Oh Lordy yes how I tried to help my fellow man through offering this free investing advice. Oh Lordy no how they did not want it. Questions! Yes, questions I invited them to ask. But did they? No sir, they did not. Languish, yes, languish my investing section did. Fed, yes fed I tell you, up to here I was. So moved it, I did. Put something else up instead. Happier now? Oh Lordy yes.
[Legalese: I am not a financial planner, and I’ve never played one on TV. Nothing in Investing Resources should be considered professional investment advice. If you decide to invest based on any of my recommendations, I am in no way, shape or form responsible. Any financial catastrophe that follows ain’t my fault and ain’t my problem. All standard legal disclaimers apply.]
Rule #1: Invest Ethically
Most of us, unless, apparently, we’re Swiss, wouldn’t dream of giving money to Nazis, and similarly, you should never place your money in an investment vehicle which violates your ethical principles. Socially responsible investing is for everyone, and making an ethical investment should be your primary consideration in your investment choices.
At the same time, it’s important to recognize that not everyone uses the same ethical compass. One of my holdings, Merck, conducts tests on animals as part of its efforts in pharmaceutical research. To my way of thinking, these tests are a necessary part of bringing life-saving drugs to the marketplace. Clearly, some people will disagree, and unless they’re purchasing Merck stock as part of an attempt to change the minds of shareholders and the board of directors regarding this issue, these people will want to steer clear of Merck.
It is crucial to understand that when you purchase shares in a company (or fund), what you’re saying is, “Here’s my money. Take it, and do some more of what it is you do.” Make sure you support what you believe in with your dollars. If, at the end life, we can’t say that we’ve tried to live moral lives, then we can’t say very much at all.
Rule #2: Invest Long-term
In the short-term, God only knows which way the markets are going to go, and sometimes even He isn’t sure. Or if He is, He’s not telling. You, as a mere mortal, stand no chance of guessing. Remember the axiom: Traders die broke. If you’re bouncing in and out of holdings trying to make a half a point here and quarter point there, your financial security is living on borrowed time. In the day-to-day the markets can be utterly irrational, and even if you get lucky and guess right you’ll pay a fortune in brokerage commissions and short-term capital gains taxes.
By contrast, the long-term investor doesn’t care about the day-to-day results of the market. He or she knows that if a company’s fundamentals are sounds, then long-term the stock will appreciate. The long-term investor can sleep well at night because if the stock market plummets, it just means that there’s probably a good buying opportunity for some of the stocks or funds he’s interested in.
Rule #3: Thou Shall Diversify
Because even long-term investors are capable of picking a dog of a stock, it is crucial that portfolio be diversified among various industries and various parts of the world. If, for example, the United States stock market drops dramatically, I, for one, would feel a lot better knowing that I’ve got some assets overseas. Likewise, I don’t want all my assets concentrated in a single industry because if the industry hits hard times, the financial consequences for me could be severe.
So the material point is this: No one knows if an industry or if a particular country’s economy is going to tank. By having your assets diversified, you substantially lower your financial risks. If you’re just beginning an investment portfolio, you can achieve this diversity by using the Dividend Reinvestment Programs (DRIPs) of a bunch of different companies or by purchasing mutual funds instead of a couple individual stocks.
Rule #4: Sleep Well
Different people have different tolerances for risk. I may sleep soundly knowing that my portfolio could lose 25 percent of its value overnight. You may not. Because there is, generally speaking, a relationship between reward and risk (the more risk, the more reward), determining your what level of risk is acceptable for you is important. For some people that means the money stays in the bank, and that’s fine. If your investments are causing you anxiety, you’ve probably taken on too much risk.
At the same time, understand what risk is. If your retirement is 30 years off, you’ll be giving up thousands of dollars if you invest strictly in CDs, for example. The risk here is that you will not have adequate financial resources upon retirement. That is what you should be worried about, not whether the market is up or down for the day. Personally, with a 35 year time horizon, I’ve opted to invest very aggressively. (No junk bonds, though. I said “aggressively” not “stupidly.”) Because I’ll be investing for such a long period of time, even if my investments drop substantially, I have plenty of time to recover their value. And if historical performance is any indication, I should come out way ahead. The same maybe true for you.
Rule #5: Buy and Sell Correctly
Human psychology is a marvellous thing. Stock prices start going down, and everybody jumps off the bandwagon. “Sell! Sell!” Nobody, it seems, wants to get caught “holding the bag” as prices drop. Not surprisingly, falling into this mentality generally leads one to sell at the very time when one should be buying. Remember: Short-term prices fluctuate for all sorts of irrational reasons. Make sure you’re selling because (1) the reason you bought the stock is no longer valid, (2) the stock has fulfilled your investment objectives or (3) you’ve found a better place for your money. For the long-term trader, the best length of time to hold a stock is, generally speaking, forever.
Rule #6: Start Now
Here’s the example that Fidelity Investments uses in its product literature:
- Susan started investing $2,000 annually (about $167 a month) in her 401(k) plan account when she was 35. She contributed for 10 years, for a total contribution of $20,000. Then she stopped, but continued to keep that money invested over the next 20 years. Rick, on the other hand, did not start saving until he was 45. He also saved $2,000 a year (about $167 a month), and continued to save until he retired at age 65. Rick saved for twice as long as Susan, and contributed twice as much. Yet at retirement Susan’s nest egg was substantially larger because she started early and tapped the power of compounding.
