Hi Mark, Well I was going to wait until tomorrow to do the work myself and present the results, but since it's been stirred up once again, I'll just present the idea and let someone else do the work.
I guess everyone else wants to treat the initial investment as history and a "Learning Experience." I think that's fine, especially if the investment is being sold off. Then, there's no question as there's only what's left to start a new investment.
However, I think what was being asked was how to start up an account with an existing investment that's currently showing a paper loss. Further that there's cash available without selling and a willingness to use that cash most effectively with that particular investment.
So, just for the By The Book crowd, I thought a fair way to test this would be to use Mr. Lichello's own model. Let's assume the investment was at $10/share just as in Mr. L's example. Further let's assume that AIM wasn't known at the time of the initial investment.
Now, some months later we find out about Mr. Lichello and his miracle cure for wounds inflicted by nasty old BEARS. However, at this time we find our investment is now only worth $5/share. What shall we do?
My suggestion is to use one of the AIM software products that can simulate a trade history (hint, hint!) and we'll run some What If's.
Let's assume that there was initially $10,000 available in funds. Further let's assume that just $5000 was invested at $10/share just like Mr. Lichello's model. No further investing was done, so there's still plenty of cash available should we find Mr. Lichello's model appealing.
I'm suggesting that Portfolio Control should be 5000 just like Mr. L's model. Bernie is suggesting that it should only be 2500. (I can't believe that Bernie would suggest something that's not BTB, BTW!!!) Now, let's get back to Mr. L's model. It goes $10-8-5-4-5-8-10-8-5-4-5-8 each year. We already started at $10 and bypassed the first $8 and now want to start AIM at the $5 point in the cycle.
So, to play fair and so we know exactly what our profits and losses are, we need to start the spreadsheet with $5000 invested, $5000 in cash reserves for my model. This will give us the 5000 Portfolio Control that I want. In the next period the price is $8 but we ignore any buy signal there since we, in fact, didn't buy there. However, now we start up AIM at the $5 point. AIM will buy, there will be some residual cash reserve. Next stop is $4 and AIM will buy again and there will still be a tiny amount of cash left.
Now the price returns to $5. How are we looking? Let's keep going back to $8 and $10. Okay, is this looking better? OOPS, it was just a head-fake by the market and down it comes to $8, $5, $4 again. And so on.
How many periods does it take to have the account break even? What's the value after four complete cycles?
Now, let's do it again, but with the modified Portfolio Control:
We invest $5000 in the stock and hold $5000 back as cash reserve. The investment was done at $10/share just as before. Now the investment has dropped to $5/share. We read about AIM and ask Bernie what to do. Bernie says, "Well, there's no use fretting about the past, let's start with Portfolio Control at 2500 since that's the value of the issue at this time."
Okay, we have $2500 invested, $5000 in cash, Portfolio Control at 2500 and a built in starting loss of $2500. The stock now drops to $4/share just as above. AIM does some initial buying. Then the stock pops back to $5. Well, that felt good! OOPS, now it's back to $8 and then $10 and AIM's selling its butt off. Well, thank goodness, because the price didn't hold up and now is falling back to $8 then $5 and $4 for another cycle.
Okay, how many periods does it take for this investment to become whole again? After four whole cycles what's the total value?
Okay, then which way wins?
I hope this helps. I think personally that FEAR is guiding the advice to start the account at half the Portfolio Control from the initial investment. It's like saying, "The market's fallen 80% from the peak, therefore, I should anticipate that it will fall at least that far tomorrow." Wrong. We may not be at the bottom of this cycle, but we're a heck of a lot closer to it now than last March!
If we say, "Well, this stock is really a lousy investment and therefore I should start it with a reduced Portfolio Control." we're really saying it's a bad investment. If that's the case, I'd suggest selling it and buying something else. However, it appears that the questioner has some faith in the company and hence the questions.
To summarize:
If the company in question is a good investment for the long run, I believe that one should treat it exactly by the book. If it's not a good company, then sell it and take the lumps. Start something new and forget the loss.
I haven't run the simulation suggested above myself. However, I know who's going to win and why. I hope one of you will do the simulations as I suggested and post the results.
I know that some folks are going to argue that we didn't need to start the second example with $5000 of Cash, but the point is that it's apparently available. Now, how is it best put to use? There's an accountant's million ways to fiddle with the starting and ending points to favor one thought over another. However, my intent is to give the person the best advice I can to bring his current investment whole and make money from that point on. Lots of ways to skin this critter, but I still feel that we're all here because we thought Mr. Lichello had a good idea. Let's give him some credit and let his unadulterated method help this guy get off to a good start.
Best regards, Tom |
