the stock market, which technically is not gambling, however it was largely reserved for wealthy players.)

One of the weirdest crimes I've ever learned about is aggravated gambling. This does not, as you might expect, concern gambling while angry, and it's still a thing in a lot of states.

http://www.gambling-law-us.com/State-Law-Summary/