It matters not what lines, numbers, indices, or gurus you listen to, you just can't “know” where the stock market is going or when it will change course. Interest rates are less volatile, but direction assumptions can be potent. Much too much time and analytical effort is wasted trying to predict changes in direction, when knowing what we can't know is such a powerful eye opener! Let's stop wasting time and get down to the business of investing in a manner that uses what we do know more productively! 

We are going to develop an "all you need to know" graphic that will help you chart your way to investment success. Visualize a standard sheet of graph paper with just three lines on it. Two of the lines will be relatively straight, with an upward bias. The first line is the "Total Working Capital" line and it should grow at an annual rate of from 5% to 12%, depending on asset allocation. Line Two is the "Gross Realized Income" line, and it too should always trend upward. The third line is labeled "Total Market Value", and it will follow a somewhat erratic, wavelike path, constantly moving up and down slightly below the "Working Capital" line. If we observe the chart over an extended period of time, we would observe lines One and Two moving upward regardless of what line Three is doing, BUT, we would also notice that the "lows" of line Three begin to occur above earlier highs. Line Three will rarely be above Line One, BUT when it does move upward, a greater movement upward in the other lines should be expected.

What’s different about this, and it really isn’t very complicated? There is no mention of an index, an average, or comparison with anything. That’s one of the problems that investors have today…the idea that investing is some sort of race with “the averages”. What we should be looking for is the attainment of personal long-term goals, and this method of looking at things will get you there without all of the hype that Wall Street uses to create unproductive transactions, foolish speculations, and frequent dissatisfaction. Ready for some working definitions?

Line One measures the growth in the productive “Working Capital” contained in the portfolio and is equal to the Cost Basis of securities and cash. It is increased by dividends, interest, deposits, and “realized” capital gains and decreased by withdrawals and “realized” capital losses. Goal directed portfolio management based upon Quality, Diversification, and Income (and which encourages short term Profit Taking) is required for maximum benefit.

Line Two measures the Gross Realized Income generated by the portfolio. If you are using your asset allocation formula properly, the "Base Income" (dividends and interest only) portion of Gross Realized Income will increase every year. [It may be worthwhile to add a base income line to your graph.] Obviously, the total will be better in rising markets than in falling ones, but the base income will just keep rolling in!

Finally, the purpose of the Market Value line needs to be understood. This is your “portfolio analyzer”, the tool you use to monitor growth in working capital and income, and definitely not something to be compared with the DJIA. For example, if Market value rises above working capital, you can be sure that greed has entered into your thought process. There must be profit opportunities in there! If base income falls, so has: (1) either the quality of some of your holdings, or (2) you have changed your asset allocation for some (possibly inappropriate) reason, etc.

It's OK if your Market Value falls in a weak stock market or in the face of higher interest rates. The important thing is to understand why it happened. If it’s a surprise, then you don't really understand what is in your portfolio. You will also have to find a better way to gauge what is going on in the market. Neither the CNBC "talking heads" nor the "popular averages" are the answer. Take a look at the unweighted and totally un-tinkered-with NYSE Average. It even has enough Closed End fixed income funds in there to assess the impact of interest rates. The only problem is that it includes securities that aren't investment grade. If you need a "drug", this is a better one than the ones you've grown up with. The best method of all is to track "Market Stats", i.e., Breadth Statistics, New Highs and New Lows.

Have a nice change!

Steve Selengut
steve@...
800-245-0494
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Author: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read"