and make it impossible to jump in to newones when you are presented with an exceptional value. You haveno choice but to remain on the sidelines and watch your capitallanguish as the rest of the market passes you by.It makes sense to manage capital so that some portion of cashis always available. Also, if you sell proﬁtable stocks, you might wantto sell paper-loss stocks at the same time. This accomplishes twothings. First, it frees up more money by removing successful andunsuccessful holdings at the same time. Second, the capital gain in
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the successful company is offset by the capital loss in the other. Thisdoes not mean you should always take proﬁts when they appear. Itdoes mean you need to have a ﬁrm idea of when you will sell, basedon price movement in either direction, to take proﬁts and to cutlosses.The lost opportunity factor applies in other ways as well. Forexample, whenever your capital is fully invested, it limits your abilityto remove money from your portfolio if it is needed for somethingelse, like paying bills, for example. The only way to get funds outwould be to sell stock you really would prefer to keep. You lose theopportunity for future growth by selling prematurely. Another pointto remember: Investors sometimes time their buy and sell decisionsbased on dividend payment and ex-dividend dates. If you need totake the cash early, or if you don’t have cash to make your movewhen you want, you lose that opportunity as well.Finally, current news and changing events often creates exceptional bargains in the market. Because the market overreacts to allnews, bargains come and go rapidly. A stock whose earnings areeven slightly disappointing may lose several points of value in a single day. If you do not have cash available to invest and feel that thestock is going to rebound later this week, you will be unable to makea move. Being fully invested and having all of your money ‘‘at work’’in the market might seem wise, but when you consider the range oflost opportunities, it is often an expensive strategy.Some people deal with this problem by using margin investingif and when those momentary opportunities arise. But just as creditcards should be used sparingly for unexpected emergencies, margininvesting should be used only in very exceptional cases, and alwayswith full awareness of the risks involved. Lost opportunity is a problem, but overuse of leverage through use of the margin account canalso be very high risk.Margin investing, a fairly easy strategy to employ, can be quiterisky. Exposure to proﬁt opportunities always comes with exposureto greater risks. Using borrowed money requires that you make agreater proﬁt than before because of the need to pay interest on theborrowed funds. If you are aware of the inﬂation and tax risk when
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you invest on margin, you have to overcome a triple stumbling blockjust to break even: inﬂation, taxes, and interest.Because interest grows with time, you then face an additionalhurdle with time working against you. Most stock investments beneﬁt from time due to dividend income (especially if you reinvestdividends to compound your return), and well-managed companiesgrow over time so that the value of stock grows as well. But if youborrow money to invest in a higher number of shares, you face theproblem of interest liability.When you analyze the break-even demands of inﬂation andtaxes, adding interest to the picture makes margin borrowing anextraordinary risk. In comparison, limiting yourself to available cashis more sensible, and for most people, a much more acceptable levelof risk. You are better off missing some opportunities than you areby exposing yourself to higher risks by borrowing money to invest.Risk management in your portfolio is a necessary feature. If youare not aware of the risk levels you face and of the various kinds ofrisk, then you cannot be aware of your own risk tolerance. It isimportant to set goals for when to cut losses or take proﬁts. It isequally critical to decide in advance how much risk you can affordto take, what risks you have to avoid, and how to manage your risksto avoid unanticipated problems.In the next chapter, the related question of diversiﬁcation is expanded beyond the question of risk. Having too little or too muchdiversiﬁcation in your portfolio will cause problems, but simplyknowing how to diversify is an important attribute worth developing.
