Mechanical investing is not for everyone. But, for investors willing to follow a well-defined disciplined strategy, our Workshop area has developed strategies that match many investing styles. The trick is to trust the strategies.
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What is mechanical investing? If it sounds like unemotional, logical, rote investing, you're getting the picture. But, that's only part of the picture. Mechanical investing is also a lot of fun. Even though the emphasis is on rote investing, so many strategies and variations have been developed in the Workshop that you can probably find one that suits your investing style fairly easily.
Like to trade hot stocks frequently? There are strategies that select some of the fastest-moving tech stocks in the market and call for trading them weekly. (But, what are you doing here?) Want to spend one day a year investing in relatively safe large-cap stocks? Got that, too. And much in between.
My goal here is not to convince anyone that they should become a mechanical investor. But, so much great stuff has been happening in the Workshop, stuff that is an extension of the Foolish Four philosophy, that I think it is worthwhile to explore what is going on in there.
For you who understand that there are no guarantees in investing; who weathered the recent bad spell where the Foolish Four was seriously underperforming the market with equanimity and expect that such times will come again; who are comfortable with using past performance as an indicator (not predictor!) of possible future performance, but understand its limitations; who are content to give a mechanical strategy the time it needs to work -- for those of you who are all that, the Workshop is well worth exploring.
Mechanical investing seeks to quantify investing advice. For example, if you are familiar with the original Motley Fool Investment Guide, you may remember the eight criteria that Tom and David used for selecting good small-cap growth stocks: annual sales, daily dollar volume, share price, net profit margin, relative strength, earnings and sales growth, insider holding, and positive cash flow.
These criteria are all easily quantifiable factors that you can get from a company's balance sheet, annual report, or from Investor's Business Daily. In fact, we sell a spreadsheet in FoolMart that filters all the stocks listed on the major U.S. exchanges for those eight criteria. But, in the Investment Guide, the eight criteria are used to develop a "short list." The final selection is left up to the investor.
Mechanical investing uses similar, fundamental criteria, but seeks to carry the process through to its logical conclusion, the selection of a portfolio of stocks. Through backtesting, the selection criteria are verified (verified as working in the past, that is) and factors such as the number of stocks to buy and holding periods are quantified.
I'm sure that many people use the stock screens developed in our Workshop as "short lists" just like the Foolish Eight Spreadsheet. Many, if not most, people prefer to pick their own stocks. I've used the Workshop screens that way myself with considerable success.
But, I have come to believe that, for consistent long-term success, I would be better off following a clearly defined strategy in a highly disciplined way -- something more like the Foolish Four where you buy the top four or five stocks that a screen turns up, hold them for a prescribed time, then sell them and buy the new stocks at the top of the screen. This takes a certain amount of faith, especially during periods when the market is down or flat and so are the strategies.
If mechanical investing, as it has developed in the Workshop, had just one rule, it would be "follow the strategies." That's much harder than it sounds. It's easier, of course, if you have little faith in your own ability to pick stocks. (That was certainly an advantage for me!)
It is also easier during times like the last few years when the market was lively and many mechanical screens turned in almost unbelievable performances. In fact, it worries me a bit that it has been almost too easy to get caught up in the mechanical investing fervor. Watching your portfolio double in a year is pretty convincing, but that's not really the best reason to invest mechanically. Years like 1999 don't come along all that often, and it would be unrealistic to expect those returns in the future.
Of course, we can always hope!
Next Thursday, we will discuss some of the things that can go wrong with mechanical investing. If you missed our first Workshop Thursday report, you can find it here.
Fool on and prosper!