2013/3/7 - What to do now if you’re mostly in cash

I recommend that investors who are mostly in cash follow these five principles.

Nobody knows what is going to happen next

Markets are highly complex and their direction primarily depends on the actions of thousands of institutional money managers. All it takes is one news story or one bit of analysis to change the collective minds of a few big institutional money managers which can then turn the direction of the markets rapidly.

The brutal truth is that nobody knows with certainty what is going to happen next.

Gurus are a dime a dozen, and there is no shortage of opinions.

The best course of action is to base your investment plan not on the opinion of gurus. It is better to follow analytical frameworks that have shown a proven track record of success in both bull and bear markets.

Scale in

If you buy into my thesis that nobody knows with certainty what is going to happen next, it is best to approach the markets cautiously in a manner that you are not hurt even if you are wrong.

One simple technique that all investors should use is to scale into positions slowly. As an example, if you have decided to buy 1000 shares of Apple AAPL as a very long-term position, consider buying only 100 shares at this time. Wait for a pullback to the first technical support level, or a break of the overhead resistance, and then buy another 100 shares. Continue the process to slowly accumulate the full position of 1000 shares over a period of time.

Focus on strategic allocation

Unless you happen to be one of the best stock pickers in the world, it is best to focus on . Consider allocation across the globe into non-correlated assets as much as possible. In other words, allocate between assets that do not typically go up and down together.

For example, if you have decided to allocate a certain portion of your assets to airlines such as UAL UAL, U.S. Air LCC, and Delta DAL, consider buying a little bit of crude oil perhaps through an ETF, such as The United States Oil ETF USO.

Focus on risk

Instead of focusing only on returns, focus on risk-adjusted returns, i.e., returns in excess of those commensurate with the risk taken.

Leave opinions at the door

Consider leaving opinions at the door and be driven by hard data. Opinions are your biggest enemy in achieving investment success. No one likes to admit it, but my experience has been that the vast majority of the time, an opinion is inadvertently formed first and then justified by data. This gives rise to confirmation buys. In other words, the data that supports the opinion is considered right and contradictory data is discarded.

Here is an example of what opinions can do. I know of an investor whose portfolio was all in stocks and worth about $4 million in 2007. In late 2008, he was so convinced that the market was going to continue to go down that in one swoop, he went from all stocks to all cash. At that time his portfolio had fallen to less than $2 million. He stayed in cash until 2011.

In 2011 he was convinced that the U.S. dollar was about to fall dramatically due to the Fed’s quantitative-easing program. To protect himself against his notion of the falling dollar, he bought the ETF Gold Miner ETF GDX, Barricks Gold ABX and Newmont Mining NEM for about $1 million. He split the remaining $1 million between the gold ETF GLD and the silver ETF SLV. For the last year and a half, as his losses in precious-metal investments mounted, he always found data to support the decisions he had made. Now his portfolio is worth about $1.4 million.

In summary, the best advice I can give you is that if you have been mostly in cash, enter the markets slowly and cautiously in small increments, and avoid being driven by data and being led by opinions.

Disclosure: Subscribers to the Arora Report are long Apple.