Gyroscopic Investing

WildAboutHarry, ngpc who posts here (and also AgAuMoney I think) have modified PPs that contain individual stocks that are individually rebalanced. There are links back to discussions about that in: 
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=5

Possibly rebalancing such a portfolio every year might be a good idea? I have to stress that I have almost no knowledge or experience as an investor. I'm just mentioning how the phenomenon of what stocks look to be doing came across to me.

Clive

Fundamentally, if after having rebalanced the prior trend continues, then it would have been better not to have rebalanced. If the prior trend reverses then its better to have rebalanced. There's 50-50 probability of prior trends continuing or reversing. Pure luck might be the only driver as to whether you relatively benefit or lose out.

I think the crucial point is that whilst there may be a 50-50 chance of a prior trend continuing or reversing at any given moment, it becomes effectively certain to reverse before long (although of course individual stocks can go to zero). Just as with tossing a coin, you are not going to throw heads 50 times in a row ever. The arithmetic of compound growth also basically makes it utterly impossible for anything to grow at 30% per year for very long. Lots of individual stocks do often move by that amount.
My guess (I obviously don't really have much idea) is that the 1981-2000 period was a strange one off extended stock rally and what we have had since 2000 is more like what we will have ahead

stone wrote:Just as with tossing a coin, you are not going to throw heads 50 times in a row ever.

Well, you have an 8.8817842 × 10-16 percent chance

Clive, on the re-balance effect, is the dividend strategy simply enforced, regular, quarterly "re-balancing" (I write re-balance because the site's spell checker does not like rebalance)?

stone wrote: To the extent that the volatility of different stocks is correlated, the HBPP strategy captures that volatility and allows it to be reinvested in a compounding way. So as stock prices bob up and down, they get rebalanced into gold and LTT and cash on the ups and back into stocks on the downs. I guess though that a HBPP with a TSM fund for the stocks must miss the volatility between individual stocks.

So what would win out, low beta stocks with infrequent rebalancing or high beta stocks with frequent rebalancing?  Browne originally recommended buying high beta mutual funds.

Did you read the Minimax paper?

WildAboutHarry wrote:

AgAuMoney wrote:Repeat:  Cap gains do not compound.

I'm having a hard time with this concept.  Can you elaborate or point me to a source to review the concept?

Assuming two identical companies, one pays dividends, one doesn't.  Assuming you reinvest the dividends, don't you end up in the same place?  That is, the value of the stock plus reinvested dividends (first company) should match the value of the stock (second company).

I'll see if I can come up with a better explanation than I gave before.  (Edit:  but not right now.)

Your "assuming..." is very true, in theory.  And ONLY in theory.  In practice it doesn't work out that way, partly because there is no pair of companies exactly the same except for the dividend.  But if history is any indication, in most real cases receiving the dividend in hand works out better even if you do not reinvest.  If you do reinvest, or invest the dividend in some other productive concern, you do that much better.

WildAboutHarry wrote:TSM tracks most of the Vanguard dividend funds reasonably closely.  The dividend funds held up relatively well in 2008 (compared to TSM).  And they do "outgrow" TSM over long terms.

Dividend funds are EXTREMELY bad compared to any reasonable effort to do it yourself.

The flaws are almost innumerable.

When I investigated dividend funds (ca. 1999-2002) I found they would hold stocks in anticipation of them becoming dividend stocks.  Or hold stocks which paid a high current dividend but without the financial wherewithall to continue paying.  And on and on.  I investigated a dozen or more finding absolutely none without gross problems that made them not worth owning.

When I watched dividend funds in 2007-2009 I found they did not react at all timely to obvious problems (and in many cases could not because of their "based on an index" or "follow our benchmark" mandate).  This led them, for example, to hold financial stocks (many of where were dividend stalwarts) long after the companies cut their dividends and their share prices collapsed.

Also note that dividend funds also suffer all the problems of every other fund -- forced to invest by cash inflow when valuations are high, forced to sell to meet redemption demand when valuations are low, no discretion if bound to an index or else strong incentives to show strong quarterly and annual results and not be caught with 'dead money' in poor holdings so they whitewash just prior to reporting, focus/mission creep, etc.

Clive wrote: Fundamentally, if after having rebalanced the prior trend continues, then it would have been better not to have rebalanced. If the prior trend reverses then its better to have rebalanced. There's 50-50 probability of prior trends continuing or reversing. Pure luck might be the only driver as to whether you relatively benefit or lose out.

