When selecting a newsletter many people spend days, even weeks researching the various offerings. They check everything including standard deviation, beta, and the yearly performance for the last ten years, for those newsletters with the guts to publish such information. Then read countless reviews and testimonials to assure they are not alone in their pick. They plunk down their hard earned cash and eagerly await the arrival of each issue. Six months later their account is in the hole and they can’t figure out what went wrong. The newsletter is still reporting the same solid gains as before, but somehow they aren’t translating to your account.
What they failed to realize is the performance figures assume the subscriber takes ALL of the recommended trades. Most people cherry pick what they like best and skip the rest of the recommended trades. This of course leads to a difference in the returns between you and them, sometimes greatly. It is especially important to take all trades from quantitative strategies and those newsletters that work sector diversification and non correlated picks into the overall portfolio to reduce volatility. If you are trying to emulate the newsletters’ returns how could you leave out half the trades and still expect to match their performance? Where reasonable you should take all the recommendations and place your orders in a timely manner.
While on the subject of how to use a newsletter, the rational extension is who should and shouldn’t use newsletters. Now if you like to use a newsletter for the educational aspects and the cost isn’t too high, then I’m all for it. Many newsletters do a fine job of explaining their stock analysis and macro trends. What I don’t like to see are those people with two or three thousand dollars trying trade a newsletters ten recommendations per month. For accounts that size the commissions chew through your profits in no time. Just what size account is big enough to start trading stocks? The answer is it all depends but I’ll give some rules of thumb. First to keep commissions from eating all the profits I like to see the round trip commission to be 1% or less of the total trade value. Say you pay $8 per trade for a total of $16 per round trip. $1600 times 1% equals $16. So your minimum investment to keep round trip commissions 1% or less is $1600. I can hear you now. “Great. I have $2500 and am raring to go.” Not so fast! That would be only one security or stock holding. If something goes wrong, and sooner or later it will, you could take a punishing loss that may take you out of the game altogether. No, one stock isn’t enough. As a bare minimum I say five stocks. Even if one holding goes to zero before you sell (highly unlikely) you are still only down 20%. While a 20% loss is nothing to sneeze at, you could still recover from it. So now we have five stocks with a minimum investment of $1600 in each. That makes $8000 as our minimum account size before buying individual stocks.
So what do you do until you amass that sum? Invest in a mutual fund of course. Just employ dollar cost averaging in your favorite diversified mutual fund until you build up to a reasonable account size. I can’t give specific recommendations on funds because managers move frequently. Let’s just say a US equity fund or a balanced fund depending on your appetite for risk. Considering the majority of fund managers don’t beat the S&P500 in the long run, a good index fund just may be your best bet.
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