Chapter 24
Right Ratio for Shares and Cash
Robert Lichello, the inventor of the AIM system, originally came out with the idea of using 50% cash and 50% shares when you start an AIM investment. So for example if you're investing $10,000 into a stock you would start with $5,000 worth of cash and $5,000 worth of stock.
I went along with the 50-50 split for many years until I finally encountered a severe bear market around the year 2000. When you have a severe bear market your cash ratio can go down substantially. And if you look in Chapter 12 of my book, and look at how Campbell Resources did for 3 years you will see that you might need very deep pockets to come up with additional cash that AIM calls for if you started with the 50-50 arrangement and also you are using the 10% SAFE amount to determine buys and sells.
Since I have been playing with AIM for many years I have done considerable thinking on good ways to tweak the game to help you make maximum profits. And one way you can make additional profits is by the wise use of the ratio of shares and cash.
Different kinds of investments call for different kinds of ratios between the share amount and the cash amount. I'll give you some examples below so that you have a better idea of what I am talking about.
Closed-End Fund
A closed-end fund is a special type of mutual fund. The biggest difference between a closed-end fund and a regular mutual fund is the fact that a regular mutual fund can constantly add to the fund as new investors put money into the fund. For example Fidelity Magellan many years ago was considered one of the top mutual funds in the United States. It grew and grew from a small amount to I believe over $5 billion. Basically all mutual funds are open which means they can continue to grow as new investors put money in. But also they can shrink if mutual fund investors start taking their money out of the fund.
I have never liked regular mutual funds to use for AIM investing because of many restrictions on buying and selling and many fees and I always felt that closed-end investments were a better way to use AIM than open mutual funds were.
Here's a quick way to explain what a closed-end fund is. Somebody decides on an objective for a closed-end fund for example they could represent all the good companies in Brazil, China, or it could be designed to bring in high levels of dividends – there are many different objectives you'll find with a closed-end fund.
The nice thing about closed-end funds is this. And I would use as an example one that I have recommended in the past and still recommend called HYF. Let me explain how the mutual fund is set up and works and why it is good for AIM investing.
When a fund like HYF is set up, they issue let's say for example 10 million shares at $10 each. The shares are issued just like shares in a stock. So these 10 million shares are bought by investors and the closed-end fund gets listed on one of the stock exchanges normally the New York Stock Exchange. Once the 10 million shares are sold, the only way for a new investor to buy shares in that closed-end fund is to buy shares on a stock exchange from somebody who owns the shares. Basically just the same way you would buy shares of stock you traded on the stock market and you buy somebody else's sells.
The advantage is now that a closed-end fund trades on the stock exchange you can buy and sell instantly you don't have to wait for the end of the day and for the net asset value to be determined. Also closed-end funds are much more likely to have better highs and lows than regular mutual funds. And closed-end funds are just as conservative as an open mutual funds but without any of the drawbacks.
Let's go back to our example of HYF. This is a great closed-end fund for investors that are looking for a monthly dividend and a high monthly dividend to boot and also a little up-and-down action using AIM at the same time. This fund is at a very low price and in the last year the high was around $2.66 and the low was $1.83. And HYF pays a dividend of a little over 10% a year.
If you look at how it traded in the last year you will see that I was way too conservative for one of my investors in Houston who started with $20,000 in HYF because he wanted to have a high income monthly dividend on one of his investments. I started him out with $10,000 worth of cash and $10,000 worth of shares in HYF. He bought his initial shares in August of 2011 and with his $10,000 he was able to buy 5,000 shares at $2.12 or he originally bought $10,600 worth of HYF. Again investing is an art and not a science so we don't have to buy exactly $10,000 worth of shares so I set up a spreadsheet to show $10,600 worth of shares of HYF and $9,400 worth of cash in HYF so again he started off with a round some of $20,000.