That's true, except the probability is not 50-50  (Two outcomes does not mean 50-50) and rebalancing is useful at increasing profits even if not optimal because it isn't all or nothing.

There is no way without foreknowledge to obtain optimal results in the stock market.  So once you give up that foolish dream, an obtainable goal is to do the best you can with the effort you are willing and able to apply.

The best case for rebalancing is to look at the chart of a cyclical company.  The objective is to buy low and sell high, and rebalancing is an automatic way of doing that.  Not buy "lowest" and sell "highest" but merely to capture some of the gains and buy for a lower than average price.

Buying on lower than average is easy.  Just buy all the time.  Dollar cost averaging works.

But what about capturing some of the gains?  What if you don't want to have any more capital at risk in a given company (or fund, but I don't do funds as a general rule)?

That's where rebalance comes in, just like in the PP.

It works.

I've been holding SLW and TTM for several years and have been very successful at taking money out when they outgrew their allocation and putting money in when they suffered a decline.  I've had similar success with many other companies but most of my holdings are not as volatile and do not give me as much opportunity as those two.  Both of them have effectively well under $5 of my money left in them per share, and in about 1/4 of the years it took my PG to get to that point.

MachineGhost wrote:Browne originally recommended buying high beta mutual funds.

Actually his original recommendation was for high-beta stocks, not funds.

Funds are a great simplification that considerably reduces the work involved.

Plus in my opinion there is no way to know future volatility (when and how much) and future results so trying to optimize for volatility could easily lead one to sacrifice returns.

My personal approach is to first go for quality (and my screen for that is dividend growth followed by some fundamental analysis).  Once that hurdle is crossed, companies that have historically been more volatile go into the PP, others go into my VP where high-yield goes into tax free and those with lower current yield but historically higher-growth I prefer in the taxable account.

There is some compelling evidence that "quality" is the best indicator of future returns.  Some theorize that this explains the benefit of dividend growth or even simple dividend investing.  The key being if the universe of dividend payers tends to have a higher proportion of "quality" companies than the market as a whole, and the universe of dividend growing companies is even more concentrated.

Too many "ifs" and "theories."

I just know what >20 years of experience has taught me via the actual results, with about 10 targeting growth mainly via funds and some stock picks, and about 10 more since then focusing on dividend growth.  I cannot make a focus on "growth" work with any reliability.  But picking "dividend growth" I get growth very reliably.

MachineGhost wrote:

stone wrote: To the extent that the volatility of different stocks is correlated, the HBPP strategy captures that volatility and allows it to be reinvested in a compounding way. So as stock prices bob up and down, they get rebalanced into gold and LTT and cash on the ups and back into stocks on the downs. I guess though that a HBPP with a TSM fund for the stocks must miss the volatility between individual stocks.

So what would win out, low beta stocks with infrequent rebalancing or high beta stocks with frequent rebalancing?  Browne originally recommended buying high beta mutual funds.
Did you read the Minimax paper?

I guess it might make sense to have "the best" stocks from each sector of the economy irrespective of whether they were high beta or low beta and rebalance each individually against LTT, gold, cash (or use some other effective volatility capture method). Some good companies will dish out potential returns by way of volatility and some via dividends. BUT if you are just holding a stock in a VP with no rebalancing strategy then my guess is that high beta stocks will be at the mercy of market timing and any gains could well be subsequently taken back.

Clive, do the equal weighted back tests studies you mention look at equal weighting in the context of something like a HBPP? I guess it is critical to have enough "buffering" of the volatility in order to capture it effectively.

Because I started my PP with a fairly small amount and wasn't familiar with individual companies, I put the stock part of the PP as CTY.L , BRSC.L and TEM.L and have kept those at equal weight. My hope is that those three are really quite different from each other and the volatile stocks have a chance to be rebalanced without being lumped in with the dividend stocks (that are in CTY.L). BRSC.L and TEM.L are both very volatile but seem to move at somewhat different times.

Clive, if you have say ten stocks each comprising 2.5% of a HBPP and rebalance once a year, then the trading costs would not be too onerous unless the portfolio was small (like mine was at least initially) would they?

You seem to be doubting the whole principle of rebalancing where each time something doubles it must halve in order to bob along keeping the same value and when $100 doubles you gain $100 whilst when it halves you loose $50. I can't reconcile your seemingly doubting that with your 3xPP strategy and many other things you write on other threads

Clive wrote: I'm not a great believer in mean reversion. Seeing more of a Wagon-Wheels-R-Us versus Michelin type longer term tendency. Not to say that at times the less obvious choice might be the better (prolonged oil shortage perhaps).
Mostly things plateau for a period of time, and periodically jump up or down to a new plateau level where they might remain for lengthy periods of time. Those jumps are mostly random, both in interval and in direction. If you have a rope that stops you falling all the way down (33% in 3x so your downside is finite) when the next big move is down, but you fully rise when the move is up !!!
Correlations of course also have significant bearing, as the gains in one can help offset the losses in another.

