Last Wednesday's posting gave everyone a prelude of how I came to be in Bert Ward’s seminar on Michael Price’s investment strategy and FastTrack after a ten year association with the West Bloomfield chapter of the American Association of Individual Investors (AAII). But for any of what I’m about to discuss to make sense, a basic primer on finance is a necessary prerequisite for those of you who may have a very sparse grounding in investing. So what follows is Mike’s Five Minute course on an Introduction to Finance. And the Five Minute course really boils down to just one sentence: at its bare bones basics, investors fall into two major categories: fundamentalists and technicians.
FUNDAMENTALISTS:
Traditional college finance classes typically teach fundamentalism. Basically this involves studying a company’s performance, the quality of its products, its management, its financial statements, to name just a few. It is the sum total of all these factors that paint a comprehensive picture of the company’s health and comprise what are collectively referred to as the company’s "fundamentals," thus the term. It is the objective of fundamental analysis to identify companies which have healthy fundamentals but which Wall Street, for whatever reason, has devalued. When a company’s stock is depressed because of external economic factors that have nothing to do with the company’s performance, that generally indicates a good "buy" signal.
This is what Warren Buffett has been doing for the last 60 years. Buffett started his investing career when he purchased his first six shares of stock at age 11. By the time he graduated high school at age 15, his portfolio was already worth $90,000 in today’s money. By the time he had his master’s degree from Columbia Business School at the age of 20 in 1950, he was worth $10,000 (over 200k in today’s money). Remember what our father used to tell us back in the 1960’s: as a GM executive, he knew he had "made it" when he reached a $10,000/year salary. Buffett already had that much in 1950 fresh out of business school at the age of 20. He has spent his entire career continuing to be the master of fundamental analysis (his fans call him the "Oracle of Omaha") by identifying and buying healthy but undervalued companies and then holding them virtually forever. And it has made him a billionaire! Who says "buy and hold" doesn’t work? AAII, that’s who!
But the real beauty of buy-and-hold is that you don’t have to be a Warren Buffett and you don’t have to be a master (or even a beginner) at fundamental or any other kind of analysis for it to work. For the average Joe, all you need to know is this: Buy Blue Chips And Hold! The beauty of buy-and-hold is that anybody can use it at any time and it will always, always work in the long run. Buffett has personally perfected the process by buying companies at a deep discount and then managing them on their rise to super stardom. But the average Joe doesn’t have to do that. All of fundamental analysis basically boils down to those five little words: Buy Blue Chips And Hold! It’s called "value" investing. When you are buying "value" stocks, it doesn’t matter when you buy them. Whenever you buy them, whether it be on a down swing or an upswing doesn’t matter a damn. If they are quality companies, they will yield 8 to 10 percent annual returns on average over the next twenty to thirty years. This is a better annual return than you can expect from any other investment, including real estate.
Buy-and-Hold is a strategy you can use without any training and with about 15 minutes of work every year. And if that’s all you do, you will still do very well for yourself. In fact, though it may seem counter-intuitive, you actually do better with buy-and-hold when the stock market is down than when the stock market is up. That’s because when you’re buying stocks when the prices are dropping, this lowers the average cost of your stock. Since your profits are the difference between your cost and whatever your selling price is years from now, the lower your average costs, the greater your eventual profits. That’s another reason why buy-and-hold can’t fail: you make money when the market goes up, you make money when the market goes down. No matter what happens, buy-and-hold always works.
But what is a Blue Chip and how do you buy them? A blue chip is any stock of high enough quality that it is listed on the Dow. What’s the Dow? The Dow Jones Industrial Average, also known as the DJIA, that pesky little number they quote on the news every night that some people say takes the temperature of the market’s (and country’s) economic health. (Other people dispute that, but that’s an entirely different topic.) Of all the tens of thousands of companies that are listed on the various exchanges, the Dow picks the handful of the best and uses them to compute an average. The Dow actually has two indices. There’s the Dow 30 which is an average of the 30 best companies on the exchanges, and the Dow 65. As a rank amateur investor, you can literally throw a dart at any company on this index and you will do quite well. You can simplify matters even more by just buying a mutual fund that has all these high quality companies in it already. There’s nothing easier than buying a mutual fund. Of all the tens of thousands of funds that are out there, all you need do is go to Morningstar.com and throw a dart at any 5-star rated fund and you really can’t go wrong. However, since diversification is the key to success, most any investment advisor will wisely caution you to limit any one stock or fund to no more than 10% of your portfolio. (Some very prudent advisors will even limit you to 3%!) There are any number of strategies available and any number of places on the Internet where you can get information about them, not to mention the hundreds of books on personal finance that can be checked out of the West Bloomfield public library. That’s another great thing about buy-and-hold. You can spend five minutes learning it or you can spend years. It can be as simple or as complicated as you want to make it.
The point is pick one and go with it. You can’t lose. And that includes the last two years of gloom and doom. The AAII will point to the fact that the Dow losing 40% of its value between the spring of 2008 and the summer of 2009, the worst downturn in the market since the Great Depression, is proof positive that buy-and-hold is a load of crap and anyone who uses that strategy is an idiot. But isn’t it interesting that not a single one of these people are boasting about having seen this 40% drop coming and having converted their holdings to bonds before it happened? That’s because nobody can see these things coming. If it were possible to see these things coming, we would all be millionaires without trying. That’s why they call investing "risk management." When it comes to money, everything has an element of risk, even U.S. government securities (though, truth be told, U.S. government bonds and treasury notes have always been the most stable investments in the world and it would take a nuclear holocaust or some other end-of-world catastrophe for U.S. government securities to default. That’s why even major corporations buy them all the time.)
Still, the fact remains that, even factoring in this extraordinary recession of the past two years, buy-and-hold still works because it is intended for the long run. I’m sure anyone who has used the Buy Blue Chips And Hold strategy can look at their portfolios in 1990 and still see a 10% annual average return for the last twenty years. And this even takes into account the tech bubble of 1998 and the housing bubble of 2004.
There’s also the argument that buy-and-hold doesn’t work because many of us don’t have 20 or 30 years to wait for our returns to come in. I think that’s a short-sighted argument since life expectancies are growing all the time. Even at 70, there is still a very good chance we’ll be alive in 20 years and we need to be planning for that. Buy-and-hold works even for a 70 year old. But truth be told, as people approach retirement there are numerous other strategies that can be combined with buy-and-hold to reduce risk and provide more security. Adding bonds to the mix is just one. But these strategies are beyond the scope of a five-minute course.
The one thing that is particularly peculiar about the AAII is the preponderance of retired men who are in the group. Almost the entire membership is 70+. There is a smattering of us 50-somethings and 60-somethings. (One thing so refreshing about the FastTrack group is that so many of its members are in their 30’s and 40’s. But I’ll get to that later.) You would think that younger adults would be interested in investing, since this is when you have the most options available. But for some reason, people under 50, let alone 40, just don’t seem at all interested. I guess most people see themselves in spending mode and prefer not to think about saving and retirement planning. In that sense, it’s understandable. If you haven’t been planning and find yourself retired at 60 or 65 and know now that nothing else is coming in anymore, suddenly you feel a strong incentive to take your pension and your nest egg and make it grow and make it grow quickly. That’s the promise of the AAII. They promise to show you how to take what you have and make it grow and make it grow quickly. Their promise is the use of technical analysis to do short term trades to beat the market and beat it big! That’s for the next posting.
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