1. To Buy or Not to Buy: Investing in Stocks
2. Focus on Earnings
3. Diversification
4. Sell High: The Key to Successful Investing
5. Types of Bonds
6. Risks of Owning Bonds
7. Dollar Cost Averaging
8. Developing a Mutual Fund Portfolio
To buy or not to Buy: Investing in Stocks There are as many ways to invest as there are investors and many of them can be successful. But one proven rule still prevails. YOU MUST HAVE A PLAN. And THIS PLAN MUST BE REASONABLE. So, before you start investing, think about your rules, write them down and then follow them without variance. The reason most investors lose money investing is because they let their emotions make their decisions. All of us has a gambler within us, and when we see a chance for a windfall, or we think we see it, we want to throw caution to the wind and take a chance. This is not a good idea for stock investing. If you want to know why, take a trip to New York and take the NY Stock exchange tour and observe all of the people who actually work there. They are scurrying about, talking to each other and talking on the phones, constantly. These are people who make millions a year, are very smart, and understand the markets very well. Understand you are competing against them if you take a gambling bet on a stock. And they know much more about what is happening with that stock on a near term basis than you every could. They are planted where the action is, and they are very well connected with information. And information is what makes stocks move. However, their interest is in the near term. These people are traders, generally. Their study is concerned with today’s action, not next month’s. They will be in and out of the stock hundreds of times before the average investor on the west coast sells his position. Therefore, our advantage is in our long term prospective. Trading action may drive the stock down for today, and it could give us a chance to buy it cheap for the long run. Patience is an advantage for the retail investor. Buy for value, not events. Analysts are paid big money to predict profits for public companies, and they are generally on track because big companies get good press for making the analysts happy. There is an abundance of information to make a good decision to buy if an investor will take the time to look at the numbers. With these numbers, we can make rules to invest. Rules are important. For instance: In the Advisor Monthly we give you investments we have already screened for these investment criteria. But if you are buying outside this list, have a set of rules and follow them if you want to make money in stocks. Earnings. What do they matter, and mean? Earnings are the single most important factor when considering a company to buy. Think about it…why do you buy a business, why does anyone? For the profit it will bring you! If it does not make money, why would you buy it? Even the IRS states that if a business doesn’t make money for a prolonged period, it is officially a hobby, not a business. When we look at buying a company, we want to figure out first if it is overvalued or undervalued. . Being undervalued is not measured by the stock price, it is measured by the ratios. A PE is the ratio we look for when evaluating earnings. It is the Price of the stock over the Earnings per share. So, if a stock was $10, and its earnings were $1, the PE would be 10. If the company earned $2 a share, the PE would be 5. So, it follows, the lower the PE the better. Different industries sport different PE ranges. Very cyclical industries, like the autos, are typically sold at a low PE. The reason for this is that the reliability of earnings is low. High growth industries like technology, typically sell for a high PE. The reason for this is that they have a greater chance of making it big, their debt is low, and the potential for making big profits is clear. So it is important to compare companies of the same industry when buying, so that you can choose the “cheapest” stock. This month’s newsletter has information on the latest earnings numbers from Wall Street. You will see some are up, some are down. The stocks that are not earning money right now are expected to very soon. Otherwise, we would not be recommending them. Take a look, you will see that we expect them to continue to make money, and to make it at a faster and faster pace. We expect them to participate in this economic recovery and we expect them to reach a price that is at least 40% above their original buy price, based on profits. Next month we will talk about balance sheets. ETF’s—What You Should Know Are they the investment of the future? Or the next target for regulators? Since ETF’s first came on the scene in 1989, their popularity has exploded. But what began as a simple approach to long term investing in a broad index has been transformed into a day-trader’s playground. Like all mutual funds, Exchange Traded Funds are best used within a strategic or tactical allocation plan. Traditionally, ETF’s are passively managed. That means they don’t try to beat their index, they simply try to follow along. Many conservative investors like them for their broad diversification and low investment fees. Also, since they are bought and sold on an exchange, we can use advanced order types likes Stop and Limit Orders to exercise greater control and there are no hefty sales loads to worry about . One of the most popular strategies during the Tech Boom was to “Trade the Q’s” (Ticker QQQQ) which tracked the Nasdaq 100. In addition to giving the average investor a simple, low cost investment solution, ETF’s also presented a great opportunity for the Wall Street Traders. As the object of ETF’s expanded from Stock and Bond Indices to Currencies and commodities, they transformed into complicated derivative investments that are not suitable for most amateur investors. These days, you can purchase leveraged ETF’s which attempt to magnify market moves, or inverse ETF’s which attempt to go up when the benchmark goes down. There are ETF’s that attempt to mirror hedge funds, and even ETF’s that track other ETF’s. However, the complicated baskets of derivatives and options that are often used to manage the price movements sometimes fail to live up to expectations. Many oil ETF investors found this out last year when oil prices moved from $35 to $85 and their investments were left in the dust. ETF’s are owned and managed by the Big Money Center Institutions, the same ones which operate program trading platforms and quantitative strategies designed to detect and exploit market weaknesses. As the number of ETF’s topped 1500 at the end of 2009, we expect them to be a big target for regulators and recommend you steer clear! Diversify! Diversify! Diversify!
