Category Archives: Stocks

The Dean of Wall Street

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Five Cent Nickel (after inflation, it’s only worth a penny) uses these wise words of Warren Buffett’s teacher/mentor – and the ‘father’ of Value Investing (the art of buying a stock for less than its ‘real’ or ‘intrinsic’ value) to teach us about the value of index funds:

The recommendation to track an index rather than pick stocks may sound somewhat surprising coming from the man who wrote one of the most well-respected books ever written about picking stocks. However, as more and more investors are learning every year, index funds make a lot of sense compared to the alternatives.

5c’s heart is in the right place, but it’s not what Benjamin Graham was suggesting at all; he simply suggested that analysts and untrained investors should invest via Index Funds …

… then dedicated his life to teaching others (and, practising what he preached) how to select common stocks that will give better than average results.

The trick is that you need to become a trained investor to do so … it’s a business and like any other business, it requires training, dedication and a certain degree of risk-taking (although, I fail to see how suffering a 15% loss – as I did – while the indexes all lost 50+% is more risky?!).

Phil Town reportedly turned $1,000 into $1,000,000 using Grahamesque ‘value investing/trading’ techniques, and Warren Buffett created a $40+ Billion monolith using similar techniques … and Graham himself made millions. And, studies have shown that this is due to skill, not luck (as is the case for most successful ‘businesses’).

By all means, realize that you don’t have the skills and stick to Index Funds … because, if you DO want to invest in stocks, these experts are telling you that you MUST first acquire the skills.

Another sensational headline

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Motley Fool are masters of the sensational headline; case in point: their blog shouts Avoid the Mistake That Cost Buffett 8 Years of Better Returns, which turns out to be a reasonable discussion of technical analysis v fundamental investing a la Warren Buffett:

Technical analysis is the practice of predicting where stocks will trade based on charts of historical pricing and volume information. There’s a certain logic to it. Stocks trade based on supply and demand, which is greatly influenced by investors’ attitudes about the stocks. The charts should reflect those attitudes and might predict where the individual stocks will go.

But Buffett discovered one small problem. Technical analysis didn’t work. He explained, “I realized that technical analysis didn’t work when I turned the chart upside down and didn’t get a different answer.” After eight years of trying, he concluded that it was the wrong way to invest.

So, what does Warren say is the right way to invest?

Well it would be unfair of me to steal Motley Fool’s Thunder [ AJC: see I, too, can write clever headlines 😛 ] …

… instead, I want to point you to an even better strategy for small-time investors who can hop in/out of positions far more nimbly than Warren Buffett:

Combining value investing with basic technical analysis as touted by Phil Town of Rule # 1 Investing ‘fame’. Phil reportedly turned $1,000 into $1,000,000 over 5 years using these strategies, so maybe you can, too?

I didn’t have this same kind of success (with stocks!), but I did only start to use these strategies as the market crashed 50+%, yet my loss (including doubling my risk by using margin lending) was a 15% loss in the US (on approx. $1,000,000 invested) v a 60% loss in Australia (on approx. $750,000 invested) and a 80% loss in the UK (on approx. $3,000,000 invested) where these techniques were NOT used.

Before you say “what a dope”, my UK ‘investment’ was actually part of my buyout, so I had no choice … but, Australia and US were my [stupid!] decisions to invest at the peak 🙂

So, a 15% US loss should actually be read as a 35% ‘gain’ over the market, thanks to these tools …

Here’s what Phil Town has to say about sticking to his technical analysis-based buy/sell signals:

For all you arrows users (Investools or Success): I buy with three greens and it’s amazing how many times I regret it when i jump the gun and buy with two.  So three green.

And I get out when the stock stops going up and I get two reds down below.

And, here’s how to combine the two:

– Select a stock based upon sound fundamentals: i.e. is it trading below its long term value?

– Buy when the ‘technicals’ tell you that the major fund are beginning to buy in and sell when they are beginning to sell out.

