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Allan Roth - 5 Ways I'm an Active Investor

If you think of me as strictly a buy and hold index investor, think again. Sure, in the grand scheme of things, I guess it would be fair to say that I'm very much a passive investor who believes in diversification and low costs. But there are also ways I consider myself an active investor. There are five ways, in fact, and here they are:

Active Strategy #1: Market Timer
In no way am I a "buy and hold" investor. I actually time the market and have profited from from it. No, I don't use technical or fundamental analysis, I use something far more scientific -- behavioral economics.

My system for market timing is simple and effective -- it's called rebalancing. And I use this system whenever the target allocations I have set for my portfolio move up or down by more than 5 percentage points. For example, my equities target is 45 percent, so I will rebalance if the percentage becomes greater than 50 percent or less than 40 percent.

This is a contrarian strategy that requires me to buy equities in a down market such as 2008 and early 2009, and sell in up markets such as we've had in the last couple of years. Behavioral finance tells me consumers will be doing just the opposite.

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Turn the page for active strategy 2: Fixed income
Active Strategy #2: Certificates of Deposit
I have more of my fixed income in certificates of deposit than I do in bond index funds. That's because the US government creates a market inefficiency with the FDIC and NCUA that eliminates default risk. While it's possible to get millions of dollars of insurance at each institution, Wall Street giants like Goldman Sachs can't take advantage of this market inefficiency as the insurance is immaterial compared to amounts they have to invest.

I look for CDs in places like and two of my current favorites are the Ally Bank 5-year CD and the 7-year CD at Security Service Federal Credit Union. These CDs both pay more than the current yield on intermediate treasuries and the Total Bond Fund, they also provide protection against a possible bond bubble by having easy or reasonable early withdrawal penalties. This allows the depositor to pay the penalty and reinvest the funds at a higher rate.

Turn the page for active strategy 3: TIPS
Active Strategy #3: Timing TIPS
TIPS are Treasury Inflation Protected Securities issued by the US Government. Rather than pay a fixed interest rate, they pay a fixed rate plus inflation as measured by the CPIU (Consumer Price Index Urban).

I believe TIPS should always be part of one's fixed income portfolio but I think there are times to buy more. For whatever reason, investors act irrationally when it comes to TIPS. Since it's the real inflation adjusted return that matters, TIPS should be the lowest risk vehicle in the US. In my view, TIPS should have less volatility than comparable traditional Treasuries paying a fixed rate, though just the opposite is true.

In 2008, one could earn nearly 4 percent plus the CPIU. Today, the yield is down to roughly zero plus the CPIU - nearly the lowest I've ever seen. Thus, I tend to recommend buying more TIPS when the real yield is high. I'm not so active on this that I will often recommend selling when the real yields drop. However, I did recently sell some TIPS to buy the Security Service Federal Credit Union CD mentioned earlier.

Turn the page for active strategy 4: Private investments
Active Strategy 4: Private Investments
Everyone is speculating as to whether Apple and Exxon are properly valued, and I'm not big on speculating. Even mutual funds specializing in small cap stocks have dismal track records vs. small cap index funds. I'm not going to be active here.

Though I have made a few private investments ranging from buying stock in start-up companies to buying an investment rental condo from Fannie Mae. All of these investments fall under the category of "high risk" and "undiversified," so I limit my allocation to these types of investments.

Still, there are reasons these markets are inefficient and I'm typically not a passive investor. I look for reasons why others may not be investing in the areas I am considering as, for example, I would do when receiving cold calls from energy companies claiming they have a 20 year track record of successful drilling. These are opportunities to pass on, since the success record they claim should have past investors beating down the door to invest some of their profits.

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Turn the page for strategy 4: Gambling portfolio

Active Strategy 5: Gambling Portfolio
Though you might not suspect it, beneath my dull exterior beats the heart of a thrill seeker. I understand and accept the logic of index equity funds and have the vast majority of my portfolio in those instruments. But a guy has got to have some fun now and again, and my total US and International index funds just don't give me the adrenaline rush.

So once or twice a year I buy a stock. It's usually a stock with a price that has plummeted to less than $5 and has a 50 percent chance of going into bankruptcy. I'm betting that portfolio managers don't like getting caught with a stock filling bankruptcy and the stock may be undervalued. If the stock survives, I score. At times, my gambling stocks have had returns of several thousand percent.

The gambling portfolio also helps me stay the course on the rest of my boring portfolio by activating a part of my brain that gets no stimulation from indexing.

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Turn the page to sum up my overall strategy.

Have I sold out?
Look, I'm basically a passive indexer and quite proud to be a Boglehead. And I am because indexing is the only way to guarantee you will beat most investors. It will always be the core of my investing philosophy.

I think there are good reasons for the first four active strategies I use and I can easily defend them. The fifth strategy of my gambling portfolio? Not so much. I'll admit it is a bit of a weakness that is hard to defend, which probably trades emotional well being for economic gain. I may have convinced myself that I've beaten indexing with my gambling over the years but:

  1. I've never gone back to check, perhaps confirming my desire not to find out.
  2. If I have beaten the indexes, it's been with an immense amount of risk as those companies I buy probably have a standard deviation close to 100 percent.
So though I have my active investing side, it is still disciplined, low-cost, diversified indexing that is at the heart of my portfolio, and the same should be true for most people. Should you choose to stray from this time-tested method, make sure there is logic to support it.

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