Never miss an issue of Master Investor Magazine – sign-up now for free!
As you will know from my previous articles, I remain bearish in terms of market sentiment and I’m saddened to tell you that nothing over the past week has changed my view. In fact, unfortunately, I am more confident of a market correction than even before. The only good news that I can tell you is that the last time I wrote this weekly article I was 30,000 feet in the air; today at least I am sat in a Starbucks coffee shop with my feet firmly planted on the ground. Indeed, I often drink coffee early in the morning in preparation for my 7am Brazilian Jiu-Jitsu (BJJ) class – it’s the calm before the storm.
The reason that I mention these facts is not because I don’t like flying or that I enjoy coffee (although both of those facts are undoubtedly true). It’s to do with the BJJ – you see there is a very interesting parallel between BJJ and the stock market which I only recent discovered. You see I was thinking just the other day that BJJ is very much like investing. That’s because Jiu-Jitsu, especially if you are a lousy white-belt beginner and not very good at it like me, is all about survival. It’s not about winning but surviving.
I was taught this by my lethal instructor. He said that if I could just learn to survive the chokeholds and the submissions, eventually I could then learn to work on my offensive game. The longer I survived without losing, the better the chance I would eventually have of winning. It’s a game that challenges the mind, a game of incredible patience, and it’s a game of extreme strategic manoeuvring.
The more I look, the more I can see so many parallels with the stock market. There are way too many investors who try and jump in to the stock market enticed by the millions that are there waiting to be taken, when really their focus should not be on winning at all, but instead on simply not losing. One should be prepared to survive the stock markets when things get bad and if they can do that, if they can survive when others are blowing up their portfolios, then they will almost certainly make money when the good times return.
I have written about this before many times and spent a lot of time researching, which is why I know it to be true. It’s the primary reason why I became an expert in hedging, not because I thought it would be another thing to put on my resume (I don’t need a resume – I run my own business), but because I strongly believe that to learn how to hedge is the key to financial success in the marketplace. Understanding the potential downside and risk to your portfolio and to protect against that is more important than nearly anything else and yet it’s what 90% of investors either fail to recognise or do anything about.
If investors could just turn their attention away from trying to pick the next big thing that they think is going to make them rich, then they would realise that all of the gold that they are searching for is actually right in front of them – it’s not stock selection but strategy that wins the end game. It’s not trying to win, but trying to survive that will ultimately unlock the treasure chest.
And that comes down to human psychology – can you play the patient game or you are an out and out gambler?
Never miss an issue of Master Investor Magazine – sign-up now for free!
Last year I was with my young children in an arcade, when in the space of less than 10 minutes my eldest daughter, who was 8 at the time, became instantly hooked on playing on one of their gambling machines. This particular game was where she had to roll a 2p piece into the machine and it would try and push into a whole bunch of other 2p coins – with the intention to hopefully help the whole bunch to cascade over the edge. My younger daughter, who was 5 at the time, wasn’t nearly as interested. And then it occurred to me – that as humans some of us are hard wired into taking risk whilst others aren’t. Some of us like to gamble, others don’t.
If that’s the case then it must also be true that it is much easier for some people to avoid the big risks whilst for others it is discipline that has to be learned, developed and practised over time. This is of course absolutely true because I see it every day; for example, most of my clients don’t like risk. But there is a problem and it’s a big one which is this – the problem is that most investors don’t know how to measure risk and so they don’t even realise when they are investing and when they are gambling.
Take penny shares for example. Everybody knows that they are high risk but most people don’t realise exactly why. It would all be good and well if the risk was simply based on the volatility of the stock, or the wide-spread between the bid and offer price, or the risk in the company itself in terms of its business model, cash reserves, profitability or management team. All of these risks would be entirely acceptable for the investor, but there is one other major reason that penny shares, including many within the Alternative Investment Market (AIM), are risky, and that is because many of them are rigged. Yes, that’s right – you heard me correctly, I did indeed say ‘rigged’.
You see after I worked for some of the big investment banks including Deutsche Bank and Royal Bank of Scotland, I moved into a different world and worked for a much smaller company that was involved in ‘principal dealing’. I wasn’t to know at the time but I worked out years later that the world of IPOs and penny share placings for small companies raising capital is set up in such a way that the client usually loses. It’s not that the firms want the clients to lose, it’s just that there is only so much of the pie to go around, and some firms get greedy and take too much it for themselves. This in turn means less for the client, which ultimately means that the chance of the client winning in the trade severely diminishes.
Whilst this may shock a few readers, there isn’t anything new in what I have told you, and some quick searches on the internet on companies like ‘Pacific Continental’ will give you an idea of how wide-scale this problem was back in the 1990s and early 2000s. Thankfully the FCA came down very hard and shut down a lot of these dodgy practices; some of them morphed into CFD brokerage firms but don’t get me started on that or we may be here for a quite a while.
The fact is that the AIM market remains to this day a dark and a highly unsavoury place to hang out as an investor unless you really know what you are doing. It runs on a different set of less transparent rules which are open for greater amounts of manipulation, and it’s an arena in which the retail investor will almost always come second place to the professionals; it’s an unfair match up but one that uninformed investors still apparently relish.
The other big problem with some (but not all) of the smaller AIM companies is that you are often competing against the market maker who is making a price in the stock. It’s not like buying HSBC where you are buying from an anonymous buyer – in order for you to win, the market maker usually has to lose, and believe me, it’s not easy taking money from a professional market maker. I tried a few times, and lost each time.