IF this works for you (and, it has worked pretty well for me), it allows you to rid the short-term ‘waves’ in a stock’s price …

… but, you sell out for good, once your ‘value analysis’ tells you that the stock is no longer cheap.

Guaranteed Returns?

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In choppy and down markets it’s natural to be nervous … so, it’s no wonder that investors start to look at funds that purport to ‘guarantee’ your initial capital, your return, or some combination of both.

I have a close friend who is a financial adviser, who works strictly on a fee basis, yet his practice is associated with the products of one major insurance and fund management company.

He was telling me of the rise of these Absolute Return funds that work on the basis of not only guaranteeing the original amount that you invested, but also lock in your returns to date …

– in other words, if you invest $1,000 this year and the market falls, the fund guarantees to pay you back at least $1,000

– then next year is a good year for the market and your fund increases by 10%; now the fund guarantees to pay you back at least $1,100

– but, next year there’s another market crash and the market drops by 15%; but, the fund STILL guarantees to pay you back at least $1,100

– if you remain with the fund and the market eventually totally recovers, as soon as the fund value rises above your new $1,100 ‘guarantee’ then so does your return.

There have been plenty of systems that have produced similar results … they usually do this by some combination of insurance and/or derivatives (e.g. stock options). In fact, you could replicate some of these results for yourself simply by buying the right type and duration of stock option along with the underlying stock (or index).

The problem is that all of these end up costing you money: the insurance premium and/or options are bought out of your initial (or ongoing) investments. The ‘cost’ of these ‘guarantees’ comes as some combination of increased fees or reduced returns when compared to a similar fund that does not offer the ‘guarantee’ …. it’s that simple.

You can provide yourself a similar – or better – result at far less cost: buy a low-cost Index Fund and wait 30 years to cash it out; I can virtually ‘guarantee‘ an 8.5% minimum return 🙂

A strange conjunction of posts …

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I was skimming through the alltop.com listings of personal finance blog titles as I do from time to time, when I came across these two posts  on Ranjan Varma’s blog:

Timing the Market is Nonsense

and

Quantum Gold Fund Gives 29.7% Return

I don’t know about you, but I rolled on the floor laughing … if you don’t see anything ‘wrong’ with the juxtaposition of these two headlines you’re wasting your time reading my blog 😛

But, it’s the first article – on market timing – that I want to talk about … because there’s an interesting (and very short) ‘slide show’ embedded in it that I want you to see:

http://www.slideshare.net/thinkingcarl/average-is-not-normal-presentation?type=presentation

There are two points that the slideshow ‘author’ makes that I want to discuss here …

Average is Not Normal

The creator of the slide show suggests that in the last 80 years the stock market has “averaged” a 10% return, but in only 2 of those years has it actually returned anywhere near 10%

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Timing is Everything

The slide show creator then uses that data to (erroneously, in my opinion) reason that timing in the stock market is actually critical … for example, would you want to start investing here?

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or, here?

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So, where would you rather invest? Come on, be honest?

Before I tell you where I would invest, let me tell you where the real big bucks are to be made …

… the real money is to be made in the second chart; investing at the peak of the market!

But, it only works if you can recognize the peak:

Jesse Livermore, the legendary trader of the 20’s and 30’s reportedly made and lost a fortune 4 times before he (understandably) blew his own head off. One of his greatest profits came when he SHORTED the market on the day of the famous stock market crash that heralded the beginning of the Great Depression. We’re talking so much money that the President of the USA called him to beg him to stop because he was singlehandedly making the market crash worse!

Given that I’m not Jesse (and, neither are you) my answer is:

I don’t care …

… you see, whether the curve is up in the beginning, smooth all the way, ziggy zaggy every which way in the middle, I only care what my starting and ending numbers are. And, what I do know is that, over a 30 year period (based upon ANY continuous 30 year period starting on any day that you care to name in the past 75 or so years … INCLUDING purchasing on the day before the greatest stock market crash in history … the one that saw the beginning of the Great Depression), the stock market will NOT give me less than an 8.5% return.