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THE EGG-ANDBASKET IDEA
D
iversiﬁcation is perhaps the most misunderstood concept in thestock market. The most popular beliefs about being diversiﬁed is toown shares of more than one stock, and it is considered ‘‘good’’diversiﬁcation to invest in growth mutual funds. But these approaches do not always accomplish what investors need and want.The approach of simply buying shares in a mutual fund is notalways adequate. For example, a fund whose management investswith poor timing may experience losses greater than market averages in down conditions or perform below average in up conditions.If you are fortunate and pick a good fund you can see great proﬁts,but there are no guarantees based on past performance.Owning shares of stock in different companies is a good startingpoint. It is equally important to be diversiﬁed in terms of marketsectors, and in some conditions investors should diversify outsideof the stock market as well, in the money market, bonds, or realestate. The strategy of splitting capital among different markets isusually referred to as asset allocation, a variation on the theme ofdiversiﬁcation. One problem with the allocation approach is a ten137
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dency for ‘‘experts’’ to announce the best allocation model, and theyexpect everyone to accept it. For example, you may hear that thismonth an analyst is recommending 50 percent equities (stocks), 25percent debt, and 25 percent cash. Does this always apply to you?Is it realistic to set up one model and assume that everyone shouldaccept it?Asking questions is a smart idea. An allocation model might be‘‘right’’ for some people but not right for others, depending on personal risk tolerance levels and individual beliefs about the market.As with all forms of diversiﬁcation, the allocation model should beestablished personally and based on what you want to achieve, whatlevels of risk you can tolerate, and where you believe proﬁts aregoing to occur.Investors concerned with the overall market need to study thequestion in greater detail rather than the simple assignment of percentages to various markets; in fact, for most people, allocation isset-up ﬁnancial limitations. If you are buying your home, you already have an equity position in real estate. You probably also havesome savings, so you are in the money market and have some builtin liquidity. Most of the rest of your money is likely to go into stocksor mutual funds. This is the logical level of allocation.Within the stock market you need to be concerned about diversiﬁcation between sector leaders and nonleaders. stocks that are interest rate sensitive and those that are not, sectors having differingcharacteristics in both market and economic terms, and stocks ofcompanies of different status and longevity within their industries.Diversiﬁcation is a form of risk management, and forms of diversiﬁcation should take into account the proﬁtability and prospects forfuture growth as expressed in terms of earnings trends.
Diversiﬁcation MethodsTo begin, consider the many ways you can diversify:1. By stock. The most basic manner of diversifying is by stock.You simply buy shares in more than one company. However, buying
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similar stocks (like different stocks in the same sector) is not goingto diversify your portfolio effectively, because all of those companieswill be subject to the same market and economic events.You need to be concerned with how stocks are going to react tomarket-wide change. On those days when the Dow Jones IndustrialAverage (DJIA) drops 200 points, most stocks follow that course.Does this mean that all companies are inherently weak on the sameday? Of course, it does not. But remember, the market overreactsto all news. When the 30 industrial stocks in the DJIA fall, the market tends to move in the same direction. It is equally probable thatprices will return to previous levels within the next few trading sessions. The market should be viewed like a ﬂock of birds, with everymember of the ﬂock moving and shifting direction based on whatever the leader does. There is very little room for individual thoughtin the ﬂurry of the moment. But if you pick stocks with inherentlygood fundamentals, a strong competitive position, and a promisingfuture the day-to-day price movement is not going to represent apermanent change.Even so, picking stocks is risky. Just as stocks tend to follow themarket leaders on the way down, they tend to do the same on theway up. This is the nature of a volatile market. Daily change is goingto be extreme in uncertain times, but prices have a way of smoothingthemselves out over the intermediate and long term. You accept therisk in exchange for the promise of future proﬁts. But in pickingindividual stocks, it is wise to diversify by beta of the stock.Beta is a technical indicator placing a relative value on how astock’s price moves relative to the overall market. The measurementis usually applied against the S&P 500 Index, which is a broaderindicator than the DJIA. A stock that tracks the market exactlywould have a beta of ‘‘1’’ and a stock that tends to move more thanthe market (meaning it is more volatile than the average stock) willhave a beta above 1. Likewise, a stock that reacts to a lesser degreethan the overall market (a very low-volatility stock) will have a betaunder 1. An online search of ‘‘betastock’’ produces numeroussites for calculating beta and articles discussing this indicator.2. By sector. It is more effective to buy different stocks in various sectors than to spread money around in the same sector. Real
