WATCH OUT FOR "THE THIEF THAT ROBS US ALL"
Alexander Green, Chief Investment Strategist, The Oxford Club
Political columnist George Will once noted that he couldn't understand the traveler who flies with white knuckles from New York to L.A. - then heaves a sigh of relief as he pulls onto the San Diego Freeway.
He was talking, of course, about the misperception of risk.
The same thing happens in the stock market. Investors fear a correction, a crash, a bear market. And it's not hard to see why. After all, a bear market is defined as a decline of at least 20% in the broad index. And this is real money we're talking about, money you may have spent a lifetime accumulating.
But there is a greater danger than a stock market sell-off lurking in your future. It's called shortfall risk. This is the risk that you outlive your money.
And it's not a small one.
This Will Rob You Blind
Inflation is historically low right now. But that could change. (Ask anyone who survived the '80s.) For the 100 years from 1913 to 2013, inflation in the United States averaged 3.22%. That may seem modest, but the total effect is that something that cost $100 in 1914 would cost $2,375 now. A 3.22% inflation rate cuts your purchasing power in half over 22 years.
And people are living longer than ever. Life expectancy in the West is growing by three months per year. (That means you're gaining six hours of life expectancy a day without even exercising.) Consequently, the number of years we spend in retirement is increasing, too.
Combine rising consumer prices and increasing life expectancy with rock-bottom interest rates and you have a big potential problem. How do you make sure your portfolio doesn't kick the bucket before you do?
By investing in a generous slug of stocks, that's how.
Unless you are independently wealthy or own a business that is throwing off a river of cash, there really is no alternative.
Real estate is a consumption item, not a true investment. (You may feel differently if you bought real estate using 9-to-1 leverage, but that is risky - like buying stocks on margin. And, even then, to calculate your true return, be sure to subtract your interest costs, property taxes, insurance, repairs and maintenance costs.)
Even at its high, gold hasn't even kept up with inflation over the last 34 years.
Bonds have paltry yields. And cash pays nothing.
THE ONLY REAL SOLUTION
That makes stocks the only serious alternative. And it's why Warren Buffett wrote this in his famous op-ed piece in The New York Times as the stock market collapsed in October 2008:
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497... Equities will almost certainly outperform cash over the next decade, probably by a substantial degree.
OF COURSE, THIS DOESN'T MEAN YOU CAN SIMPLY THROW YOUR HARD-EARNED CAPITAL INTO THE STOCK MARKET LIKE A GAMBLER PLACING A BET IN LAS VEGASS. YOU HAVE TO BUY QUALITY, SPREAD YOUR RISK, DIVERSIFY BROADLY AND TRAILING STOPS TO PROTECT YOUR PRINCIPAL AND YOUR PROFITS.
AND YOU DON'T MAKE THE MISTAKE OF THINKING YOU CAN ABANDON STOCKS NOW AND GET IN LATER WHEN STOCKS ARE LOWER. MILLIONS TRIED THAT DURING THE FINANCCIAL CRISIS - AND GOT LEFT BEHIND AS SHARES DOUBLED AND TRIPLED.
Like our traveler to L.A., you shouldn't misperceive the danger you face. The substantial, long-term risk to your standard of living is not the gyrating stock market. IT'S INFLATION ..... the thief that robs us all.
That is why it is important to build your portfolio around a coherent plan. If you don't, then it is very easy to unwittingly react to recent events.
Think back, for instance, to how you reacted to events such as the US fiscal cliff, the US debt ceiling, SARS, avian flu, interest rate rises, interest rate cuts, Quantitative Easing, the European debt crisis etc...
Were you one of the many who were afflicted by Recent Event Syndrome? Did you put your investments on hold because you bought into the idea that "this time it is different" only to find that it wasn't?
It is not easy to ignore recent events because these events are really happening. However, as investors, we need to remind ourselves that over the long term shares rise, which is why Warren Buffett quipped that his favourite holding period is forever.
Buffett also said: "The rich invest in time, the poor invest in money", which, in my view, is probably one of his most powerful quotes.
If you want to be rich, it is important to regularly invest in a robust portfolio of shares that will reward you over time with capital gains and dividends. The richer you want to be, the more you should invest. But if you want to remain poor, then invest in money.
Are Earnings Moving in the Right Direction?
Over the long term, stock prices follow earnings. If a company's earnings consistently go up over time, its stock price should, too.
