In the Money Insight: Buying Low and Selling High with Jake Falcon, CRPC®
Falcon Wealth Advisors Founder and CEO Jake Falcon, CRPC®, recently joined me on In The Money Insight to discuss the relevant topic of buying low and selling high.
Video:
Falcon Wealth Advisors Founder and CEO Jake Falcon, CRPC®, recently joined me on In The Money Insight to discuss the relevant topic of buying low and selling high.
Blog:
Cory: Jake, people often say they want to buy low and sell high but have a hard time executing when it’s time to buy low. Why is this?
Jake: A lot of it goes back to fear and greed, two powerful emotions. For an undisciplined investor, it’s easy to get scared and want to sell your stocks when the market is not performing well, as we’ve seen in recent weeks. Similarly, it’s easy to get greedy and take risks during bull markets.
Cory: Recent days have seen the S&P 500 down 20% on the year and the Nasdaq down 30%. I think people understand the idea of buying low and selling high, but when it comes time to buy stocks when they’re down, it doesn’t feel natural.
Let’s talk about how our team at Falcon Wealth Advisors aims to buy low and sell high for our clients. Can you discuss how we rebalance portfolios for clients, Jake?
Jake: Rebalancing involves using math and not emotions. In the financial plans we build for every client, we determine how much of their portfolio should be allocated to stocks and how much should be allocated to bonds (and sometimes other investments, too).
Let’s say we determine a client’s portfolio should be comprised of 50% stocks and 50% bonds. When that number falls out of balance by more than 5%—say the market drops and all of a sudden the portfolio is made up of 55% bonds and 45% stocks—we will sell what is making up too much of the portfolio to buy what is not making up enough of the portfolio. This means we’re selling a high asset to buy a low asset. With rebalancing, all we must use is math; we don’t have to try to predict the future, which no one can do.
Cory: Indeed. Rebalancing and asset allocation is part of a larger strategy called Mean Variance Optimization, which is designed to balance risk and reward.
As our clients know, they own individual stocks and bonds. When we rebalance a portfolio, we typically trim profits from investments that have done well (because they’re the ones making up the largest allocation in the portfolio) and use their profits to buy other stocks or bonds that we consider “on sale.”
An example of this happened in April 2020 when oil prices went negative in the early stages of the pandemic. This led us to purchase stocks from energy companies that were underperforming, and now we’ve seen oil prices rebound in the past two years, which has benefited our clients.
Jake: Yes. And when we bought energy stocks, it wasn’t because we knew oil would shoot over $100 a barrel by 2022. Instead, we knew it was cheap and underweight in our clients’ portfolios, so we bought it.
Of course, because we own individual stocks, it’s critical for you and me, along with our Research and Trading Group, to spend a lot of time researching the companies we invest in to make sure they are fundamentally strong. Buying a stock low doesn’t do you a lot of good if it’s not a strong company you believe in for the long term.
Cory: Let’s talk about how we determine how much of your investments should be invested in the different styles on this Callan chart.
As you can see, everything from large-growth value stocks to commodities are represented on the chart. Jake, can you talk about how we determine what percentage of a portfolio should go into each one of those styles?
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Jake: With most of our clients being high net worth individuals and families, we try to help them preserve their wealth and ‘hit singles and doubles,’ with the goal of achieving consistent returns. We often overweight the large-cap, blue chip companies in the portfolio because these stocks are typically lower risk.
Cory: Yes, part of effectively executing Mean Variance Optimization involves evaluating the historical risk and return of each of the styles noted in the chart above. What we’re trying to do is optimize with potential reward with the lowest amount of risk.
Drilling in deeper, we have different sectors represented in each of these boxes, like defense stocks, energy stocks, technology stocks, etc. If we know someone’s target allocation for stocks and bonds, and how we’re going to weight each style in their portfolio, how do we then determine how much of the portfolio should be invested in each sector?
Jake: I would first like to note we have a very specific formula for determining what stocks should be in your portfolio. If you decide you don’t like just one stock and want us to sell it, you risk having the same impact as pulling a block out of a Jenga tower. Every stock we buy for clients works in concert with the other stocks in the Falcon Wealth Advisors portfolio.
To answer your question, what we do is called equal weighting in each sector. From telecommunications to technology to energy, we make sure we have similar amounts invested in each of the market’s sectors. We don’t have to try to get lucky and predict what sectors will do well; this approach of equal weighting has outperformed the S&P 500 historically. It also prevents us from ‘getting out over our skis’ and being overly invested in one particular area. Because as we’ve seen with technology stocks in recent months, things can change quickly.
Cory: I think many people assume that an index fund that mirrors the S&P 500 is equal weighted across sectors, but that’s not the case. 2020 capped off a tremendous multiyear run for the technology sector. By the end of the year, tech stocks made up almost 40% of the S&P 500. As you mentioned, technology stocks have been hit hard recently and these investors in index funds have likely seen their portfolios decline in greater value than if their investments were equal weighted across sectors.
Jake: If a new client came to us with, say, $2 million and we invested 40% of it in any one sector, technology or otherwise, they would probably think we are crazy. But if you invested $2 million in an index fund mirroring the S&P 500 at the end of 2020, you may have essentially done just that.
This is one reason we don’t invest our clients in index funds and instead prefer an active management style. I believe a lot of investors in index funds have lost more money in recent months than was necessary, as all they could have equal weighted and rebalanced their portfolios. This is what we do for our clients, and broadly speaking, our core portfolio of stocks has outperformed the S&P 500 this year because we didn’t overweight a particular asset class—tech.
Cory: Yes, I would guess the run tech has been on since the financial crisis has been one of the longest and strongest runs ever for a single sector.
Jake: True, although we also saw tech—aka dot com stocks—go on a run in the early part of this century only to see them come back to earth. It seems that may be happening again.
Cory: Well said. I don’t think it would be out of line to call what has happened over the last year a ‘dot com bubble bursting 2.0.’ Some of these tech companies have been obliterated over the course of the past year, just as we saw about 20 years ago.
Jake: I think you could call it a ‘fad stock bubble bursting’ with so many of the ‘meme stocks’ losing value. While we saw some people treat investing like gambling last year, we believe your life savings is too important for that. And that’s why clients hire us to remain disciplined and to stick to the process.
Cory: Thanks, Jake. And if we were to ignore our process and sell a stock when it’s down in value, we are realizing a loss and those lost dollars cannot recover when the market does. That’s why it’s so important not to sell a stock—assuming you still consider the company to be fundamentally strong—when the market is down.
I hope this conversation showed that a lot of planning and thought goes into how we invest clients’ money. We’re not just saying, “Let’s put half in stocks and half in bonds and call it a day.” We instead make sure portfolios are diversified with different styles of stocks from several sectors, which provides diversification.
Again, I’m proud we use math and not our emotions or intuition to make investment decisions. If you want to learn more about how our process and strategy allows us to buy low and sell high in different types of market environments, please contact us today. You can reach me directly at Cory@falconwealthadvisors.com.
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