So, I will only buy stocks for 30 years as an investment (or less, if I feel like gambling) … or 20 years, if I only need a ‘guaranteed’ 4% return …

If the market happens to ziggy zaggy up in the right ways, and I’m lucky enough to get somewhere near the averages, well, there’ll be some extremely happy charities and surviving family when I die 😉

Time to hop back in?

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buffett_chart1

Fortune Magazine publishes the above chart and says:

There should be a rational relationship between the total market value of U.S. stocks and the output of the U.S. economy – its GNP. [Warren Buffett] visualized a moment when purchases might make sense, saying, “If the percentage relationship falls to the 70% to 80% area, buying stocks is likely to work very well for you.”

Well, that’s where stocks were in late January, when the ratio was 75%. Nothing about that reversion to sanity surprises Buffett, who told Fortune that the shift in the ratio reminds him of investor Ben Graham’s statement about the stock market: “In the short run it’s a voting machine, but in the long run it’s a weighing machine.

Now, I don’t have a crystal ball, but it appears that most of the world’s greatest Value Investors (a technical term for ‘cheapskates’) are hopping back into the market, as this article – this time from Forbes – says:

Over the past several weeks, more and more of history’s most successful investors have turned bullish. Warren Buffett, John Neff and David Dreman–all of these gurus and others have said that they are now in full buying mode. Even Jeremy Grantham, a notorious bear, has said that stocks are cheap, as cheap as they’ve been in two decades, in fact.

I’m wondering: if you were prepared to buy when the market was high and people were beginning to speculate whether it would last, why wouldn’t you be prepared to buy (and hold for the long-haul) now, when the market is closer to the bottom than it was then?

I have some money that I can get an immediate 33% ‘kick’ by moving it from the US to Australia (due to favorable exchange rates), yet I am sorely tempted to keep it in the US and trade options with it, as I feel that there will be great volatility between a Dow of 8,000 and 9,000 … the time when traders make (and lose) fortunes.

Not suggesting that you do the same, but I am suggesting that if ever there were a time to buy (for the long-term), it might be right now … there might be deeper bottoms still to come, but there will be higher, highs as well … by buying and holding now, you will ride out those bottoms (if they come) and guarantee that you will reach the highs (when they come) … how can that be a bad thing?

Making Money 201? Whoohoo … time to have some fun!

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I’ve just loaded 14 new videos into the Vault (click on this link, or check the VodPod Widget on the right hand side of this page for the latest) …

Now for today’s post: Part 2 of a 3 part series on weathering the current financial storm …

OK, so we’re all panicking … at least that’s what the media seems to be telling us as 180 year old investing firms crumble, banks crash and the financial markets are in turmoil, even after a $700 Billion ‘rescue package’.

Time to run for the hills?

Well, if meeting average market returns over a long period is enough to satisfy your needs, read yesterday’s post … click the close button on this page NOW (and, also on every personal finance page / news source hot tip / etc. /etc.) … and, live happy my friend: by the time that you retire, the events of today (and, the two or three more ‘meltdowns’ that you will no doubt live through) will be distant memory and you can only hurt your financial prospects by paying any attention to current events … and, I mean any given set of ‘current events’ between now and the day that you sign-off for ever.

But, that’s not you, is it?

You want – nay, need – extraordinary returns, extraordinarily soon … right?!

In that case, maybe it’s time to listen to our good friend Warren Buffett – The World’s Greatest Investor:

“Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics is equally unpredictable, both as to duration and degree. Therefore we never try to anticipate the arrival or departure of either. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

– Warren Buffett, 2001.

So, does this seem like a time to be fearful to you … or a time to be greedy?

According to Warren, it’s a time to be … greedy: how?

Well, in the current market, everybody knows that cash is king … so, let’s go and make lots more of it!