Is Cash Flow Following Earnings?
Folks sometimes confuse earnings with cash flow. Earnings, also called net income or profits, are reduced by all kinds of non-cash expenses such as depreciation and amortization. Those expenses lower profits (and taxes) but have no bearing on how much cash the company took in.
Non-cash expenses are not included when we calculate cash flow.
Generally speaking, we want to see cash flow from operations going up every year. If earnings are rising and cash flow is not, that warrants further investigation.
If cash flow from operations is going down while earnings are going up, you'll want to understand why. Sometimes that can be a red flag that the company's earnings aren't especially stable.
However, if earnings are moving in the right direction and cash flow is following earnings, then you're starting from a very good place. Obviously, you'll want to do more work and see if earnings and cash flow are likely to continue rising. If you believe they will, that is a good candidate for a stock to add to your portfolio.
The focus of most investors differs from that of value investors. Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.
Many make the mistake of taking profit too early because they are primarily looking at profit. From the forum I have notice Cordlife & Straco are 2 good examples. Most of the people who are excited on these 2 stocks most likely had taken profit because they are not interested in these 2 outperforming stocks anymore.
As value investors we should invest in a porforlios of cord stocks for as long as possible unless the company fundamental changes. Manage your risk.
Allow me to use your thread to repeat the wisdom of gurus regarding some common pitfalls.
1) robustness of business = price gain
Many gauge their buys or sells by their current counter price. In the long run, it might be true, in the short term of weeks or even months, the counter going lower than your purchase doesn't necessary means u make a bad call, it could mean it get cheaper. On the same veins, the fact that it goes higher the next day doesn't make u a guru, although it will mean U are lucky.
So the many discussions about how bad a company because it have went down for a few weeks or went up for a few weeks is rather short sighted. The most important price is your exit price. If u exit with a good profits, u are good, if u exit with multi- baggers, u are great, if u do not need to exit because the increasing dividends already pay for the capital invested. U are a genius. Short term price movent as a gauge of the savvy was of investment does not make sense because no one can buy at bottom or sell at top, unless u are a trader, then perhaps it is important to look at daily price movement
3 types of value traps
Earning peak and PE at is lowest, and u think it will continue to grow, when it has already hit its potential or u didn't know u bought into a cyclical. Looking at PE u thinks its undervalued.
The company turn up great as predicted, but u bought at too high a price, with the growth already priced in and the earning growth didn't last longer than a year or two.
The company really has growth potential and is delivering well, price is still undemanding. But u have selfish directors and owners who pay themselves well and give themselves too good to be true options while giving a low dividends as crumps. The value might stay unlocked for a long time.
Not fully understanding why market give it a lower valuation. With the exception of extreme bull market when even loss making companies see price going up everyday. There is a reason why blue chip trade at better valuation than pennies, why holding companies are traded at a discount, why companies with overseas asset need a discount to price due to risk premium. Of course, if u hit the flavor of the mind, like dual listing a few years ago, or yield play recently, valuation can get stretched. But stretched rubber bands always go back to its equilibrium.
S-chips are traded at a discount because of the fear of frauds, esp small s-chips. It is currently fairly valued at 2-3 PE. Of course, when the cash flow back to investors as strong dividends that keep growing the risk premium might be reduced. Those with red flags will be traded at low valuation due to risk premium. It doesn't mean they cannot be good investments, if u are confident that will prove themselves over the next few years by returning more and more cash to shareholders, then u get a deal.
Allocating too much to trading, or moving your goal poles as a trader and investor. U indeed to trade for a quick bucks, but when price move unfavourably, u decide to console yourself by saying u are a value- investor. The true is: u are probably neither and will get the worst at both ends. If u are trading, do TA and have cut loss. If u are value investor, accumulate more when price go down. U can also be 70percent value investor and 30 percent trader, as long as the Strega work for u. But u have to practice and make up your mind.
Going for the big one..
Anyone that bought the 3 cursed pennies at the earlier stage would have make 10-15 times. But we need to ask ourselves how many times can we be lucky before we burn ourselves. If u have a strong base, and allocate 1 month of dividend income for speculative plays, and restrict your bets, and if u win big, u plough the money back to value investing, and use the bigger dividend fr speculation, I would think that is reasonable. Because u do not lose your capital, just part of your dividend income.
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