Paper Anniversary

This weekend my MFI portfolio celebrates its 1^st year anniversary! While I didn’t get rich, I really can’t complain. My Annual Internal Rate of Return is at 22%. I don’t want to lecture or be considered an authority, but I thought I would go ahead and list some of the lessons I have learnt during the 1^st year.

1. MFI Works. I can’t say with complete certainty, but I am sure enough to have a big chunk of $ invested. Of course the LBTBTM did 17 years of back-testing. Barron’s ran their own tests validating it. And then my one year+ of monthly testing portfolios has outperformed the indices in 13 of the 14 months I have tracked. That can’t be chance.
2. Relax. Since MFI works, you really need to relax and give it time. I am still scarred from the Bubble Burst of 2000-01. I have fears that my gains will be wiped away next week and am antsy to cash in the gains. I think I also get bored and feel that I need to micro-manage my portfolio. I don’t. Hold your stocks for the prescribed year.
3. MFI Upside Down. I think about MFI for my non-MFI portfolio (about 50% of my total actively managed assets). If MFI is a technique to help you identify the stocks with the likelihood to perform best during the upcoming year, it also is a technique to help identify what stocks have the worst outlook. Essentially firms with negative yields such as start up bio-techs etc. We all see the homeruns that some investors get from these companies that can double overnight if their research pans out. But it is a sucker’s game.
4. Be Patient. I know everyone thinks that a stock needs to be bought today, as tomorrow it’ll be “discovered”. That is rarely the case. Also be patient in selling the stock (wait your year). I was patient in PNCL and I made a lot because of that. I was impatient with PCU and missed a double.
5. Blue Light Special. While I have not proven it, I do have evidence that shows that if an MFI stock drops 20% it is even a better candidate to buy (assuming that no disaster has befallen it). I bifurcated June 2006 portfolio after one month and the stocks that had dropped the 1^st month have since outperformed. Also, if you had bought MFI stocks (from lists Jan-June 06) that had dropped 20% sometime thereafter when they were down 20%, you’d be doing quite nicely. Finally, I created a Blue Light Special Portfolio in mid January of MFI stocks (19 stocks) down 20% or more and it is up 10.3% since then compared to about a 2.7% gain for the broader indices.
6. Don’t Sweat The Details. I see a lot of questions about how to follow MFI to the letter of the law. I think it is more important to follow MFI to the spirit of the law. If the amount invested in every stock isn’t exactly equal, that is ok. If you decide not to buy in 4 even quarters, but every two months instead, that is ok. If you decide to buy 40 stocks instead of 25-30, that is ok (as long as transactional costs are reasonable).
7. Think Outside the Box. I have seen some blogs talking about buying options on MFI stocks rather than the stock itself. I don’t think that is unreasonable as long as you’re comfortable with increased volatility. Theoretically, it should work as long as you have some means of testing that the option prices are reasonable (I would think that overall if the stock price is depressed for some reason, the options will be as well). My most financially rewarding move has been my sidecar portfolio. This portfolio in size has usually been about 1/7^th the size of my MFI portfolio, yet its gains have been about 50% of my MFI portfolio. Perhaps I have been lucky. But I am convinced from the Blue Light Special study above that there are optimal times to buy MFI stocks. So I am keeping money in the sidecar for those times. In fact, it has worked so well, that I am freeing up more $ for the sidecar. I only do this in my IRA to get rid of impact of short term capital gain taxes.
8. Do a Little Research. I know JG says the system will work without research, and my monthly tracking portfolios support that. I do think that people should still check for two things: (1) Has the company been bought? PWEI and PLAY were on the lists long after being sold. They really have minimal chance of going higher (a counter bid) and risk of going lower (bid falls through). I don’t think we want to be involved in arbitrage. (2) Is the income of good quality?? I think this just requires a quick look at the quarterly income sheets and profiles of the companies. If the company had a large one-time (non-recurring) amount of income (like FORD had a one time deal), I’d avoid them. Also, if they are dependent upon one customer (like PLAY was with the Ipod), I’d think twice.
9. Don’t Think Too Small. While in my portfolio, small stocks (under 1b marketcap) have done better than large cap, they do have their issues. I feel like I have moved the market when buying ISNS & EZEN. The microcap stocks are extremely volatile. In looking at my larger study of MFI stocks in my monthly tracking portfolios, large caps have outperformed the small caps. I am not saying never buy a stock under 100m, but do see what their average trading volume is like and don’t have your portfolio overweight in that area.
10. Diversify. The MFI approach can give you stocks over-weighted in a sector. Be careful that you don’t pick 5 mining companies. Also, as MFI doesn’t have financial companies, utilities or insurance companies I hold some of those in my non-MFI portfolio.
11. Have Fun! I really enjoy monitoring my portfolio and writing my blog. I actually am sad days the market is closed, like President’s Day. If it is too much work or stress for you, you can still do quite well with ETFs and Mutual Funds. I can tell you that IWV is a tough advisary!

Enough lecturing. Just my opinions. No guarantees, that is for sure. Now a graphical look at my Blue Light Portfolio. I set it up in Marketocracy which basically lets you pretend you're running a mutual fund. I have a couple other interesting portfolios percolating over there, but I am not sure how to give people access to view them. My name there is marshgerda.



I hope your paper anniversary is happy as well… with lots of Green Paper.