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diversiﬁcation means more than avoiding ‘‘one basket’’ for your investment eggs. You also need to spread your money among dissimilar sectors. For example, buying three energy stocks is not effective,but putting equal amounts of capital in one each of energy, pharmaceutical, and utility companies is much more likely to spread yourrisks.If you want to invest in a single industry, consider examiningthe exchange traded fund (ETF) market. One of the best sites onlineto look at the full range of the ETF market is on Yahoo! Finance athttp://ﬁnance.yahoo.com/etf.On the other hand, if you want to buy individual stocks butaccomplish a sensible level of diversiﬁcation, consider spreadingyour capital among sectors that are not going to react in the sameway to the market. Study the economic and market features of themajor sectors and identify how sectors tend to act and react tochanging conditions, both market-wide and cyclically. Some sectorshave predictable calendar-based cycles. Retail stocks are a good example. Other sectors, like utilities, are sensitive to interest rates.Defense stocks and oil stocks are more likely to react to emergingpolitical situations and global conﬂict. In other words, each sectorcan be deﬁned by its sensitivities. To diversify by sector, you needto pick sectors that are in favor with investors at the moment, butthat tend to react to different sensitivities.3. By market. The process of allocation among different markets further diversiﬁes your risks. A very widespread market fall islikely to affect a broad range of stocks, so allocating your assetsamong stocks, real estate, and the money market (savings, certiﬁcates of deposit, etc.) is a wise move. Allocation is not necessary inall market conditions, however, because its importance changeswith the market conditions.It is important to realize, though, that diversiﬁcation by market(allocation) is not always a matter of choice. For example, even ifyou believe real estate prices are going to rise in the future, how canyou position your portfolio to take advantage of that change? Youcan buy property directly but that requires cash as well as effectivecash management (not to mention dealing with tenants if rental
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property). As an alternative, you can buy shares in real estate investment trusts (REITs) or real estate development companies. However, this simply puts you back into the stock market in the realestate sector. In this example, an attempt to allocate only becomesan effective means for diversifying by sector, which might beenough. Additionally, if you are buying your own home, you have aduality of purpose. First and foremost, it is a long-term shelter foryour family and that overrules investment decisions. Second, it isalso a long-term investment. Based on price and down payment,you are not going to allocate less money in real estate unless youremove equity by additional mortgaging, which is often not a soundidea.The same limitations apply to the liquidity issue. An advisormight suggest that you keep 25 percent of your portfolio in cash orsavings, but that yields quite a low rate of return. Is it wise to followthis advice? As you have already seen, the effects of inﬂation andtaxes create a ﬂoor of required break-even return. And the usualhighly liquid, insured savings account or CD will not match it. Ifyou are interested in the annual return, consider some high-yieldingstocks and make your return via dividends rather than interest.Stocks are more liquid than CDs and have approximately the sameliquidity as savings accounts but the yield is often far greater.4. By investment attribute. You may achieve a more subtle typeof diversiﬁcation by spreading money around by attribute. For example, you might want to buy one high-dividend ﬁnancial stock,one low-P/E energy stock, and one IT stock paying no dividendand with a high P/E. This diversiﬁcation by attribute spreads riskswhile also exposing you to varying kinds of proﬁt potential.Attribute-based diversiﬁcation, when structured along with anaccompanying sector-based diversiﬁcation, is very effective. Basedon various kinds of market movement, for example, if your stocksall have low- or high-P/E ratios, the attribute itself may easily affecthow the entire portfolio performs. While attribute differences mightoffset one another, it is often necessary to accept that limitation toprotect your positions. For example, you might own three stocks,paying 5 percent, 3 percent, and zero percent dividends. The aver-
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age of these three is 3 percent, so there is no speciﬁc yield-basedadvantage to spreading the dividend yield in this manner. However,the differences in attribute may achieve stronger diversiﬁcation andprotection of your capital.
UnderdiversiﬁcationThe most common problem among individual investors is lackingenough diversiﬁcation. Many people believe that in order to be diversiﬁed, you need to own a broad array of stocks, and this is simplynot true. Many people pick mutual funds primarily for the beneﬁtof diversiﬁcation, but this is not necessary. (A second reason oftencited is the compound returns from reinvestment, but you can accomplish the same beneﬁt with stocks by reinvesting dividends inadditional partial shares.)Having too little diversiﬁcation may occur in many ways. Forthe most risk-sensitive person, mutual funds provide a sort of megadiversiﬁcation because these funds can spread money around inmany stocks and sectors. The novice investor is likely to make threediversiﬁcation-type mistakes:1. Simply having too little variety. If you put all of your moneyinto one stock, you are not diversiﬁed, no matter how promising thestock or how well positioned the company. Even owning two orthree stocks that are subject to different market and economic cycles is often enough diversiﬁcation. In fact, you can get enough diversiﬁcation from three stocks, dispelling the myth that you have tobuy shares of a mutual fund and be invested in 20 or 30 stocks.For example, you would not achieve effective diversiﬁcation bybuying only energy stocks, utility stocks, or retail stocks. But owning shares of companies in all of these three industries is diversiﬁcation. Energy stocks are sensitive to oil prices and politicaltensions. Utility stocks are most affected by changing interest rates.And retail stocks are annually quite cyclical but sensitive to consumer conﬁdence and spending trends. These three completely dif-
