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Investment Performance - Better Than You Think

Mar 7, 2008
Ouch! The mighty Dow has fallen to within a financial heart beat of its 1999 high water mark, boasting an average per year gain of less than one half of one percent in spite of several interim manipulations designed to improve the performance picture. The S & P 500 Average, an equally prestigious indicator of broader market movements, is nearly 13% below where it was at approximately the same time. Both figures reflect no investment expenses at all. So, in spite of the mostly ignored fact that neither index includes any income securities (bonds, preferred stocks, REITs, etc.), a reasonable person could well expect his or her portfolio market value to be well below where it was nearly ten years ago! Now that's a fairly dismal scenario, but it's the in-your-face reality for most investors as we move forward into what we all hope will be a more spring-like investment climate.

The chronic failure of market value indices and indicators to move ever upward with less amplitude is a function of both fact and emotion. The basic facts involved are economic, and there has never been a stock or bond market cycle that has not been affected by the natural movements of the world economy. (The China syndrome, by the way, is evidence of the strength of capitalism--- a pat on the back as opposed to a slap in the face.) It is the emotional realities of the investment world that have led to the rise in volatility. Greed and fear have always had in impact on markets, but as the numbers of individuals with self-directed portfolios has grown, so have the magnitude of the ups and downs.

There is less stability now in even the most conservative investment portfolio structures, as evidenced by the current weakness in fixed-income-content securities despite major reductions in interest rates. Even though interest and dividend payments have been maintained throughout the credit difficulties, these securities have lost some of their market value. But it was investor demand and investment institution greed that led to the creation and distribution of the securities that led to these problems. The problems will be resolved eventually, income security market values and the market indices will move ahead to new high levels. Only the ulcers will remain, while Wall Street creates the new products that will fuel the financial crisis of 20XX.

The Working Capital Model (WCM) approach to portfolio performance evaluation eliminates the tears and fears because it is based on more than the current market value illusion of wealth--- a number that won't sit still long enough to ever be meaningful. Market value, within the WCM, is used only to determine what to buy and/or when to take profits, but all structural decisions are based on Working Capital and all performance evaluations are based on investor goals and objectives. Working Capital is the cost basis of your securities plus any uninvested cash that is looking for a productive home. Its movement reports on the effectiveness of decision-making during the markets' gyrations. Since 1999, both Working Capital and income production should have grown considerably.

Understanding Working Capital is easiest with bonds, the primary purpose of which is to generate income that can be spent if you choose to, without dipping into principal. Principal, by the way, equals cost basis. A bond portfolio whose market value is below (or above) cost basis pays the same amount of interest as it does when the market value hasn't changed. In other words, the bonds do their job regardless of what their current price happens to be. In most instances, the only way you can actually lose money is to sell them when your emotions get the best of you.

Variables in the stock market are more numerous, but all the charts will tell you that IGVSI companies almost always survive market corrections and move forward to new market value highs, eventually. Since the purpose of equity investing is to generate growth in capital (profits are called capital gains, aren't they) when the market value exceeds the cost basis by a reasonable amount. The key to finding a comfort level with equities is to look at the fundamentals (P/E, profitability, debt-to-equity ratio, dividend payment, etc.) of the companies you own and to avoid the current news analyses. Avoid looking at current market value, particularly when the market is in a cyclical downturn, unless you are thinking of adding to significantly weaker positions to reduce the average cost of your position--- an integral part of the WCM.

None of the numbers on your Wall Street designed statements reflect your personal deposits to your portfolio, but the Working Capital total, which should always be higher than your net deposits, is unintentionally clear. Your statement compares market value to cost basis and does not consider the gains and income that you have reinvested in your holdings. Perhaps even more insidious is the fact that withdrawals from your accounts are not reflected. If you are purchasing stocks when they move lower in value and selling any of your securities when they move higher, the securities reflected on your portfolio should always be unimpressively black or green. Seeing red should not make you see red.

The WCM focuses on the purpose of the securities an investor holds. The performance of income securities is evaluated by measuring growth in income while the performance of equities is based on the amount of capital gains dollars that profit taking adds to Working Capital. Even when both investment markets are correcting to lower valuations, contributions to Working Capital will continue. Working Capital will grow constantly; the rate of growth will vary with rallies and corrections. If you can embrace the WCM focus on non-market value issues, you will sleep better in all markets.

Most investors are either preparing for or have arrived at the point in time where they want their portfolio to provide the income they need to retire or to fund other activities. The WCM assures that the asset allocation will support the income production efforts, but only when the actual cash withdrawals remain a smaller number than the total income. If you withdraw more than you make, including any commissions that you choose to treat as a flat fee, your Working Capital total will fall and your portfolio's ability to produce a growing level of income will fall with it. In most cases, the amounts you withdraw from your portfolios are totally under your control and can be kept below the amount of income produced. The longer you can keep it that way, the more secure your retirement income will become.
About the Author
Steve Selengut
Sanco Services
Value Stock Index
Author: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read" and "A Millionaire's Secret Investment Strategy".
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