Managed Asset Allocation - The Working Capital Model THREE

Rising markets require GREED CONTROL just as surely as falling markets demand protection against FEAR --- the two heads of the "ole" Uncertainty Monster!

While the media and your buddies drool or cringe, respectively, your Working Capital focus keeps you on target, looking for higher yielding, quality, income securities and/or quality equities that have fallen from grace with the Market. Remember that Smart Cash is only "smart" if it doesn't burn a hole in your Asset Allocation.

Knowing that excessive cash is the result of profit taking should encourage investors to avoid the purchase of high priced old favorites, hot new issues, and the best performing funds. When the FEAR head is talking to you, The Working Capital Model will be whispering in your other ear to get that Equity Allocation back where it belongs with lower priced quality issues --- possibly the same ones you recently sold for profits.

I know of no other Investment Manager anywhere (other than those who have contacted me and obtained my consent), private or public, that uses The Working Capital Model to direct individual investor portfolios --- certainly none of the major operators, who are dependent for their survival upon the whim of even larger "others".

The following is a slightly edited excerpt from Chapter Seven of: The Brainwashing of the American Investor, 2nd Edition.

Now I realize that this approach is totally different than anything you’ve ever dealt with before, but in one fell swoop it surely eliminates all of those nagging ifs, ands, and buts, that make standard bottom-line market-value analysis totally useless and excessively stressful (to the investor).

I created the Working Capital method of portfolio performance evaluation many years ago (1975), when it became evident that a trading strategy was quite a bit different from most styles of investment management. It shows you where you are and allows for meaningful comparisons with where you’ve been. As a kicker, it allows for an instant and accurate appraisal of Asset Allocation.

Working Capital is defined as the actual Cost Basis of the securities in the portfolio as opposed to their current market value. This concept is also consistent with the retail store approach towards equity investing which was discussed earlier. Income of any kind, including realized capital gains, and deposits increase your working capital while withdrawals and realized capital losses alone decrease it. Current market value is not a factor. Since you will constantly monitor the age of the securities in the portfolio the tendency to hang on too long to nonproductive assets is also avoided.

The total Working Capital will always be more than the Market Value of the portfolio, unless the bulk of the portfolio is invested in fixed income securities. (AND then only if interest rates have moved down since the time the income securities were purchased.) This is both expected and accepted because it is easy to understand without having to sift through a dozen research reports that try to explain an array of unknowables about the economy and the company’s management team. However, the closer the broad market gets to truly high ground, the narrower the difference between working capital and market valuations.

Is this clear? Working Capital doesn’t change as a function of market value. It grows through the addition of cash from deposits, dividends, interest, and realized gains. It decreases when losses are realized and when cash is withdrawn from the portfolio. The day-to-day changes in market value that you used to worship can now be thrown out into the street with the other garbage!

We are replacing our profitable investments (merchandise we have sold at our store) with new ones that have potential for future profit (inventory on the shelves). Thus our current portfolio value will not “catch up” until new buying opportunities dry up. If you have nothing to buy, Smart Cash builds up (compounding at money market rates) while profit taking continues.

Always Remember: The Investor’s Creed

My intention is to be fully invested in accordance with my planned equity/fixed asset allocation. On the other hand, every security I own is for sale, and every security I own generates some form of cash flow that cannot be reinvested immediately. I am happy when my cash position is nearly 0% because all of my money is then working as hard as it possibly can to meet my objectives. But, I am ecstatic when my cash position approaches 100% because that means I’ve sold everything at a profit, and that I am in a position to take advantage of any new investment opportunities (that fit my guidelines) as soon as I become aware of them.