I'm also not a believer in the idea that a move down is predictive of the next move being up but that is not required for a "rebalancing bonus" phenomenon. Entirely random movements give a rebalancing bonus. I'm sure you are more familiar than me with http://en.wikipedia.org/wiki/Geometric_Brownian_motion . If you had a bunch of such Geometric Brownian Motion "stocks" kept at equal weight, then you would get a rebalancing bonus. Those Geometric Brownian Motion charts have a very spooky resemblance to actual stock charts.

AgAuMoney wrote:I'll see if I can come up with a better explanation than I gave before.  (Edit:  but not right now.)

Thanks.  I look forward to it.

AgAuMoney wrote:Dividend funds are EXTREMELY bad compared to any reasonable effort to do it yourself.

Can you recommend any good titles/web sites on the do-it-yourself route?

I ran a 10-year comparison of Vanguard's Equity Income Fund versus TSM, T.Rowe Price Dividend Growth, and Fidelity's Dividend Growth.

On a growth basis: Equity Income > TSM > T.Rowe Price > Fidelity.

On a price basis it was flipped: TSM > Fidelity > T.Rowe Price > Equity Income

This suggests that Equity Income, at least, was able to throw a good stream of dividends.

It looks to me that those two scenarios would end up the same IF all these things were true:
1: With the dividend company, every share holder and not just you reinvested the dividends.
2: With the non-dividend company, the retained earnings were all used for a stock buyback and that stock buyback followed exactly the same schedule as the dividend payments for the dividend company and every shareholder took part in the buyback using the same proportion of their shares.
3: The stock buy-back does not embolden the company to dilute the stock with employee stock options.

In reality I guess those conditions are not likely to be met. Instead, if you are someone who is likely to be reinvesting your dividends, then it is likely that you will not take part in the buy-back. The buy-back is likely to  transiently bid up the stock price more than the dividend reinvesting does because many shareholders won't be reinvesting the dividends etc etc. So after reinvesting the dividends, you end up with a greater proportion of the company than you would have done after the buy-back.
I guess it is possible that if you are wanting to rebalance out of a stock, then a buy-back might actually be better for you

AgAuMoney wrote:

WildAboutHarry wrote:

AgAuMoney wrote:Repeat:  Cap gains do not compound.

I'm having a hard time with this concept.  Can you elaborate or point me to a source to review the concept?

Assuming two identical companies, one pays dividends, one doesn't.  Assuming you reinvest the dividends, don't you end up in the same place?  That is, the value of the stock plus reinvested dividends (first company) should match the value of the stock (second company).

I'll see if I can come up with a better explanation than I gave before.  (Edit:  but not right now.)

Your "assuming..." is very true, in theory.  And ONLY in theory.  In practice it doesn't work out that way, partly because there is no pair of companies exactly the same except for the dividend.  But if history is any indication, in most real cases receiving the dividend in hand works out better even if you do not reinvest.  If you do reinvest, or invest the dividend in some other productive concern, you do that much better.

WildAboutHarry wrote: After reading this thread I confess to Googling about dividend strategies and felt a nostalgic longing for owing individual stocks.  KO! WAG! XOM! MCD!  They are all there!  

I still have 3 of those in my vp. It's very pleasing to see the dividends get a raise every year and I will be sad when I let them go.

Clive wrote: Simply picking the sectors/stocks that you believed would be in the worst (lower) category and not holding those has quite a nice potential - but picking losers is just as difficult as picking the best - which is into the realms of in/out timing based on moving averages (stop loss to potentially minimise maximum loss).

Sector rotation investing has long been a profitable strategy with the Fidelity sector funds.  Last time I looked at the strategy, it made about 15% CAGR since 1990.  I've not implemented the method because the maximum drawdowns are still rather large and DecisionMoose with its alleged macroeconomic overlay beats it (even though the edge has been decreasing over time as 6-month momentum has become the market).

In fact, I believe that the sector movement accounts for 49% of a stock's move, the industry in some other moderate portion and the stock itself is only about 10%.

Clive wrote: I've repeatedly stressed that I consider leveraged ETF's as being a means to achieve similar rewards with less left tail risk. 33% in 3x, 67% in cash instead of 100% in the 1x type of left tail risk reduction (rebalanced infrequently (once each year)).

