How I became an ex-millionaire

Over the past two years I became a millionaire (on 6 Dec 2006 my Net Worth first went over A$1 million), was a millionaire all through 2007 (my NW peak at $1.184m on 20 jun 2007 and at $1.199m on 1 Nov 2007), and yesterday my estimated NW dropped below A$1m again. Today the stock market is up around 4%, so I'm probably a millionaire again!

If nothing else the past two years have proven some of fundamental truisms of investing:
1. Booms end in a bust
2. When people say "this time it's different", it isn't
3. Diversification helps smooth portfolio returns, but isn't a panacea.
4. Markets tend to revert to the mean
5. Never let tax considerations influence fundamental decisions about asset allocation

During 2006 the stock market was booming and the Sydney property market was still in a slump. At that time I was bemoaning the fact that my portfolio was overweight (around 50%) in real estate compared to what I'd like my allocation to be (around 35%), but with the high transaction costs of selling real estate the only way to realistically adjust with portfolio asset allocation was to borrow some funds against my real estate equity using a HELOC and invest additional funds in the stock market. Now that the market has slumped and Sydney property is making some modest gains I'm glad to be "overweight" in real estate.

Back when the stock market continued it's bull run into 2007 I decided to buy some "insurance" by purchasing some Index Put Options with an expiry date in Dec 2007. These were "out of the money" throughout 2007, but did appreciate in value somewhat during the market slump in July 2007, only to lose value as the market recovered later in the year and expired with no value in December. I had intended to buy some new Index Put Options in December 2007, but never made more than a cursory investigation into the available options, and, not finding any suitable ones with a reasonable price, delayed taking any action while I considered alternative methods of insuring against a bear market, such as short selling Index CFDs or ETF shares. In the end I took no action, and decided it that I'd "missed the boat" when the market corrected 5%-10% in early January. *Bad Move*! If I'd only "rolled over" my Index Put Options into a new series that had a Sep or Dec 2008 expiration date back in December, I'd have preserved around $150K of my Net Worth and would now be in a position to use the gains realised on the Put Options to buy into the market at the current low levels. Instead I've lost a significant percentage of my Net Worth, I have no free cash available to invest in the stock market at the current attractive prices, and my margin loan accounts are getting close to margin call levels of gearing!

The other bad call I made in 2007 was to not sell off some of my stocks when they reached all-time high prices and the market seemed to be reaching "full value" AND the US sub-prime fiasco started making the headlines. I made the mistake of paying attention to pundits who were predicting that although the Australian market was getting close to "full value" it wasn't on exceptionally high p/e's and could gain another 5%-10% by mid-late 2008. Wishful thinking!

When the market has had a bull run for several years, and some fundamentally bad news comes out that doesn't appear to dent the market's confidence, you're in the situation of Wiley Coyote running in mid-air off a cliff. I should have ignored all the talk about "this time it's different" (eg. the Australian market is supported by the commodities boom, the Australian/Asian markets are uncoupled from problems in the US economy, etc. etc) and just taken some profits out of my stock portfolio. I had tax reasons to not want to realise significant capital gains during 2006/2007, but I then continued to let tax considerations influence my decision to hold onto my unrealised gains during 2007/2008 when the market was starting to get choppy.

Oh well, at this stage all I can do is hope the current situation is a milder version of 1987, when the market recovered relatively quickly from it's massive sell-off. If the situation is more like the oil-shocked, stagflationary era of the 1970's it could be quite a long time before my Net Worth regains the peaks of 2007.

Copyright Enough Wealth 2007