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ferent cycles and economic changes affect the three industries indifferent ways.2. Believing you are diversiﬁed when you are not. Are you diversiﬁed if you own stock in three different companies? You might be,but you might not be. For example, if you own stock in three retailcompanies, you are not diversiﬁed, even with the subtle submarketsexisting in every sector. Retail companies are affected by speciﬁcfactors, and all are at the same overall risks.It is also a problem to invest in three different companies withseparate sectors, but subject to the same economic inﬂuences. Forexample, if you own a delivery service stock (like UPS or FedEx), atransportation stock (airline, trucking, rail), and a food chain stock(Kroger, Safeway), all are going to be directly affected by changingoil prices. They will be affected in different ways and to differentdegrees, but the lack of diversiﬁcation makes this a potentially troubling form of selection. The likelihood is that if oil prices changedramatically, all of these industries will be affected in the same pricedirection, thus the approach lacks diversiﬁcation. You would bemore effectively diversiﬁed by identifying major inﬂuences on stockvalue and selecting companies in dissimilar industries. This way,when an outside factor (like oil prices) adversely affects one stock,it will not adversely affect the others.3. Applying personal bias so that the portfolio is placed at risk.You might like real estate but fear stocks because someone youknow lost a lot of money many years ago. For example, you mightbelieve that stocks are excessively risky because your father or uncleplaced the family savings in Enron in the year 2000 and lost it all.Remember that there are variations of risk in every market, andone experience can affect anyone’s judgment. In the example cited,hindsight reveals that it was ill-advised to put too much capital intoa single stock, whether Enron, Google, or Exxon-Mobil.Personal bias can affect judgment about stocks, real estate, themoney market, precious metals, options, commodities, or any othermarket. But it is often the case that the lack of a thorough understanding about unfamiliar markets causes a great deal of that bias.This bias also extends to brand names. For example, if you like the
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taste of Coca-Cola (KO) and do not like Pepsi (PEP), does thatmean that Coke is a better investment? In fact, the differences intaste preference have absolutely nothing to do with the investmentvalue of stock.Some of the best-managed companies are also the most hated,not only for their high proﬁle, but also for their simple success. Highproﬁle equals high target. Consider opinions you hear about ExxonMobil, Microsoft, and Wal-Mart. Many people detest these threecompanies, and yet, stockholders in all three have been amply rewarded. They are among the best-managed companies available. Ifyou decide to not invest in these because of a social or politicalposition, that may be a valid decision point, but be aware that thedecision has nothing to do with investment value. If you avoid certain companies for noninvestment reasons like taste preference orsocial conscience, you should also be aware of the criteria on whichthat decision is made.
OverdiversiﬁcationThe opposite of too little diversiﬁcation is too much. Some investorsmay be surprised to hear that such a thing even exists, but it does.The classic example is an extremely large mutual fund, so large thatit cannot move in and out of positions quickly. These mega-fundshold so many publicly traded shares in their portfolio that their reasonably expected rate of return has to approximate the market, atbest. All too often, even the large funds underperform because theyare overdiversiﬁed. Table 7-1 summarizes the 10 largest mutualfunds as of late 2007, as measured by net assets under management.Note that all are above $16 billion.Mutual funds are not necessarily the answer to underdiversiﬁcation. In fact, overdiversifying may be equally as damaging to yourportfolio. Today, investors also like to select index funds or ETFs tocover entire sectors, types of stocks, or even countries. Rememberthat whenever you purchase shares in equity mutual funds, indexfunds, and ETFs your outcome will be equal to the average of all
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TABLE 7-1. TEN L ARGEST MUTUAL FUNDS
Fund Name
Net Assets(in Billions of Dollars)
American Funds Amcap AAmerican Funds American Mutual AAmerican Funds EuroPaciﬁc Gr R5American Funds Grth Fund of Amer R4American Funds Smallcap World AFidelity Blue Chip GrowthFidelity Dividend GrowthFranklin Income CLord Abbett Afﬁliated AT. Rowe Price Mid-Cap Growth
$18.4517.4617.2417.8319.7218.8916.6816.2016.6417.29
Source: Yahoo! Finance, at http://screen.yahoo.com/funds.html
the components. For example, if you were to purchase shares of apharmaceutical ETF, you would get a number of companies in thatsector. Why not focus on the one or two best-performing stocksand receive a far better overall return? For the money invested, youwould be smart to split among a diversiﬁed sector array than a single-sector ETF.When you consider the size of some mutual funds—approaching $20 billion, for example—it makes sense to ask a critical question: How can such a large fund possibly beat the market?In fact, most do not. A study of a decade-long return comparingmutual funds to the S&P 500 was revealing. The average stock fundgrew by 23.6 percent, so that $10,000 rose to $83,194 with reinvestment of income. That is impressive. However, the S&P 500 inthe same period grew 28 percent, so that $10,000 increased to$118,074.1Considering that broad diversiﬁcation is a primary selling pointfor mutual fund investing, it is troubling that mutual funds, on average, did not beat the market. In fact, the average fell short by morethan 4 percent over the decade studied.