At an 8 percent annualized rate of return, Susan’s account will hold $151,000 while Rick has only $99,000 when retirement rolls around. No matter how little an amount you start with, the sooner you start, the more money you’ll have when you retire.
Rule #7: Use Quicken
Simply put, Quicken has done more to change my life than any other piece of software I own. Because it tracks all your finances, it also allows you to see your earning and spending patterns, budget for the future, track investments and so on. At a cost of around $40, this is the best investment you’ll make when it comes to figuring out where you are financially and where you want to go.
Rule #8: Use Debt Wisely
If you’re carrying a balance on your 18 percent credit card, forget sticking money in the stock market. No investment you make will get you a guaranteed 18 percent. Instead, pay off your credit card and do not carry balances in the future. Until you can get your credit card situation in order, investing must be put on hold. If the use of credit cards leaves you unable to live within your means, get out the scissors and start cutting. You must control your debt, or it will control you.
How To Pick Stocks
Realistically, a person can’t successfully pick stocks without access to some kind of investment resource like Value Line, Morning Star or Standard & Poor’s Stock Guide. Your local library should have copies of each. Personally, I find Value Line to be the most useful tool in my stock picking, but, as they say, your mileage may vary.
I am by nature a conservative, long-term, value-oriented investor. In other words, I hate losing money, I like holding investments for a long time and I only want to buy good stocks at good prices. If your approach to investing is similar, the following paragraphs and explanations may be useful to you in learning how to invest successfully in the stock market.
Before I will even consider a stock or fund, I apply a series of investment criteria, or screens, in order to weed out companies which are inappropriate given my particular morals, tolerance for risk, etc. You can use my screens or develop your own, but have some. There’s no sense in looking through the data on hundreds of different companies if you don’t have to, and using screens will let you weed out a lot of companies in a hurry.
I apply the following screens before considering any equity:
I won’t invest in companies who do business in the defense or nuclear industries. On a case by case basis, there may be other ethical considerations which preclude me from investing in a company. Now these are, granted, my own moral positions (or qualms, if you prefer), but for God’s sake, bring your own ethical arsenal to bear on the investment decisions you make. Everybody wants to change the world for the betterâ€”here’s one way you can.
I highly recommend that you only consider equities (with the exception of closed-end funds, to which Value Line does not assign a ranking) which are rated A minus or better. Sure, you could do an exhaustive financial analysis of a company, but why bother if Value Line’s analysts have already done it for you? It’s always a possibility that a company, no matter how strong, will go bankrupt, but I feel a lot better knowing that the companies I invest in start their journey to the poor house on solid financial ground.
To oversimplify, the price-to-earnings (P/E) ratio of stock lets you know how good a buy a certain stock is at its current price. The higher the number, the less value you are buying with each dollar. In fact, at some point you’re even speculating that future growth will drive the earnings and share price higher. That is not how I like to invest.
Because the success of a company is, in the long-term, directly tied to its earnings, I am very hesitant to buy stocks with high P/E ratios. At time of purchase, my stocks have a P/E of 15.9 or under. Some people don’t mind buying companies with higher P/Es, and while I don’t advise this, if you’re going to do it, at least make sure that the company’s projected growth rate is as high or higher than the P/E.
(I limit myself to these stocks because I don’t want to overpay for what I’m buying. In the case of closed-end funds, this means the funds will have a discount to their net asset value (NAV).)
It’s not enough that stocks have a P/E that is low compared to the rest of the market. Stocks need to be low compared to their own history as well. For me that means that stocks will be no more than 1.5 points over the historic average of their P/E.
All stocks carry a total debt burden of less than 4x current net profit. If something goes wrong, I want to know that the company will be able to dig itself out.
All equities I examine are projected by Value Line to grow at a minimum annualized rate of 10 percent or more through the next 3 to 5 years. (Bear in mind that these projections are no guarantee of future results.) If I’m not going to make at least 10 percent (and remember, that’s on the low-end), then why invest?
How To Pick Mutual Funds
Picking a good mutual fund is in some ways more difficult than picking a good stock, primarily because most mutual funds do not do as well as their appropriate benchmarks. Something like an astounding 85 percent of all mutual funds fail this simple testâ€”a fact that means you should seriously consider investing in an indexed fund like the Vanguard Index 500.
But if you’re intent to “beat the market” with your mutual fundsâ€”again 85 percent don’tâ€”then your best bet is to check out the mutual fund review issue of Kiplinger’s Personal Finance Magazine.
I apply the following screens before considering any mutual fund:
Though I have less control here compared to buying individual stocks, I try to only purchase mutual funds which invest in companies I wouldn’t have a problem owning myself.
Simply put, don’t pay one. There are plenty of good no-load funds available nowadays, and there’s no good reason to pay a commission, or “load,” on any mutual fund you buy. I screen out load funds out as a matter of course.
The most compelling statistics to me are the 3-, 5- and 10-year returns generated by the funds. Any fund can have a hot year or two, but since I’m investing long-term, I need something which can provide sustained growth for a long time. Obviously I’m talking about funds which consistantly beat their benchmarks.
Pity the guy who has to run a fund like Fidelity Magellan. With something like $50 billion in assets, it’s near impossible for him to move in and out of companies (or industries) without leaving a substantial wake in the form of raised or lowered share prices. Truth is that once a fund gets large, it gets harder to make money. I try to stay with mutual funds with less than $10 billion in assets, and even then I prefer funds with much less.
A final, often unconsidered, factor is the expense ratio. This is the percentage of money the fund pays the manager for the work he does. Lower is obviously better.