Is that really true when the net loss in terms of $ would be the same for the 1x portfolio as the 3x portfolio?

dualstow wrote:I still have 3 of those in my vp. It's very pleasing to see the dividends get a raise every year and I will be sad when I let them go.

I can't remember the last individual stock I owned (not counting ETFs and CEFs).  You know, even though DRIPs are anachronistic, stock ownership via a company-run DRIP eliminates several layers of counter party risk.  Didn't Wrigley shareholders get a few packs of gum along with the annual report?

Neat. Best I got was a shareholder coupon for a Roomba discount from iRobot (IRBT) stock.

Clive wrote: But does it work in generally and consistently.

Investing in dividend growth?  I think so.  As I've mentioned, perhaps in another thread, the div growth stocks I was holding prior to 2000-2002 held up well, and since 2002 I've been focused primarily on this approach and done very well with it.  The difference in my IRA resulting from the different composition in 2001 vs 2008 was huge, and the recovery in 2009 having dividends investing continuously at those low valuations was astounding.  Research I've done re. the great depression says that dividend growth was hard to find, but many companies paid consistent dividends thru the 1930's and 1940's.  If at that time you avoided selling you did OK.  If you had capital to invest you did great.  Dividends helped a lot if you tried to meet either or both of those challenges.

and assuming you held one stock in each sector that replicated the sector average gain (loss),

That's a huge assumption with no foundation, and does not at all resemble my portfolio.

Dividend growth companies do tend to be above average in their sectors.  If not, they soon could not afford to keep increasing their dividends, and then I wouldn't be holding them.

It turns out to be really hard to model this approach, because the simplifying assumptions typically made (as you did) are way off base.

SLW and TTM may have worked well for you in the past, but a swing low and stay low could leave you heavily averaged in, and awaiting a subsequent recovery for a long period of time.

It's not just SLW and TTM but those did start out as speculative holdings at a smaller position size.  I've been able to 'skim the cream off the top' a few times when they outgrew my allocation.  I've done the same thing with MCD, DOV, INTC, MO, and others.

I don't always do this.  I've been holding PG since the early 1990's and never sold or added to that position.  The dividends and spin offs have started or added to many other positions and still PG is a bit larger than I'd like.  Not quite big enough yet to act on...  JNJ has been in my portfolio about the same time, but not done nearly as well.  The dividends have been nice, but

To throw in some additional perspective, I hold about 50 individual stocks.  I don't try to equal weight sectors or anything like that.  But I do roughly equal weight positions except for a few speculative which are often 1/2 or 1/4 sized but not more than full-sized.  Full-sized would be way less than 2% of my portfolio (my "portfolio" is everything but the checking account, so after including the PP and my other cash, silver and gold it means at least 45% of my portfolio is not in stocks) or about 2% of my stock holdings.

With that approach, there is no way to be "heavily averaged in" unless company fundamentals went to pot for many years and I didn't notice (ala stayed invested in Kodak or Polaroid for the past 30 years, which didn't happen and wouldn't since they also quit growing their dividends).  And it seems to me that less than 2% "waiting for a long time" is not the end of the world.  After my recent addition to my SLW position, my net investment in SLW works out to be just under $3 per share.  PG is just under $7 per share and TTM is just over $7.  I've held PG almost 20 years, SLW and TTM about 6.  (They are all in the same account so comparison is easy.)

I've done the same approach in some accounts with silver and gold using SLV and IAU both between them and other portfolio positions.  I'm a bit more concerned about those going into a long slump, as there is no 'fundamentals' to value as there is with a company.

There is a lot of fascinating research about dividend stocks, and some about dividend growers.  It tends to paint a pretty positive picture, with the biggest problem seeming to be that this approach to investing is slow and boring.  None of the 2x or 3x leveraged swings in those companies, and even the cyclicals tend to move pretty slowly compared to the typical "small cap growth" company.  So if you can tolerate being the tortoise rather than the hare, you might find a place watching your monthly income go up a few dollars nearly every week.

I will admit I do tend to stray slightly around the edges and pick up things like SLW (and more recently it's little brother SAND).  But the huge majority of my stock holdings are dividend growth.  Those little dalliances will pan out (like SLW) or they fail (like PLUG and BLDP in 1999 or HEV/ENER a few years ago) and I lose a month of dividend income, or maybe two or three months.

WildAboutHarry wrote:

AgAuMoney wrote:I'll see if I can come up with a better explanation than I gave before.  (Edit:  but not right now.)

