Why You Shouldn’t Be Afraid to Buy Stocks Now, Part II
by Alexander Green, Investment U Chief Investment Strategist
Monday, June 18, 2012: Issue #1797
On Friday I made the case that everyone who is interested in achieving great wealth or protecting what they have should invest in stocks.
Not because stocks have generated a certain return over a certain period of time. Not because the outlook for the economy is fabulous. (It’s not.) And not because I have any inkling what the stock market is going to do next. (I don’t … and neither does anyone else.)
You should own stocks because great fortunes are usually the result of business ownership. (And the fortunes generated in real estate often involved massive amounts of leverage that seemed safe only when investors believed real estate appreciation is a one-way street. Not many do anymore.)
The simplest way to gain a piece of a great business is not to found one but to take an ownership stake through the stock market.
It’s not only easy… it’s fair. If I buy shares of Microsoft (Nasdaq: MSFT), for example, my return will be the same as the world’s richest man, Bill Gates. Sure, he may own a few more shares than I do, but our annual percentage gains will be the same.
Every stock market investor needs to be smart about it, however. In particular, you need to follow three proven principles that form the foundation of Investment U and The Oxford Club’s investment strategies:
- Asset Allocation
- Trailing Stops
- Position-Sizing
Let’s take a quick look at each.
Asset Allocation is a phrase that makes the average investor’s eyes glaze over. Yet it is your single most important investment decision. It refers to how you divide your portfolio up among non-correlated assets: stocks, bonds, cash, metals, inflation-adjusted Treasuries and so on. Diversifying a portion of your risk capital outside of equities reduces your portfolio risk and volatility. History shows that businesses (stocks) outperform everything else over the long haul, but few people have the stomach to stay fully invested in prolonged bear markets. Benjamin Graham, Warren Buffett’s mentor, said no one should ever have more than 75% of his portfolio or less than 25% in stocks. It’s a good rule of thumb.
Trailing Stops. Anyone can plunk for a few shares. But the secret of investing is knowing when to get out. Unfortunately, no one rings a bell at the stop. But running a 25% trailing stop behind your individual stock positions allows you to both protect your principal and your profits. We’ve written on this topic frequently. For more information, click here.
Position-Sizing. You should not invest more than 4% of your stock portfolio in any one stock, at least initially. If it climbs, it may eventually become a much bigger portion of your portfolio but that’s ok. After all, you’re going to be running a 25% trailing stop to protect your profits, too. But look at the other side. If a stock goes against you and you take the maximum loss (25%) in the maximum position size (4%), your stock portfolio is going to be worth just one percent less. And if stocks are only, say, 60% of your asset allocation (as The Oxford Club recommends), the maximum loss in your maximum position size in your maximum stock allocation means your portfolio is only down six-tenths of one percent.
Many investors need the high returns that only stock can provide but can’t handle the risk. The solution? Asset allocate properly, run trailing stops and watch your position sizes.
It sure beats the heck out of sitting on the sidelines… and wishing you were earning higher returns.
Good Investing,
Alexander Green
Editor’s Note: This article is the finale in a two-part essay from Alex. To read the first part of his essay and find out why you should look at stocks more as ownership and investment in quality businesses, click here.
Large Cap Value Stocks: A Great Big Value?
by Alexander Green, Investment U Chief Investment Strategist
Monday, June 11, 2012: Issue #1792
Even investors with little appetite for stocks should be looking at one dirt-cheap sector: large-cap value.
More than a few investors are feeling a little gun-shy right now. Weak economic indicators – including soft employment and low consumer confidence – and ongoing problems in the Eurozone have put many on the defensive.
That’s not necessarily a bad thing. When the market starts to wobble, there is often more downside ahead.
But there’s a big difference between investing defensively and not investing at all. Successful investing is about managing risk – not running from it.
That’s why even investors with little appetite for stocks should be looking at one dirt-cheap sector: large-cap value.
Brandes Institute recently sliced U.S. stocks into 10 deciles by value characteristics and found that value hasn’t just done better. From 1980 to 2010, the cheapest stocks outperformed the most expensive by 575%.
Why does this happen? As a former money manager, I know that investing in value requires patience. That’s something most retail investors – and many small institutions – simply don’t have. They’ll hold a stock or a stock fund a couple quarters and if nothing is happening – especially if growth stocks are doing well – they’ll grouse that they’re sitting on “dead money” and roll into something else, often at precisely the wrong time.
The great global value investor John Templeton used to hold his stock positions an average of seven and a half years. Yet many investors would describe this approach as “From Here to Eternity.”
That’s why value investing is often referred to as “time arbitrage.” It often takes several months (or years) for value investing to work its magic.
Yet now is likely an excellent time to get started. Credit Suisse data reveals that the cheapest stocks in the S&P 500 index based on five metrics, including the price-to-earnings and price-to-sales ratios, have lagged the most expensive ones by 9% this year. And, according to Russell Investment, the last time a value index ranked on top and a growth index on bottom was the disastrous year of 2008.