Since the original buy in August 2011, the only AIM action he has had was one buy that I recommended to him that actually didn't exceed the AIM threshold for a buy but HYF was at a 52-week low so I thought it was a good idea to buy more shares of HYF and I had him buy 200 more shares at $1.83 so he grew from 5,000 shares to 5,200 shares.
Remember he started off with $9,400 worth of cash in August 2011. This investors called me yesterday and we were having a very nice chat about AIM and I got to thinking about the ratios between cash and shares of the investment because my investor brought up the subject.
He was asking me if I thought it was a better idea to use two thirds of the money to buy the shares or the stock or the closed-end fund or the LEAP and one third to put into cash. If an investor started with $21,000, then what my investor was suggesting was let's use $14,000 of that $21,000 to buy shares in the stock, closed-end fund, LEAP, and put the other $7,000 into cash.
I told him that for about the first 10 years I was using AIM I always recommended blindly to use two thirds shares and one third for cash. But that was before the great bear market of 2000, 2001, 2002. Then I worked on developing bear strategies to help investors conserve their cash when the market was in a severe bear turn and everything was going down.
The first thing I did was to return to Robert Lichello's original concept of 50% cash and 50% stock. But as you will see in Chapter 12 of my book, Why the System Works, you will see that just using the 50% cash and share ratio will not prevent the depletion of your cash when your investment has a severe bear turn. But if you have deep pockets the best system to use is the 50% cash 50% stock ratio and I'll explain it to you quickly.
Campbell Resources started off around $6.40 and about two years later was selling for $.85. Naturally AIM was gobbling up lots of cheap shares as Campbell Resources went down and down. For that example I used the mythical starting $10,000 that was split into 5,000 CASH and 5,000 SHARE VALUE.
When you look at the spreadsheets in Chapter 12 you will see that you had to put in an additional $25,000 worth of cash to make all of the buys that AIM told you to make as Campbell Resources went down and down. There was a three month stretch when Campbell Resources was selling below $1.00 and AIM just gobbled up lots of cheap shares buying over 1,000 shares in each of those three months at extremely cheap prices.
But faithfully following AIM with the 10% buy amount and the 10% sell amount that Robert Lichello recommended, you eventually finished with a profit of 38% despite the fact that Campbell Resources finished down 62% after the three years.
So putting in all that additional money did pay off in the long run but not everybody has deep pockets and can put in additional cash when AIM calls for it. I realized that so I said I have to guide my AIM strategy to be more conservative and try and save cash as an investment goes steadily down.
As I was talking to my investor, it suddenly occurred to me that we could use different ratios depending on the different types of investments that he owns. He is invested into 3 LEAPs (a long-term option investment that expires in January of every any given year, so for example now you have LEAPs that expire in January 2013 and January 2014.) He owns like I said the one closed-end fund HYF and another ETF or electronically traded fund with the symbol BOE. He also owns a very aggressive ETF from Direxion called the China Bull (YINN) (3X) leveraged that follows the Chinese market. This fund is leveraged so if the Chinese stock market or the Dow Jones Industrial Average for example goes up 3%, this fund with the symbol YINN would go up 9%.
When I talked to him yesterday he got me thinking about the ratios between cash and stock or shares and I decided to tell him that with the conservative closed-end fund HYF he did not really need to have a 50% cash and 50% share ratio. Like I said earlier he's owned HYF since August 2011 and since August 2011 his CASH account on that closed-end fund has gone from $9,400 down to $9,034 because we bought the 200 shares in October at the 52 week low of $1.83.
I told him right on the phone that HYF is a great dividend payer and the $9,000 in the CASH account with his broker in the money market is paying virtually 0% interest. I told him we could be more aggressive owning shares in HYF and right off the top of my head I recommended on Monday he buy another 1,000 shares at the market price of $2.16. He just doesn't need to have $9,000 worth of cash sitting with his broker earning no interest when this investment is very conservative, HYF will never need a very large amount of cash to make additional buys in the future. It's just a different kind of investment so now I'm going to be more aggressive on conservative investments and recommend to my investors that they put more money into shares and less money into cash.