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You can effectively diversify within your own portfolio with asmall number of carefully selected stocks. But the risk of overdiversiﬁcation remains even if you limit your exposure. For example,some investors like to combine direct ownership of stocks alongwith a regular contribution to a mutual fund. The more capital allocated to the fund side of your portfolio under this incremental strategy, the more overdiversiﬁed you may become. Much of thisdepends on the kind of fund you pick, of course. No one wouldsuggest that all mutual funds are overdiversiﬁed. But you exposeyourself to this risk by purchasing shares of a fund, so it is sensibleto consider the potential for a problem.You can also overdiversify by buying relatively small numbers ofshares in too many different companies and sectors. It should beadequate to pick a few leading sectors and buy the strongest candidates in each. This combination of factors evolves over time so periodic reviews are important, but by focusing on a relatively smallnumber of sectors and stocks you are more likely to avoid the problems of overdiversiﬁcation.
Bias and Diversiﬁcation: Making Your DecisionsAnother concern in developing a sensible level of diversiﬁcation isthat of personal bias. This was touched on earlier in the discussionof underdiversiﬁcation, where the example of Exxon-Mobil, WalMart, and Microsoft was used to make the point. These wellmanaged companies are also big targets for criticism from manygroups. Social, union, political, and environmental interests all ﬁndfault with these companies, and it creates a speciﬁc bias against them.So why would you buy stock in any of these ‘‘evil’’ corporations?The truth is that the bad press these companies have received iscontroversial, and is not believed universally. But even if you subscribe to the negative impressions of any company, should you avoidbuying their stock? That is a serious question, because the shunningof a company’s stock for nonﬁnancial and nonmarket reasons is acriterion outside of the usual.It is wise to make decisions with your underlying premise clearly
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in mind. If you avoid a particular company because you believe thatit pollutes the environment (Exxon-Mobil), does not use unionizedlabor (Wal-Mart), or crushes the competition (Microsoft), then youshould be completely conscious of the reason. You may recognizethat your own list of fundamental and technical indicators pointsstrongly toward buying shares in these corporations, and yet you donot want to because of these biases. This is entirely legitimate, aslong as you know that this is why you make the decision.To expand on this, consider why and how some companies geta bad reputation. Many successful corporations are expected tocontribute more than product at a competitive price, and this assumption can have unintended consequences. For example, in thecase of Coca-Cola, which operates internationally, the followingstory appeared a few years ago:In October 2002, AIDS activists worldwide planned demonstrations andrallies to protest Coca-Cola, which they insisted must do more to helpand treat HIV-infected workers and their families in Africa. Although thecompany had recently increased its beneﬁts to provide anti-retroviraldrugs to employees and spouses of its bottling companies in Africa,activists allege that the initiative will cover only 35 percent of Coke’sbottler workforce in Africa and that its proposed 50 percent cost-sharingscheme will be too expensive for small- and medium-sized bottlers.2
This story is illustrative of the problem. The company had increased its beneﬁts, but the criticism was that the increase did notcover enough of the local workforce. The question has to be asked:At what point does the cost/beneﬁt ratio tip? If you were to take upthe role of a social activist, you might want to avoid investing inCoca-Cola for the reasons cited. However, as an investor, your concerns would be quite different. What about the proﬁt margin of thecompany’s international unit? Is it the company’s responsibility toreduce beneﬁts to shareholders to provide extra beneﬁts?The question is often one of practical considerations, and not amatter of a cold desire for proﬁts and lack of concern for humansuffering. For example, the Wal-Mart debate involves two opposing
