I have read about the efficient market theory. Apparently the stock market already layers in all information, so investment strategies basically revert to a coin toss or gambling.
But then how do the Warren Buffett’s, John Henry’s, Jim Simons’s, and Peter Lynch’s of the world beat the market? And if all of the information is already layered in, then why did the tech crash of the early 2000s and the global financial crisis of 2008 affect the stock market so much? Why do stocks sky-rocket at the mention of their drug receiving FDA approval, pop on a company’s surprise earnings expectation, or even receive a boost because they mentioned the word marijuana or bitcoin?
The efficient market theory did not explain the price swings when news and crazy black swan events occurred. And traders beating the market meant that the coin toss argument did not hold up either. I had so many questions because it did not compute.
So I researched those that beat the market to see how. And I realized that each traded the market in a different way. Each had a different system. Nothing pinpointed a commonality. And then the light-bulb flared… they each traded a system. Emotion was largely removed. Each trader identified a trend, caught a ride (some longer than others), and then jumped off when the ride ended.
Warren Buffett has long been revered as the greatest buy-and-hold value investor of all time. He has said that his “favorite holding period is forever.” This brings to light the perception that he does not sell stocks, but on the contrary he sells them all the time. It might be his favorite holding period, but sometimes his system tells him otherwise (just ask IBM, which he no longer owns).
This finally made sense. Stick to a system, not matter what others say. Do not bow to the pressures of the media hollering from their chairs about an impending recession. A recession might occur. But I would much rather my system tell me than listening to them. Time to let the markets and trends do the work.
So I have chosen to break up my investments into three strategies: (1) Traditional 401K and index funds, (2) Roth IRA and individual stocks, (3) Brokerage Account and a breakout trading system. I love each strategy for varying reasons, and look forward to their growth over time.
Investment Strategy #1: Traditional IRA and Index Funds
I use my Traditional 401K (a pre-tax retirement account matched by my employer and capped at $19K in deposits per year) for market returns. The funds are invested in the following:
- 30% of Funds – Columbia Large Cap Index CLPYX
- 30% of Funds – Columbia Mid Cap Index CMDYX
- 30% of Funds – Columbia Small Cap Index CSPYX
- 10% of Funds – Vanguard Developed Markets Index VTMGX
I picked the lowest expense ratio index funds that my Traditional 401K offered. Columbia’s expense ratios are 0.20%, which are four times higher than Vanguard’s 0.05%. I wish they offered more Vanguard options, or even some Fidelity funds, but no luck as of yet (if you invest in funds, try your best to stay below 1.00% expense ratios, and index funds which track the market should be less than 0.25%).
My Traditional IRA is my set-it-and-forget-it account. Money goes into the account each paycheck, it automatically divvies the funds up between the different indexes, and I watch it steadily grow over time. A simple but effective system to invest in the market, which returned an average of 7%+ over the last 40 years, including dividends (a much better return than a savings account, along with the peace-of-mind that no ten year period in the history of the market has lost money).
Investment Strategy #2: Roth IRA and Individual Stocks
I love the feeling of owning a company. It is one of the small pleasures in my world of investing. And I feel if I own some of the best companies, they will outperform the market more times than not. I use my Roth IRA (an after-tax retirement account capped at $6K in deposits per year) to invest in individual companies.
So far I have purchased ten stocks with those funds and will track them against the returns of the S&P 500. I plan to hold them for a six year timeframe, but will continue to evaluate their progress every quarter and make sure their story still matches or beats the one I initially wrote prior to investing.
I will be sharing the ten stocks I purchased soon and publish how the S&P 500 compares.
Investment Strategy #3: Brokerage Account and Breakout Trading System
Finally, my biggest risk… Using my brokerage account, I will trade a system that scans for breakouts in the price of a stock caused my a momentous trend. I will not be able to identify the true bottom of a stock price, but I can identify a stock trending up or trending down. And at the point the stock trends up, I can purchase it (or down and I can sell it) and capture that middle gap of profits.
This system eliminates all emotion, basing it solely on the movement of the price of the stock. The system also allows for my winners to keep on winning and contains failsafes to manage risk.
For instance, a downturn in the trend of the market can make even high flying stocks look bad. So if the market trends down then I will tighten my stop losses on the portfolio (stop losses are price levels set where the brokerage will automatically sell the stock if the price of the stock dips below that level) and hold off on buying more stocks until it begins to trend up. This will help me move to cash during a bear market (a market decline) and start buying stocks again when the trend of the market turns back into a bull (a market increase).
- Bull Market (up-trending) -> buy breakouts, let my winners continue to win, and cut my losses.
- Bear Market (down-trending) -> hold in cash, tighten the reigns on my portfolio, and mitigate my losses.
I will be paper trading (trading without real money) this system for a short time to see how it reacts. So far the results have been enjoyable. The breakout trading system increased 5.39% since I started on 11/11/19 while the market has increased 2.16%.
I want to beat the stock market. And I know I will take some lumps along the way, but I am willing to take this risk. Excited to see how each investment strategy performs over the years.