Is a paper portfolio a waste of time?

StocksI received an email the other day from someone telling me he'd done well with a paper portfolio.

The would-be investor had "virtually" bought into a few of the shares I've previously written about. Specifically, he had hypothetically bought into my idea of defensive shares across sectors in a "baked beans and shotguns" portfolio.
On this basis, since late last November, he'd made an overall paper gain of 19% including dividends paid. This almost doubled the FTSE 100's (UKX) performance over the same period of +10%.
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He acknowledged that the results were somewhat flattered by the takeover of Robert Wiseman Dairies. But during a time when the FTSE has done very well, these boring six defensive shares have done even better. And they've still done a little better than the market (with an 11% gain), ignoring the anomalous Robert Wiseman. This is strange. We would usually expect to see financials and growth stocks outperforming during a good run.
So the investor's logic is that such defensive shares are the way to go for a reasonably safe ride and some good dividends along the way.

A defensive plan of attack
The investor was specifically commenting on his intention to carry on this defensive experiment -- but this time using real money, after I updated the baked bean and shotguns portfolio a couple of weeks ago.

Now I wouldn't take issue with this. I believe the shares I selected will do reasonably well over time and I own shares in four of the six companies myself. For the record, the current line-up of Armageddon shares comprises J Sainsbury, which I still think is the best value of the big three UK-listed supermarket groups at 311.7p.

I also suggested Morrison as an alternative, which looks good value at 269.3p, and BP stays in the portfolio at 438.1p for its low forward price-to-earnings (P/E) ratio, decent yield and balance sheet -- and still slightly contrarian nature from the Gulf of Mexico disaster.

Tea grower Camellia was a new addition at 9,500p (now 9,700p), due to its rock-solid balance sheet and essential nature (though be warned -- it has a very disappointing yield and is 51%-owned by a charitable foundation).

British Polythene Industries stays in for now despite its rise as the prospective P/E is still only 6.6 at 355p, as does Carr's Milling Industries . At 870p, Carr's is on a P/E of around 9.6, with NTAV per share of 674p. Small-cap confectioner Zetar looks even cheaper at 203.5p with a prospective P/E of just 4.9.

Real life vs fantasy
When I first devised this defensive portfolio, the market was very jittery indeed and the FTSE stood at 5,127. It's hardly a confident place to be now, but it's not as fearful at 5,659. So the new investor is entering the market at a worse time with real money, for those of us who prefer the bottom-up approach to investing. In other words, it's more dangerous now.

You can't tell someone else where to put their money. All you can do is try and weigh up the pros and cons of an investment and share your feelings. At the bottom of each article, it will tell you whether the writer is really putting his/her money where their mouth is. But it won't tell you how much. S/he could have £100 or £100k in a company for all the reader knows.

All I can say is that I have a financially significant stake in four of the companies above. But putting your real money at stake is a different ball game to running a paper portfolio. No matter how hard you try, you can't truly make yourself believe it's real and act accordingly.

That isn't to say a paper portfolio is a waste of time. But it is a very dangerous way of giving oneself misplaced confidence. In the heat of a real battle, on a day when the FTSE 100 has shed almost 250 points as it did on 21 September last year, or close to 9% as it did on 10 October 2008, it's easier to average down on paper than it is with real cash, even in defensive stocks.

But it may be necessary to take courage if you want to make real money -- during these times of extreme fear.

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