He has another closed-end fund with the symbol BOE and I'm also going to check that one out and recommend to him that he put more money into shares and less money into cash.
Stocks
Stocks are mixed bag. There are some stocks that are very conservative and then there are some stocks that can have pretty wild swings. In my original book I Guarantee You Will Buy Low Sell High and Make Money, I identified the two types of stocks - conservative stocks and semi-aggressive stocks. Conservative stocks to me are more like the traditional 30 stocks you find in the Dow Jones Industrial Average stocks that are have big names that are basically household words like AT&T, IBM, Boeing, General Electric, American Express, etc.
Semi-aggressive stocks on the other hand have wilder high/low swings; you can find stocks that might have a low of $3 and a high of $30. You would want to keep a 50-50 ratio for stocks that do have wild swings but you really could decrease the amount of cash in stocks that are conservative. I can't really make a blanket statement on any stock but from now on in the future with my investors I will definitely advise them that I think you could have less cash sitting in in your brokers money market account because of the type of stock or closed-end fund or ETF that you own.
LEAPs
LEAPs, like I said earlier, are long-term options on either a stock or ETF. Even LEAPs on very conservative stocks such as American Express, General Electric, IBM, can be extremely volatile. I would always recommend a blanket rule to keep 50% CASH and 50% LEAPs anytime you buy LEAPs. I even have a basic rule that you'll see in my other book that I don't even consider buying more LEAPs for one of my clients until the LEAP has gone down at least 50%. That means for example if we bought a LEAP at $4 or $400 for one contract as you have to buy contracts with LEAPs you cannot just buy 25 LEAPs, then I would wait until the LEAP went from $4 to $2 and then I would advise my client we should buy some more contracts.
I think LEAPs should be in everybody's portfolio because they pay a much higher rate over the long term than the underlying derivative or stock or ETF that they follow. LEAPs are as safe as the stock or ETF that you buy them on. And you can always roll over LEAPs from one year to the next so really they would be indefinite not expiring; like most people think that they are only an expiring investment that's not really true.
ETF's
ETF's are recent invention and have really only been around for about the last couple years. And I think there are a great new invention to the world of investing. ETFs have all the advantages that closed-end funds have which means they trade on the stock market and you can instantly buy and sell them and they give you an expanded range into many different types of investments including some from Direxion and others that are leveraged which means they can go up and down at faster rate than non-leveraged ETF's. And to compound the felony, you can even get LEAPs on some ETF's I'll talk about that in another chapter.
With most ETF's I do not feel you need to have 50% cash and 50% ETF ratio when you initially start with the investment. Any investment that is a combination of other investments is always going to be safer than if you buy one stock or one or one LEAP. It's just the nature of the beast that something that is a collection of things can never be affected greatly by anyone of the multiple investments that is in the fund or the ETF. Also both closed-end funds and ETF's have management that went into the creation of and sometimes the continuing evolution of the ETF into the future. So you are actually getting a little bit of management when you own an ETF or a closed-end fund. So you can afford to be more aggressive owning shares in the fund or the ETF and have less CASH on your spreadsheet for that particular investment.
I want to emphasize that one size does not fit all when it comes to investing and that's why I think it helps you to have somebody like me advising you on how much CASH and how many shares should be in the ratio for any particular investment that you thinking of owning.
Some investors are very conservative, some investors want some income, some investors want to go for larger returns; maybe they’re older in life and they don't have a lot of time to sit there and wait 20-30 years for their investments to make them lots of money and that's fine. AIM can handle any type of investor from the most conservative to the most risky. And again AIM will faithfully tell you exactly how much to buy, how much to sell, or to do nothing.
And the other beauty of AIM is that you can decide if you have me manage it for you. That means you will have me looking at your investments on a daily basis and advising you whether to sell whether to buy or whether to do nothing. It's always better to actively manage investments than just buy them and forget them.
So I hope this helped you decide and give you a little information at least on the questions to ask when you start investing in AIM about how to maximize your profits with the minimal risk.