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ideas. First, the company provides thousands of jobs in communities it serves while offering lower prices. Wal-Mart’s success is dueto low prices. However, the major criticism of the company is thatby not hiring unionized workers, it (1) underpays its employees,(2) exploits the poor, and (3) puts smaller local companies out ofbusiness. From the point of view of a person who needs a job, desires lower prices, and seeks a proﬁtable investment, Wal-Mart’ssuccess model is apparent. The company has done well for goodreasons. An individual who decides to not buy stock for the reasonscited should do so in full recognition of the difference in thedecision-making model. You either buy stock in a company becauseit is well managed, competitive, proﬁtable, and successful or because you approve of its operating model. For example, you mightprefer shopping in a small local store where prices are far higherbecause you want to support local businesses and you don’t want‘‘big-box’’ stores in your community. But as a consumer you needto be willing to pay higher prices, and as an investor you need toacknowledge why you would not buy Wal-Mart stock.Diversiﬁcation is essential to protect your portfolio’s positions.However, in attempting to create a healthy rainbow of variety toavoid suffering portfolio-wide losses, it is also important that yourecognize your own biases. You need to determine your premise forinvesting in one group of companies versus another. However, mostpeople will opt for better proﬁts in the ﬁnal analysis, according to astudy done by the Wharton School. The study, ‘‘Investing in Socially Responsible Mutual Funds,’’ covers the years 1963 to 2001and found that:. . . funds that employ socially conscious criteria cost their investors 0.3percent a month, which with compounding is actually 4.3 percentagepoints a year.The study lays the blame for the underperformance of socially responsible funds at two doors. One is that average annual expense ratiosof these funds are substantially higher than those of others, about 1.3percent a year compared with 1.1 percent. The authors assume these
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costs result from the added research managers conduct to ﬁnd companies they deem to be socially conscious.3
The study reveals that there may be a cost associated with socially conscious investing. The contention remains, however, onebetween social conscience and the proﬁt motive. As the author ofthe above article pointed out, anyone who really believes in the importance of such an approach may adopt a different attitude: ‘‘I’dprefer my mutual funds generate fat returns, leaving me plenty ofdough to contribute to charity, than sacriﬁce half my proﬁts in thename of so-called social responsibility.’’4The danger of allowing personal bias to enter the analyticalrealm of stock picking may also affect your ability to diversify. Forexample, if you limit yourself to a speciﬁc range of corporations,you may miss out on some very speciﬁc circles of proﬁtability. Forexample, if you believe that companies with substantial internationaloutlets ‘‘exploit foreign workers’’ and ‘‘move domestic jobs overseas,’’ does that mean you should not invest in any internationalcompanies? Some of the most successful U.S.-based corporationsare international in nature, and many attribute a majority of theirrevenues to non-U.S. operations. In some cases, a speciﬁc bias, nomatter what the intention, could result in deﬂating your desire forsmart diversiﬁcation.Companies whose products and services conﬂict with your corebeliefs may surely be avoided, if only on the basis of personal beliefsand opinions. However, it is also smart to be aware of the source ofthe bias and how it may conﬂict with the typical investor’s desire tomake a proﬁt and to reduce losses. If your primary goal is to breakeven after inﬂation and taxes, you already have a formidable task.Limiting your potential investment realm further only works contrary to the sensible goals of a well-diversiﬁed portfolio.In addition to the important personal management aspects related to diversiﬁcation, your portfolio is also vulnerable to the issuesof liquidity in the market. This word has several meanings; the nextchapter focuses on portfolio liquidity, the need to keep your capital
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at work but available at an appropriate level to generate proﬁts andavoid losses.
Notes1 Source: http://www.atozinvestments.com/mutual-fund-return.html.2 www.oneworld.net, 10/17/20023 Timothy Middleton, ‘‘Feel-Good Investing? I’d Rather Make Money,’’ August19, 2003, at msn money, http://moneycentral.msn.com.4 Ibid.
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L I QUID I TY I N T HE MAR KET
‘‘L
iquidity’’ has several different meanings. In this chapter, portfolioliquidity is the primary topic of discussion, while other meanings ofthe term are also explained. The tendency among investors may beto take proﬁts when they become available, thus, strongly performing stocks are sold off, leaving poorer performing stocks. Consistentapplication of this idea results in a portfolio full of underperformingstocks. This chapter explains how to avoid this and achieve the opposite: a portfolio full of exceptional performers.Liquidity refers to management of a limited capital resourcewithin the portfolio. Managing liquidity is an important function forevery investor, and this function is tied closely to the identiﬁcationof stocks by attribute (earnings per share, or EPS, as part of a trend,risk, diversiﬁcation, and changes in trends in application of the DowTheory).The proper identiﬁcation and timing of buy and sale decisionsensures that liquidity in the portfolio will not suffer. This is overlooked by many