Focus on the Big Picture—Earnings
The need to diversify is surely one of the most important lessons of good financial management. Whether, you are running a business, saving for retirement, or even if you are a speculator, planning for the “what-if” scenario will help you stay in for the long haul. In recent years, most financial firms have made Asset Allocation one of their primary investment strategies. But, no matter what fancy name you pick, or how many technical statistics you try to include in your analysis, basic diversification is still the most powerful risk avoidance strategy for any investor to learn. It’s also one that many investors are missing, even those who have sought professional help.
Diversification is most important to protect yourself from 2 types of Risk: Credit Risk and Market Risk. Credit Risk is the possibility that a company will go bankrupt and you will lose all of your investment. Most investors carefully select their investments to avoid companies at risk of bankruptcy, but as we learned in the financial crisis of 2008, ANY company can go bankrupt, sometimes without any warning at all. From Bear Sterns and Lehman Brothers to WorldCom and Enron, investors have learned time and again, that no matter what the credit rating of a company is, NEVER EVER EVER PUT ALL YOUR MONEY (or even more than half for that matter) in any one company or industry. And that principal holds true for the self employed business owner as well.
Diversification is the cardinal rule of investing, and anyone who has been investing for any period of time will learn this lesson quickly. But even those who believe in diversification may not realize how difficult it can be to be PROPERLY diversified.
After the Tech Bubble Burst in 2000, most financial firms quickly jumped on the Asset Allocation band wagon, which helps an investor plan for a different type of risk: Market Risk. Market Risk is the possibility that your investment will lose value due to changes in the market, regardless of the quality of the company you have bought. Any market, even ones which trade traditionally safe investments, like Treasuries, are vulnerable to disruptions. This can occur due to many reasons, political, economic, currency, you name it. When you lose the necessary balance between buyers and sellers, there’s no bottom to how low prices can fall. We’ve seen it in every market from Stocks and Bonds to Oil to Real Estate.
With Asset Allocation, you first try to classify investments into different types, or Asset Classes. The idea is that these Asset Classes will each behave differently in the event of a major market disruption. Professionals use historical performance to measure the Correlation Coefficient of different asset classes which, at least in theory, tells you how Different investments have performed relative to each other.
The problem with Asset Allocation is that, just like every technical trading strategy out there, past performance does not predict future results. In the crash of 2008, nearly every asset class fell, even those that had a negative correlation in the past, and practicioners of Asset Allocation were surprised to find that they lost money just like everyone else.
Asset Allocation is just a fancy word for diversification, and it still has a VERY important role to play in every portfolio. It is also something best left to professionals. Determining the right mix of investments takes experience and expertise and a thorough understanding of your investment goals and risk tolerance. Done right, it can effectively protect your from credit risk. Just don’t let yourself get fooled into thinking market risk won’t be a factor. Ì
Sell High: The Key to Successful Investing!
It is well known on Wall Street that the money is made in the selling, not the buying. Knowing when to call it is the key. Cut your losses, take your profit, execute.
The problem is that people are very emotional about their money; especially when it’s time to sell. And instead of selling high and buying low, we tend to buy high, and to sell low.
In my 28 years in the Profession, I have heard from hundreds of investors, “What about this hot investment? It’s going up! Let’s buy it!” The problem is, it has already gone up so much the price has already caught up with the value.
The same thing happens with selling. If it goes down, we worry, “is it going down forever?” or if it doesn’t meet our short term expectation, we think “It is doing nothing!” At times like these, you may want to sell, but this is often precisely the time you need to buy.