That said, and for the same reasons of mis-pricing and manipulation, prices are often trading way below or above the true net asset value of the company, which means there is also a massive opportunity in the AIM market, and that is why you often see the huge spikes in price which leads to massive profits. This of course fuels its popularity.
One way of making money quite easily in the AIM market is to instead of working against the market maker, to actually work with them. So rather than just buying a company at the market price quoted, you could (through a good broker) actually work a way to purchase or sell a number of shares without upsetting the market maker or the price. In other words, to eliminate the spread you can use something called ‘limit’ orders and you can ‘build a book’ and exit a position in tranches. I won’t bore you with the details here but that is the way you give yourself a distinct trading advantage in less liquid shares.
In recent years we have also seen other considerable benefits come to affect some AIM companies including the very important fact that now a carefully constructed AIM portfolio can be used to take advantage of Business Property Relief (BPR). This means that if you have a sizeable estate and you don’t like the idea that your children will pay 40% on your hard-earned wealth after you pushing up daisies, this is one of the quickest ways of avoiding it legally.
In fact, with only a 2-year holding period from start to finish it’s one of the easiest and quickest ways to save yourself a small fortune from Inheritance Tax – and remember that if you choose wisely you could also make a decent profit – so let’s say you make 60% on your AIM portfolio over 2 years and 40% on the tax-relief, you have just doubled your return!
All of these little tricks that I have learned over the years is nothing spectacular, and on their own, they are not worth a huge amount, but put them altogether and it becomes very interesting. It’s part of a bigger and constantly evolving journey in trying to find the ‘Holy Grail’ of investment. And even after years of searching and finding out that there was no Holy Grail, I was not disappointed because I found that there was something else even more beautiful and powerful.
This shouldn’t surprise you because you may already know by now that I have made a career out of doing things differently for me and my clients. Instead of thinking just outside of the box, I have always tried to create entirely new boxes that my clients and I can prosper in. However, technically speaking what I use are not boxes at all, they are blocks.
The blocks came about completely unexpectedly and as part of my mission over the past 20 odd years where I reviewed thousands of different share portfolios. My job was quite simple – how could I take an average portfolio and improve it. In fact, that’s still a big part of my job today. And what I found as I was reviewing these portfolios was that the best performing portfolios all excelled in each of five things – what I later called the ‘5 Building Blocks’.
So, I got to work in really exploring this concept further and how I could apply it for my clients – I was convinced that even if there wasn’t a Holy Grail formula there must be a series of common denominators that all successful portfolios would have – I just needed to find out what they were and then be able to present them in an easy to follow system, that my clients could understand and that I could implement.
Never miss an issue of Master Investor Magazine – sign-up now for free!
I found that this journey led me to drawing the analogy between building a solid house and building a solid share portfolio – they were essentially one and the same thing in terms of their component parts. And hence the name for this Building Block strategy was born – I call it ‘The House’, and the 5 Building Blocks are as follows:
- The Concrete Foundation
- Basic Utilities – Water, Gas, Electricity
- Walls, Doors, Windows
- Furnishings – Fitted Kitchen, Bathrooms, Internal Fittings
The interesting thing is that I found that successful share portfolios all work on exactly the same basis. I.e. they have the same building blocks.
- Tax Efficiency
- Capital Growth
Every profitable share portfolio that I have ever known has these 5 elements, and the very best ones will exhibit all five in abundance. For example, the AIM investment would fall into building block 4, but having a good AIM strategy is not on its own good enough, because as you can see, this is only a small part of the overall equation and so you need to master all five to become really successful.
The other trick with each of these building blocks is to implement it passively, not aggressively. For example, if you want to make money in penny shares, you don’t just jump in with a market order and try and buy or sell a big position because you will get destroyed with slippage. If on the other hand you are looking to implement building block 2, income, it’s not a sensible strategy to target a company that gives the highest dividend yield, because they will often have the least dividend cover – and so on and so forth. Block 5 is all about hedging and insurance, which protects the portfolio in the same way that the roof protects the house. And so on, and so forth.
Instead of spending hours reading financial newspapers and poring over company accounts to look at individual companies, your time is better spent looking at whether your strategy for capital growth is even the right one – that’s what is so powerful about The House – it forces you to look at your ENTIRE share portfolio, not just a small part of it.
The good news is that I have spent years of research on this exact subject, so you don’t have to. And I have compiled all of my findings and best work into a 30-page E-Book. It’s entirely free of charge and will show how you can potentially make a lot more money by doing a lot less (sounds nice doesn’t it?).
Moreover, it goes through each of the building blocks and explains how each one of those blocks can be defined and measured within your own share portfolio to help you improve the overall performance. Because when all said and done, that’s what we all want, isn’t it? – to make more money from our investments without taking on too much risk. Well it is possible.
And that’s why I go back to my original point. To be successful in the stock market is all about doing less, not more. It’s not about being aggressive and offensive, it’s not about attacking, it’s about being defensive, reducing the risks and then letting the profitable upside take care of itself. That’s what works in life generally – do the small things right and the big things will take care of themselves. The focus should be on the bigger picture, i.e. on the House and the 5 Building blocks and not on the intricate elements within it.
Now my time is up and alas, I must love you and leave you – it’s time for my BJJ class – let’s see if I follow my own advice and try to be patient and survive. And in the event that you don’t hear from me next week, you will know that I tried to be offensive and that it didn’t end well for me.
For your free E-book on the 5 Building Blocks and ‘The House’, just email email@example.com
The Master Investor Show 2020 tickets are now available. Join us at the Business Design Centre on Saturday 28 March 2020.
Book your FREE tickets today using code: MIBLOG