Thanks.  I look forward to it.

AgAuMoney wrote:Dividend funds are EXTREMELY bad compared to any reasonable effort to do it yourself.

Can you recommend any good titles/web sites on the do-it-yourself route?

The key is growing dividends.  Dividends alone are good, but only if they are growing do you have inflation protection and a growing company underneath which is interested in sharing their profits with you, an owner.

I quite like seekingalpha.com in their income investing section.  There are many good dividend growth articles written by people more talented than I.  A few Davids, chowder, Tim, etc.  I almost feel guilty mentioning names because I cannot mention all who deserve to be mentioned.  David Fish publishes a don't miss monthly dividend stock spreadsheet, with companies divided into 3 groups based on how long they have been increasing their payout, with the minimum being 5 years. (I think, or was it 7?)  There are over 400 companies listed and it is a great start to doing research on a company.  Another author, Chuck Carnevale maybe? publishes "Fast Graphs" which are a great tool for understanding company valuation and the author regularly publishes valuation related articles.

Somewere recently on seekingalpha I published a slightly more elaborate version of my thoughts on cap gains not compounding unless you can compound them yourself.  Cannot find it...

A quick thought on compounding...

If you have X, and it grows by 10% you'll have 1.1X.  If another year it grows another 10% and it compounds you'll have 1.21X.  But if it does not compound you don't know what you'll have.  You might have 1.1X.  You might have 0.9X.  You might have 3X.  That is the way stock prices work.  The gains you see quoted are from an arbitrary time to an arbitrary time and you might or might not get that and you might lose it the next day even if you do get it.  Dividend growth compounds...  The company doesn't claw back the dividend, and dividend growth means when they increase the dividend 10% it is 1.1X and the next year when they increase it 10% it is 1.21X, and the next year... etc.

Clive,

compounding effects can also work to the downside.

I'm lost with this. I might understand with the help of a really simplified example eg company pays out x in year 1 then etc etc.

AgAuMoney wrote:A quick thought on compounding...

Thanks.  I'll take a look at Seeking Alpha.

I have been using Vanguard's Equity Income fund as a proxy for the dividend growth strategy just to see how it behaved in the past.  Compared to TSM you can really see the compounding effect of the higher dividend payout over a variety of time frames.  The only place I've seen so far where TSM outpaced Equity Income was in the mid to late 1990s stock boom.  If it wasn't rebalanced out, that TSM differential growth did not "compound" and was gone by the early 2000s. 

AgAuMoney wrote: To throw in some additional perspective, I hold about 50 individual stocks.  I don't try to equal weight sectors or anything like that.  But I do roughly equal weight positions except for a few speculative which are often 1/2 or 1/4 sized but not more than full-sized.  Full-sized would be way less than 2% of my portfolio (my "portfolio" is everything but the checking account, so after including the PP and my other cash, silver and gold it means at least 45% of my portfolio is not in stocks) or about 2% of my stock holdings.

Why are you not using mean-variance optimization to account for the intrastock correlations?  This is, after all, the specific area that Markowitz's thesis actually works compared to the asset class level.

One problem I see with doing Markowitz practically is the transaction costs when wanting to add a new stock.  Since it will upset the correlated weights of all the pre-existing stocks in the portfolio, it could be expensive to rebalance except using something like FolioFN.

Clive wrote: Some high dividend yield investors...

That's not dividend growth.  I realize you may not be familiar with this 'slice' of the stock universe.  It seems to be almost uniquely American.  Non-U.S. dividend payers with a commitment to dividends tend to have a policy of paying a certain proportion of earnings or some similar metric, but dividend growth is about paying more each year than the year before.  Some such companies have been paying increased dividends for well over 50 years with growth exceeding inflation for the period and most subsets of it (high inflation like late 1970's they tended to lag).

If you consider a dividend stock to be like a 2x cash investment,

It's not.

Over long periods, the share price alone might just generally pace inflation and what provides the real gains are the reinvestment and compounding of dividends. There are figures around that indicate that share price alone barely beat inflation over long periods of time.

Dividend growth stocks over long periods generally experience roughly market returns.  The dividend is "extra" much of the time, but during real booms (e.g. late 1990's) the market will beat dividend growth as PE's expand faster in the hot sector(s).

But I realize there may be some misunderstanding.

The dividend growth is not about how to beat the market.  Dividend growth is about a growing income without sacrificing market returns and minimizing the risk of volatility in market returns.  (If you don't need to sell, volatility is not a risk.)