Before we take off, let’s do a quick ‘pre-flight’ check; do you have your financial house in order?

Let’s see: your 401k has taken a hit, your house has devalued …

… but, you have little credit card or consumer debt, and you are socking away money regularly. So, CHECK.

Great!

Welcome to Making Money 201, which is all about increasing your income through some combination of hard work and risk-taking – the combination that you choose is entirely up to you (and, how ‘steep’ your Number/Date ‘mountain’ will be to climb).

Why do we need more income (besides the obvious!)?

Because, everything financial is on sale right now: stocks, real-estate, loans … the whole box ‘n dice … so, we want to be ‘cashed up’ to take advantage of all the bargains coming our way.

The only problem is ‘market timing’ … take a look at this chart from the Wall Street Journal:

It shows the stock market from 1900 to today, every year across the bottom … but, the right hand side shows a logarithmic (i.e. exponential) scale.

This means that the next move in the market, over a (say) 20 year bull market, will take the Dow Jones from 1,000 to 10,000 … sounds HUGE (and, it is: 10 times your money in 20 years!) … but is ‘only’ an annual compound growth rate of 12%.

The problem, though, is in the RED areas of the chart:

These show the Super Bear Markets – which can be described as FLAT periods in the market that can last 10 to 20 years (if history is any guide) interspersed with volatile short-term up/down movements.

So, I see two possible strategies:

1. Build up CASH

… to be positioned to take advantage of the Next Great Bull Run. Or, maybe we invest in property – I’m sure that we could produce a similar chart.

Here’s what to do: tighten your belt … resign yourself to very limited increase in lifestyle for now … and, take all of your excess income from your full-time business, part-time business, 2nd job, lottery winnings, inheritances, whatever and, buy stocks (and/or real-estate) whenever you can.

Look for bargains in the market (you know, great companies paying good dividends and/or growing profits even now, that have been beaten down to less than 12 to 15 P/E … better is 8 to 10 P/E) and start buying into 4 or 5 of these … and, keep buying! Don’t stop … ever.

This will create your own mini-Berkshire Hathaway, making you a mini-Warren Buffet: you have a ‘cash machine’ (job/s, business/es) and you use it to buy good businesses cheap; then you hold forever. If the price goes down, so what? You simply buy more at the cheaper price as soon as you can afford it. And, if the price of the stock goes up, good fer you, Son … now and go an’ buy yerself some more!

When the market does ride the next wave (one that you will only see in hindsight) you will really see how cheap you got in …

2. Ride the volatility

The first is the ‘safe’ strategy, but will net us closer to 0% growth over the life of the Bear Market than the greater-than-market returns that we need … we need time to ride the downturn and pop out the other end with a basket of great stocks/real-estate assets bought at relatively cheap prices.

But, if you are able to accept some significant risk, there is another way …

Now just might be the time to take a business / trading approach to the market!

In a volatile market, we don’t know from one day/week/month to the next whether stocks will be significantly up or down … but we do know that they will change: often significantly.

This can be an ideal time to speculate with options … but, only with money that you are prepared to lose in the hope that the upside justifies the risk.

Sounds a lot like a business, doesn’t it? Which is why this is an ideal Making Money 201 Income Building Strategy for those who can stomach the ride.

What do I do?

Pick a stock that you like, but that has great volatility … ‘tech’ stocks are ideal for this (AAPL, RIMM, etc., etc.) and buy an equal quantity of PUTS and CALLS at the smallest gap around the current stock price. Sometime during the month, in a volatile market like this, it’s a reasonable bet (at least, I like to think so) that the price will change. If it does – by enough of a margin to pay for the cost of the options – you win!

Of course, you could flip/trade houses, if you prefer real-estate … but, the strategy is essentially the same: add value from volatility and/or sweat to ‘create’ returns in an otherwise generally flat market.

So, if you’re in Making Money 201, why don’t you share with us what you are you doing to not only weather the storm, but profit from it?

