Friday, December 16, 2016

Automating my investment strategy

I have automated my 2017 investing. I already know what I will be buying in 2017 and at what prices. Let me explain further.
For me, investing is principally about removing emotion from the investment process and buying high quality businesses at prices that are bargain basement. Ideally, I’d love to be the buyer of last resort, and buy when nobody else wants to buy.
Of course, this is easier said than done. While it may be easier to identify the high quality business, the discipline to know when to sell, when to wait and do nothing, and then went to move in aggressively is more nuanced and can easily be influenced by emotion.
I’ve already made my bets for what I’d like to hold over the next decade and potentially buy at lower prices should the opportunity present itself. I’ve accumulated initial stakes in most of these businesses over the last 12 months however  present prices aren’t conducive enough for me to look to accumulate more aggressively.

As such the approach I’m taking is to set up a series of limit orders to purchase larger positions in many of these businesses at prices that are significantly below where they currently trade. I’m using a strategy of writing out of the money put options.  I’ve committed to being a buyer of high-quality businesses at prices that vary between 10 to 40% below the market value of these businesses today.
Effectively what I’m looking to do with this strategy is to remove the emotion associated with constantly looking at stock prices and then unnecessarily worrying about what makes good buy point and if or when the market will fall further.
So what this means is that the businesses that if businesses do not get to my buy points, then I’ll just have to be content to hold what I already have. I’ll be prepared to wait for the market to determine which of these businesses it wants to sell to me at my predetermined prices and which of those businesses it will choose not to.
The strategy can be thought of as being something similar to algorithmic based trading where trades are executed based on predetermined rules and prices that are input into the system.
Of course such as strategies aren’t without risk.  The biggest potential issues that could occur are a general market meltdown or a stock specific material event that destroys a significant amount of fair value and which results in a purchase being made by me at a price that is substantially above the fair value of the business.
A general market meltdown is certainly something that I’m prepared for and I go as far as to say, something that I would welcome. When negative sentiment sends down stock values without there being any stock specific reason, that typically is the best time to pick up high-quality businesses trading at significant discounts. To me this would be the preferred reason upon which I would be forced to purchase stock.
A stock specific event that significantly impacts intrinsic value would be more of a concern however given that I maintain a diversified portfolio of close to 20 different positions I believe it would be highly unlikely that such an event would impact a significant portion of my portfolio.
Further I am specifically derisking such an outcome by locking in by points for additional accumulation in writing materially out of the money put options to build in a margin of safety for exactly such a scenario.
In aggregate I believe the merits of such a strategy actually outweigh the risks and I’m comfortable proceeding with this plan and seeing what 2017 brings.
In the worst case I am the recipient of a tidy set of options premiums for my willingness to be a buyer of last resort. The businesses that I view of being exceptionally high-quality are long-term holdings. In the best case I become a buyer of one or more of these positions at prices that will likely provide a meaningful boost to my long-term returns.
By systematically automating the prices at which I wish to buy, I take a lot of the psychological aspects of investing off the table and can just let the chips fall as they will and make decisions to buy independent of market movements.
The other aspect of my automation strategy of course is the regular index accumulation that I maintain for my 401(k) program. This will also continue consistent with the rules that I’ve set up for my regular bimonthly purchases.
Investor fear and a desire to time markets are two of the largest inhibitors to long-term investment success. By trying to eliminate these behaviors from my investment strategy, I believe that will go some way to better long-term investment returns.
The net of all of this is that I have almost fully automated my investment program for 2017 and I don’t expect to make material investment purchases outside of the predetermined rules that I have in place.

This article was written by Financially Integrated. If you enjoyed this article, please consider subscribing to my feed.

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