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Contrarian Investing
Redefined

The alternative to conventional wisdom.
A new definition for contrarian investing.

And remember: "The best time to prepare for the next bull market is before the bulls have bolted." - Brainy
 
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Introduction

There is a lot of conventional wisdom that drives the finance industry today. There are many clichés and words of wisdom that are used to talk about, and to promote, various financial products. Some of these are actually furphies, which we should take only at face value - and there are some which we should not take seriously at all.

Sometimes, our own best interests are not being served when we receive supposedly unbiased and professional financial advice. But don't misunderstand this, a lot of the advice we receive, and the things we hear, are sound and intended with best interests - but some of it is not.

After hearing about contrarian investing over many years, and with much written and published about the topic, it is now time to redefine the definition of this ageing term.

Conventional definition — challenged?

The term contrarian investing can be summed up nicely as follows:
"In finance, a contrarian is one who attempts to profit by investing in a manner that differs from the conventional wisdom, when the consensus opinion appears to be wrong." (source: Wikipedia)

Over the years this has tended to mean that if we study the economic performances of the day, and invest against the consensus opinion of the day, then we might end up ahead of the crowd. But this approach is difficult to describe or define clearly, and requires a lot of time and skill for the analysis. This approach has not been easy for the average investor.

We saw in the financial crisis of 2007-2010 (widely known as the GFC - Global Financial Crisis) that conventional investing wisdom appears to be not so wise any more. So perhaps it is time to redefine, or clarify, the meaning of contrarian investing.

CAUTION!!

It must be stressed that any information here is NOT advice of any sort - it is merely food for thought. No action should be taken based on the information, comments or opinions that are expressed here.

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Contrarian Investing - The updated definition . . .

The following key points are a redefinition of contrarian investing, and in fact could serve as underlying principles in a revised investment strategy for the new investing climate. And we must apologise for any tongue-in-cheek sarcasm that might come across.

1. Don't worry about the economic cycle and occasional bear markets? - [The damage can be horrific!]

The conventional wisdom keeps telling us that the economy moves in cycles, and that we go from good times to bad, and back to good times again. And that we should stay "invested" because the good times will return. What they don't tell us is how bad the bad times can be, and how much damage the bad times can do to our investments.

Would you believe that bear markets come around rather more often than we might think? And it can take many, many months for individual stocks and the markets to recover from a bear market!

Anti-decimation slidesSo, when a bear market strikes, should we maintain our portfolio asset weighting? or should we fine tune the weightings? Should we simply stick our head in the sand and hope that the bears don't do much damage?
Or should we look out for the bears and take "appropriate action"?

Once a bear market strikes, it can take share prices 3 to 5 years to regain their pre-bear prices. For a case study sample, see Robert's presentation slides on Anti-Decimation. And don't forget that a bear market comes around on average at least once every 10 years.

Not convinced about these figures? See this summary of bear markets.

Conclusion? - It can be well worth watching out for the economic cycle, and those bear markets. With prudent money management we can avoid some portfolio damage.


2. Only invest in blue chip stocks! They're safe as houses. [Not!]

Conventional wisdom says that blue chip stocks provide the basis of a sound portfolio for the long term. This might be true. And blue chip companies might give us good dividend income over time.

Blue Chip stocks - Should be around for the long term, but capital returns not guaranteed.What the conventional wisdom doesn't tell us is that during a bear market, blue chip share prices can fall as much as 50% and more. If we had $100,000 in blue chip shares before a bear market, then they might be worth just $50,000 within a few months, and still only worth $100,000 or so after 5 years! The Anti-decimation presentation slides referred to above provide some good details about this.

And, for a glimpse of how well many blue chip stocks performed in the last GFC (or didn't perform), see a number of price charts and observations here.

Conclusion? - If we care about the capital value of our shares, then it might be wiser to sell some or all before a bear market takes hold. This could be prudent money management. And once we are confident that the bad times have passed, we could buy in again.


3. Diversification is key! [Maybe!]

Conventional wisdom tells us that we can reduce our risk by diversifying our portfolio. That is, spread our investment capital across several different asset classes (eg. Australian shares, international shares, cash, bonds, property, etc.). If we hold a share portfolio, then the wisdom says we should have shares in different companies, and across several different industry sectors. We are told that the best mix of asset classes and investments within each asset class can be advised to us by a properly qualified (independent) financial advisor.

By diversifying our investments we are reducing "the risk". But we are reducing the risk of what? This is not as simple as it seems.

If we are happy to slowly build our wealth over a long period, then diversification can be argued to be a really good way to go. Nicolas Darvas wrote his best-seller "How I Made $2,000,000 in the Stock Market" a couple of decades ago, and explains how he invested heavily in select stocks, and closely followed and managed his investment.

