Rummaging Through the Toolbox: The Year in Review

When I introduced this column, I used the metaphor of a woodworker's shop to describe my approach to investing. To build a chair, you need saws, lathes, drills, sandpaper and finishes, and experience. For successful investing, you need information, analytical tools and yes, a lot of experience. On the first anniversary of this column, let's look back at the concepts covered over the first year.

Tools and Templates

In a woodshop, a template is a form used to guide tools. As markets move, we ask, "Where have we seen this before?" Critical to success this year has been gauging the nature of the correction we have experienced. In A Brief History of Bear Markets, I noted that this year's market action was typical of an environment of tightening Fed policy. Using the tools in Learn to Read Economic Indicators Like a Fed Governor, I correctly anticipated both the end of Fed tightening and the likely change to a policy of easing. Markets were caught off guard by the deadlock in the presidential election, leading to a second major selloff this year. However, this correction looked more like the short-term pullbacks associated with the collapse of emerging-market debt in 1998 or the invasion of Kuwait by Iraq in 1990, than the terrible bear markets of 1929-'41 or 1973-'74. I used this second correction to invest new clients and have been rewarded so far. The tools described in Indicators Help Navigate Choppy Markets were used to time purchases.

Success this year has depended as much on avoiding disastrous stocks as buying good ones. The templates described in Stars, Dogs, Cash Cows and Problem Children: What's in Your Portfolio? were very useful in sorting through technology stocks. Companies with terrific prospects but negative cash-flow situations (the problem children) were underweighted in our portfolios. I refined this analysis with Show Me the Money -- Use the Statement of Cash Flow to Assess Corporate Risk.

More templates were introduced in February's Practical Models for Sifting Through Stock Ideas. In particular, I talked about the risk factors associated with Internet stocks, at the time flying high. Although the stocks I favored in that group are off 50% to 70%, I avoided other companies that are either down 95% or out of business. I also discussed how trends more often follow an S-curve than a straight line (recent examples: Internet advertising, the price of oil) in Island of Foxes and Hares: How the S-Curve Forecasts Stock Behavior.

In November, I introduced a template for evaluating the overall stock market in How to Look Both Ways Before Plunging Into the Market. At the time of publication, I was bullish to neutral on the stock market, with the only bear signal coming from politics. I aggressively invested new investors through November even though stocks generally suffered. However, as expected, the near resolution of the election and the promise of easing Fed policy caused markets to rise, as shown by Tuesday's explosive rally. I continue to be bullish in light of favorable seasonal factors, as discussed in To Everything There Is a Season: A Look at Calendar Effects.

Techniques and Processes

Having the best-equipped woodshop doesn't guarantee a good result if you don't know how to use the tools. A number of my columns discussed the analytical processes I use in serving clients. I outlined these processes in Fundamental, Quantitative or Technical: Investors Need a Style.

A number of articles addressed risk reduction through diversification, including Manage Your Portfolio Like a Baseball Team, Tune Your Portfolio With a Year-End Review, Part 1 and Part 2. I'm having a so-so year, with clients averaging gains of 4.1% (vs. losses in the S&P 500 index of 6.3% and in the Nasdaq of 29.7%). At the end of last year, 40% of clients' assets were in technology, contributing to gains of 43.9%. In January, I moved 15% of those assets to health care and financial services, which did nothing in the first quarter, but paid off for the rest of the year. In the year to date, our financial service companies are up 16% and our health care stocks are up 67.4%, while our technology stocks are down 31.6% on average. Clearly, diversifying kept us out of disaster.

Investors with the riskiest portfolios this year were employees of technology companies with stock options. Hopefully, they heeded my advice in Protect the Value of Your Stock Options and previous articles including Being Charitable Eases Tax Bite on Stock Options, Employee Stock Options: Protect Your Paper Profits and Questions and Answers on Managing Employee Stock Options.

I discussed other life-planning issues in A Quick Back-to-School Financial Review and High Income or Net Worth: Where Should You Focus? Selling strategies were reviewed in When to Sell: Discipline Over Emotion. My August column, Take Tax Losses Now, Avoid the Year-End Rush, was particularly timely given the level of mutual fund tax sales this year. Stocks that were down in September dropped off a cliff in October and November.

I will continue to add new tools to the toolbox and revisit and refine the concepts previously addressed. Feel free to suggest ideas or send questions to me at [e-mail].