To make money, you need to sell when everyone else is buying and buy when everyone else is selling. This is hard to do, even if you are a full-time investment professional. To be successful over the long term, you need to stay focused on your goals, and maintain a disciplined investment program.
Selling is much more difficult than buying; for this reason, you need to plan it out. When you buy a stock, set a target price to sell. And when it hits that price, take your profit, and don’t look back.
You will be tempted to hold on and wait for a higher price. This is a trap. The greed trap! Remember, stocks move suddenly and never when we expect. You could just as easily miss your opportunity to sell!
You may also be tempted to sell low, especially during a bear market. Don’t let your fears take over! If the investment fundamentals change, then by all means, SELL; but, selling when the market is down is what breaks most investors. You need to understand and plan for the risks in advance!
Why not use limit orders and stop orders? That is a subject for another time….check next month’s Advisor Monthly! CD’s If you need safety of principal with some return, CD’s are probably the best deal right now. Be ready for shockingly low rates and be sure to check the bank to make sure it isn’t going under. There have already been about 300 bank failures this year, and we expect up to another 500. If your CD’s bank fails, you will still get your principal back, but it may not be available for a while. The FDIC has paperwork. Treasury Bills. This is good for a three month to a one year return. The problem is the minimum is $10000, and the transaction charge is $40. So if you make 1%, that is $100 a year, and $25 for 3 months, so you are losing $15! Interest rates are very low, so unless you have big money to put in these, the transaction costs make it unreasonable. You can invest for a longer period, and buy notes for about 3.5% for 10 years, or bonds for up to 5% for 30 years, but then your risk increases. Corporate Bonds need to be bought in lots to get value, and then of course you need to diversify. A lot is 25 bonds or $25,000. each. So plan on buying at least 8 to get proper diversification, which means about $200k. If you want to invest less than that, you will need to go with closed end bond funds, open end bond funds or unit trusts. Also, keep in mind credit risk with these. Corporate bonds can be investment grade or non and can fluctuate in price with the economy. So for maximum principal preservation, plan on holding to maturity. Muni bonds Traditionally, Municipal Bonds have been a safe haven for wealthy investors who can benefit from the tax free interest. But these days, they can be risky. Remember the states have to balance their budget, and they can default on their bonds. It has happened. Some types of Muni’s are safer than others. If bought outright, the same rule of buying in lots applies, and it is important to look at your tax situation to make sure you will benefit enough from the tax break to make them worthwhile. The Yield Curve is important to bond investors, showing the relationship between yield and maturity. It’s steepness depends in the health of the economy. If it is inverted, watch out, a recession is likely ahead! Q: Are Bonds Safe? A: It Depends. Bonds have lots of risks. Generally, Bonds are more predictable for the short term. (Conversely, stock investing becomes less risky with time.) Over the long run, the risks in bonds rise exponentially. So if you have a short term time horizon for investing, bonds are what you should be looking at.
Market Risk What if you have to sell them before maturity date? Your risk is that if prevailing interest rates are down from when you bought that bond, you will get a better price, and if they are up, you will lose money on that trade. Interest rate risk If rates go up your bond will be paying you a lot less money than everyone else is getting with their new bonds. You will want to trade it in for a new model, but you will have to take a loss. Credit Risk The economy affects bonds as well as stocks. If the ability to repay these bonds is questioned, the value of the bond will go down. Opportunity risk If you lock in a low rate and wait to maturity, you will get your principal back, but what about inflation? And what about what you could have done with that money over the years?
Types of Bonds
Risks of Owning Bonds
Dollar Cost Averaging
In November, we launched our mutual fund portfolio for asset allocation. This type of “set-it-and-forget-it” approach is helpful for the smaller or beginning investor who doesn’t have the time or interest to structure and maintain a stock and bond portfolio of their own. But having a structured investment approach doesn’t mean you can’t take advantage of short term investment opportunities. In fact, dollar cost averaging (or DCA) is the most tried and true tactic for buying your investments at the best possible price!
First, a definition. Dollar Cost Averaging means investing a set amount of money in equal amounts over a set period of time. The classic example is Sally the Saver who puts$500 per month into her IRA. While Leverage Larry and Income Phil are scared to death of volatility, Sally knows that by investing a set amount every month, when the market goes down, she will be able to buy more assets at a better price. Since nobody knows where prices are headed short-term, dollar cost averaging gives you the best chance of a low average cost. Like the “miracle of compound interest”, the sheer mathematics of this strategy put the odds in your favor.