Every seasoned investor knows that various asset classes go through cycles of outperformance and underperformance. Value has lagged for a very long time – and now offers plenty of upside potential without the neck-snapping volatility of go-go growth stocks.
How to play it? You can research and buy individual value stocks. Or you can take the simple, diversified approach and just buy a fund or ETF. If you prefer the latter route, a good candidate is the Vanguard Value ETF (NYSE: VTV).
VTV tracks the performance of a large-cap, value benchmark: the MSCI US Prime Market Value Index. The fund remains fully invested and uses a passive management strategy (no active trading), so it is relatively tax efficient. The expense ratio here is the lowest in the industry – just 0.12%. And the fund’s 10 largest holdings – which make up almost a third of the portfolio – are companies you know well: Exxon Mobil (NYSE: XOM), Chevron (NYSE: CVX), General Electric (NYSE: GE), AT&T (NYSE: T), Procter & Gamble (NYSE: PG), Johnson & Johnson (NYSE: JNJ), JP Morgan Chase (NYSE: JPM), Pfizer (NYSE: PFE), Wells Fargo (NYSE: WFC) and Intel (Nasdaq: INTC).
In short, the recent sell-off has made value stocks a bargain right now. It’s a great opportunity… if you have the patience for it.
Good Investing,
Alexander Green
Potentially Make Money Despite Your Investing Mistakes
by Alexander Green, Investment U‘s Chief Investment Strategist
Monday, May 23, 2011: Issue #1518
Investment mistakes can be expensive and some times fatal to your financial health.
Yet you will make them. And that’s okay.
The key is to:
- Not make the terribly stupid ones,
- And to learn from the rest.
Here’s what I mean …
Bone-Headed, Life-Altering Investment Mistakes
Those who make bone-headed, life-altering investment mistakes – the kind that destroy retirement dreams or radically change standards of living – almost always make the same ones:
- They didn’t invest in quality.
- They didn’t diversify.
- They repeatedly tried – and failed – to time the market.
- They delegated their investment decisions to someone unworthy of the task.
There’s a simple way to avoid these pitfalls…
Divide and Conquer Through Asset Allocation
Divide your investment portfolio among different asset classes (stocks, bonds, precious metals, inflation-adjusted Treasuries and so on) using our Oxford Asset Allocation Model, re-balance annually and follow proven, battle-tested rules of investment (which obviates the need for a full-service broker).
When you buy individual stocks, there are further mistakes you can – and will – make. Sometimes your timing will be wrong. Occasionally, you’ll be hit with a bolt out of the blue, like:
- A surprise earnings miss,
- A product recall,
- A patent infringement,
- Or an unexpected class-action suit.
Performing your due diligence – thoroughly investigating each business before you invest in it – can mitigate these risks. But that can’t eliminate them. There are too many potential risk factors for even the most diligent investigator to uncover.
Lessen the Sting of Investment Missteps with Trailing Stops
What do you do? First, you understand that you’ll be wrong occasionally – and take steps to lessen the sting of these missteps.
A good example is our trailing stop policy. They give you unlimited upside potential and strictly limit your downside risk.
- Longer-term investors might use a 25 percent trailing stop.
- Short-term traders will run their stops closer, say 15 percent behind a stock.
The important thing is to follow a proven discipline. That protects your hard-won gains and keeps the inevitable mistakes from derailing your investment plans.
I mention these timeless notions because I see a lot of investors making fundamental errors today.
- They’re loading up on gold and silver at the expense of almost everything else.
- Or sitting with most of their money in cash, earning next to nothing.
- Or they’re buying extraordinarily risky bonds to earn higher yields.
Successful investors hedge their bets. They understand that they’ll get hit from time to time, just as NFL players get slammed to the ground. It’s all part of the game. Expect it. Prepare for it.
What If You’re Wrong?
No matter what your investment posture, take a minute to ask yourself, “What if I’m wrong? What do I stand to make if I’m right? What do I stand to lose if I’m wrong?”
Mull it over. Visualize your best-case and worst-case scenarios. Focus on where your investment portfolio might be overexposed or out of whack – and adjust accordingly.
As someone who has been active in financial markets for more than 25 years, I have a finely honed sense of all the potential things that can go wrong – and a good appreciation, too, that there’s plenty more we can’t even envision.
As long as I’m an active investor, I know I’ll keep making mistakes. But I’m done making the foolish ones. The older you get, the tougher it is to imagine starting over. My advice is this: If you’re going to learn the hard way, start small and do it early.
Better still, learn from someone else’s mistakes. As I tell my regular readers, “I’ve made all the dumb mistakes so you don’t have to.”
Heed the words of Benjamin Franklin. “Experience is a dear school, but fools will learn in no other.”
Good investing,
Alexander Green