Conclusion? - If we are keen to build our wealth quickly, and if we can tolerate a little risk, and if we are prepared to monitor the performance and manage the risk, then it can be argued that the least diversification the better (although it is not recommended).


4. Buy and hold - invest for the long term. [If you can wait for years.]

Over the years we have been advised that the share market returns about 10 to 12 per cent per annum, over the long term. But many people find that a bear market can severely savage their investment, and cause serious long-term damage.

After feeling the impact of a bear market, many people see that perhaps the long-term buy-and-hold strategy is no longer the infallible and wise strategy that it once purported to be.

Conclusion? - The age-old buy-and-hold (set-and-forget) approach might no longer be the best approach.


5. "Time in the market" is important - because we can't time the market! [Wrong!]

clock

The finance industry professionals (most of whom earn their income from our investments) continue to tell us that it is not possible to "time the market". They say that it is "time in the market" that is important.

Now the sceptics amongst us might suggest that these professionals earn income from the larger amounts of money that is called "funds under management". If these funds were at all diminished for whatever reason, then their income could be dented.

There are many private investors who use technical analysis to monitor the markets on at least a weekly basis, and who are happy to switch their investment from one asset class to another. There are many private investors who have successfully "timed the market" for years. Maybe they are NOT listening to the conventional wisdom that says it can't be done. Perhaps the real truth is that it can be done, but with some due diligence.

Conclusion? - It is possible to "time the market", so don't listen to those who say otherwise. Do listen to those who are doing it.


6. Borrowing money to invest? [A powerful and dangerous leverage]

There are some "advisors" out there who would love us to borrow money to invest in the share market, or other investments like real estate. And they use selling phrases like "it will return about 12 per cent per annum over the long term".

(picture of a wrecking bar that provides leverage) But some of these "advisors" don't tell us all the truth about borrowing money to invest. This includes leveraging tools like margin loans, or CFDs (Contracts For Difference). There are not insignificant costs and risks with using borrowed money (ie. leverage) to grow your investments faster.

Conclusion? - Make sure to take a lot of care, and ask all the questions.


7. Your financial planner and your broker - They are on your side!

Wouldn't it be fantastic to think that your financial adviser and your stock broker are both sincerely "on your side"? While many of them are on your side, the sad truth is that some of them may not be. At the end of the day, they provide us with advice because it is their job. They earn income from providing advice. Whether our investment increases in value, or decreases, they will receive their income. Even if we go bankrupt, they have received the income.

One of the potentially disturbing things is that sometimes, only sometimes, their advice is not independent. Sometimes they will peddle the products within their own stable of products. A financial advisor might be tied to a specific finance provider (maybe a big bank), and they might be restricted to offering us just the products that are offered by that institution.

So by all means confide in your financial adviser, and your broker, but at the end of the day be prepared to ask them questions to ensure their independence and the quality of the advice they offer.

Conclusion? - Your adviser might care a lot about your situation and your finances; but no one will care as much as you do. The one person who cares the most about your finances, is you!


8. Don't bother with charts and technical analysis - it can't help! - [Or can it? You might be very surprised.]

Let the following be stated as very truthful:- charts and technical analysis cannot help the people who don't know how to use them.

If you had a hand-help GPS device (Global Positioning System) in your hand, would it help you find your way quickly and safely across mountainous terrain? Well, it might do - if you knew how to use it! If you had no idea how to use it, then it might not help much at all.

Share market charts, and the knowledge and skill to be able to interpret them, can be very useful in the right hands. It doesn't take much to learn the basics about share market price trends and trend-spotting

The field of technical analysis is very broad, but we only need to focus on a small aspect of it in order to be successful.

The bottom line is that the people who don't want us to be successful with these tools will tell us how useless these tools are. 

Conclusion? - The truth is that many individuals do use technical analysis tools very successfully.


9. Stop Loss? Forget it - because they don't work! [It only limits your losses!]

When we take control of our investing, and we make that decision that a falling investment should be divested, we could be implementing the notion of a Stop Loss. For active investors, this is an imperative - it is so essential.

Some people will pro-actively talk down the notion of a stop loss, and claim that it doesn't work. Well, let it be said that there are many many people who use it, and rely on it, and for whom a lot of money is saved. Successfully implementing a sound stop loss approach can avoid excessive losses.

Conclusion? - The Stop Loss is an indispensable money management and risk management tool.

Summary

Take careThe above key points provide some clues about investing which differ from the age-old conventional wisdom, and which are really redefining the term contrarian investing.

Proceed with caution, and beware the sharks in the ocean!

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Last revised: 13 April, 2012.