How can you put the power of Dollar Cost Averaging to work in your portfolio? Regular monthly or yearly contributions to your Retirement Plan may be the classic step, but there are many ways to tip the odds in your favor. The next time you make a large investment, consider spreading your purchases over a few months, rather than buying all at once. If the price drops on you, you may get the thrill of a good buy rather than the pain of buyer’s remorse.
Reinvesting your dividends is also a great way of putting DCA to work for you, especially with quality investments like you’ll find within our recommended portfolios. Regular Periodic Rebalancing is another strategy worth mentioning. Technically, this is not the same as Dollar Cost Averaging, but by trimming profits from your hottest investments and investing them in the out of favor ones, you can augment your gains over time.
Ideally, many of us would like to rely on strategies like DCA, Asset Allocation and Rebalancing to take the emotion out of investing. But never forget that these risk management techniques can only work if you’ve taken the steps to plan a portfolio that works for you and your needs. Only you (and your most trusted advisors) know what is right for your money. So far, nobody’s found the scientific formula for that. Developing a Mutual Fund Portfolio A guide for the passive investor Mutual Funds can be a great diversification tool for the average investor, especially for those who are new to investing or don’t want to bother with individual securities. With professional Investment Managers and a broadly diversified portfolio, mutual funds offer instant diversification within an asset class. However, mutual funds can be much more complicated than they might seem at first glance. They should always be used in conjuction with a well thought out investment plan, preferably one prepared by a Professional who has your best interest at heart. One problem that mutual fund investors often run into is the pure number of funds out there! In fact, there are more mutual funds available today than there are stocks on the New York Stock Exchange! Often, investors turn to a stock broker for advice; however, you need to be aware of the conflict of interest that exists based on the way brokers are compensated, i.e. commissions!. Most brokers simply recommend whichever mutual funds are easiest to sell, and since brokers are usually excellent salesmen, your chances of getting the right funds may be much lower than you think. Most people end up with several mutual funds, all of which own the same top 10 stocks. They think they are diversified, but they ARE NOT! The worst mistake many mutual fund investors make, especially the millions of people with 401(k) accounts, is trying to pick funds based on historical performance. This is like trying to drive by looking in the rear view mirror; it just doesn’t work! Mutual Funds are priced based on the market prices in their portfolios at the end of each day. Because of this, they are highly vulnerable to Market Risk, regardless of the type of investment they buy. For instance, if you have a mutual fund that invests in US Government Bonds, the market price for those bonds has never been higher than they are right now. When interest rates go back to normal levels, those prices will go down. Even though the bonds themselves are government guarantees, your mutual fund will almost certainly lose money. When picking a fund, you should look at historical performance, but only to compare your fund to other funds in the same category. Some people like to focus on the Expense Ratio, but that also only tells a small part of the story. I prefer to focus on the track record of the management team, but that is something the average investor might not have access to. There are too many different variables to consider for me to list them all here. That is why some investors like to just use the Morningstar Ratings you can find on the internet. That is also why we have developed a mutual fund portfolio as our third and final managed portfolio available to our clients. Each of these mutual funds has an outstanding track record, and a great management team. The different funds represent different asset classes, so you can pick from this list without worrying about duplicating stocks, in other words, you will be well diversified. You should still take the steps to develop a professional asset allocation that shows you the right amounts for each fund. Don’t forget to rebalance at least once a year; otherwise you might end up with too much whichever asset class happens to be in favor. Sell the excess of that one, and buy a little of the others. It’s a great way to implement the other cardinal rule of investing: BUY LOW SELL HIGH! Ì
Asset Class The type of security the fund invests in is the most important thing to know! Stock funds are usually grouped by the size of company: Large, Mid or Small. Value funds tend to pay better dividends and growth funds have better technicals. Don’t forget you also need some fixed income and international to be properly diversified! Management Team Funds that have a proven track record, and a great manager often get a great reputation because of it. But don’t just go for a big name. They may be great at one asset class and lousy at another! Do your research! Fees Fees will eat away your performance, especially if you haven't picked a good management team. More importantly, some funds come with large up front or back end sales charges. These may prevent you from making the right decision when it’s time to sell! Performance This is the hardest thing to measure, because it is mostly a function of the market. Check for performance relative to other funds in the same asset class!
Things to ask about your fund
