Three Ideas for the Under-Invested (Reprise)

Hey guys, I wrote this post during the first week of December after a nice fall rally that had left many scratching their heads.  Lots of folks felt like they missed out and didn’t know what to do…and the markets have been even more explosive since then – a 7% jump in December and the S&P now above 1300, the Dow cracking 12,000.

In retrospect, this may have been one of the most important posts I’ve ever written.  It may also be just as helpful now as it was then so I’m re-running it, enjoy!
– Josh

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This post was originally published on December 5th 2010

Lots of people feel as though they’re under-invested after this week.  The anxiety is palpable.  They’ve digested the latest economic data and have come around to the fact that they should probably be in some stocks.  The cascading bond market certainly offers a bit of reinforcement in that regard with yields on the the 10-year Treasury ripping back above 3%.  And rising.

The sideline dwellers must now confront their fears of top ticking the stock market.  We’ve had an incredible run in equities for 20 months now and valuations are beginning to price in a recovery that is more robust than what many economists are forecasting.  The under-invested are caught between the Rock of misallocation and the Hard Place of not wanting to chase.

But never fear – I’m in the solutions business and I’m going to let you in on a few tricks you can use when you find yourself not quite long enough.  Before I continue, please take this pledge:

“I, (your name), am a grown up and capable of reading something on the internet without considering it to be specifically tailored advice.  I recognize that the author is speaking in generalities and has no possible way of knowing my own goals and risk tolerance.”

Thanks, they actually make me do that before writing anything advicey.

Anyway, here are a few things the under-invested can do to get in but without taking a ton of risk, just in case the recovery is being faked like the Moon Landing and we’re at a multi-year top.  I’m not going to do stock-replacement options strategies or leap calls here because I want to keep this post as accessible as possible.

1.  Buy in Thirds:  The big guys do this and with the average brokerage commission at around $0 a trade these days, there’s no reason you couldn’t as well.  Basically, you decide on the total amount that you want to buy of a given stock and you divide that by three.  You buy the first third immediately without hesitation just to put it in play (relief!).  If your target equity runs up and away, at least you’re in it and there’ll be a lid on your self-loathing.  Should the stock or the markets in general drop, however, you’ll not be trapped in a full position.  Establish the lower levels you’d like to buy in at and stick to that discipline.  Buy the next third on a dip, and possibly hold the last third for a resumption (or confirmation) of the uptrend.

Result:  You’ll either have a lower average cost or a small amount of a stock that took off.

2. Use Indexes: By owning a sector ETF or even an index, you may be giving away some of the upside that individual stocks offer, but again, the key is that you’ll be in and with perhaps less downside than if you bought one name at its peak price.  You can even use this lower-risk approach to be more aggressive than you normally would – emerging market small caps, junior gold miners – you can buy the crazy stuff in small doses to catch up and not take single-stock risk

Result: You’ve grabbed some beta without giving up the greater part of your liquidity and safety just in case the run is done.

3.  Find the Laggards: Forget the leaders, find the quality names that need to play catch up and often times they will.  Without getting into a long-winded discussion about mean reversion and sector rotation, I’ll just tell you that the biggest hedge fund and mutual fund PMs play this game all the time.  Appaloosa’s David Tepper is playing it now, in fact, with large cap tech names that have a ton of cash but stock prices that have barely budged versus the Apples of the world.  There are big chunks of this market that have simply Rip Van Winkled away this rally; some of these forgotten industries are going to start working here.

Result: By placing your bets on a few sleeping giants, you’re avoiding the hot money and possibly putting yourself in front of a big rotation.

Ok, now that I’ve completed and published this post, you can consider this the market’s official top 🙂

Just kidding.  Just kidding I’m not just kidding.  No, kidding.  Maybe.

Read Also:

The Five Stages of Panic Buying (TRB)