The fractal market …

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What does this fern leaf and the stock market have in common?

Surprisingly, a lot!

For a start, this is not a drawing or photo of a real leaf … it’s a actually a computer-generated image derived from just a few short lines of computer code.

It’s a ‘fractal image’ – a branch of mathematics that uses randomness (with many similarities to ‘chaos theory’) to describe natural objects so that they look ‘real’ to the naked eye … again, using only a very simple mathematical formula!

The two most interesting things about fractals:

1. They are easy to generate – they are based upon replication of a very simple formula, over and over again. Order-in-Randomness takes care of the rest

2. As you scale up or down the picture looks remarkably similar ….. take the leaf to the bottom right and blow it up to full-size and you will see something very similar to this original image

What does this have to do with the stock market? Well take a look at the following two graphs:

These both indicate movements in the Dow Jones Industrial Average; what’s interesting isn’t the direction … it’s the shape …. they both indicate a random series of up/down movements in a general direction (that, too, seems to change randomly).

The interesting thing about these charts is that they are the same chart (almost)!

One is a 1 year view of the Dow Jones, the other a 3 year view (it should be easy to work out which is which!) …

… you see, as the IBM scientist who ‘founded’ fractal geometry (well, actually revived … it was ‘discovered’ in the late 19th century by a scientist named Julia) in the 80’s discovered, the stock market is fractal.

While the movement is seemingly random, each piece of market movement when enlarged looks very similar to the larger scale movements … so we have up/down movement in the stock market at every scale: daily, weekly, monthly, annually that actually behave quite similarly.

The frustrating thing is this: chaos theory abounds.

Chaos theory says that when systems become complex, a very small apparent change in one variable (i.e. number) can suddenly have a HUGE change on the whole.

It’s why they say that a butterfly flapping its wings in Japan can cause a hurricane in Louisiana …

You can’t think of a system (except in Nature) more complex than the stock market: thousands of stocks make up a market … each one is a real-live business generating revenue, controlling costs, dealing with market/economic/government changes on a daily, or even minute-by-minute basis.

The whole shebang can move up … down … or sideways. But, within each movement is the movement of each company’s stock. The price of each individual stock is fixed by the investors: are they net buyers or sellers in this micro-second (that’s how fast the stock exchange moves)?

Suddenly, one mutual fund executes it’s order to sell Company A and the effect is minimal, either on that company’s stock or on the market. But, on another day a ‘perfect storm’ arises (an announcement by the feds of a change in interest-rates; a war in the Gulf erupts; etc.) and that same sell-off triggers a panic.

Who can predict it?

Nobody … and, that’s the point … look at the charts: do you see anything that looks remotely predictable in that lot?

Do you want to bet your financial future on where the stock market is heading, even for the next 3 years?

I don’t … but, I do know that while the market can (and, does) move dramatically & randomly, there is an underlying force driving it relentlessly upwards:

The companies that make up the market are producing widgets, and inflation is always making the price of widgets go up/up/up (with an occasional, but only short-term pull-back) inevitably pushing their profits (hence stock price) along with it … where inflation goes, the stock market will surely follow … eventually.

But, who can say exactly when?!

So always be a buyer and holder … never a seller be.

Don't let all of those stock investment choices fool you …

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People new to the world of finance are often blinded by all the options available for investing in the stock market:

– Direct investments in stocks – but which ones? Growth? Value? Invest far and wide? Or only in a few?

– Trading stocks or options – how to value and trade? Fundamental Analysis? Technical Analysis?

– Investing in packaged products – Mutual Funds? Index funds? ETF’s? REIT’s?

I wrote a post recently that summarized these options; here I simply want to add a little more info …

Investopedia Says:
The building of a factory used to produce goods and the investment one makes by going to college or university are both examples of investments in the economic sense.

This means that the true definition of an investment is something that makes a little money now, or more likely a lot of money in the future.

Therefore, while I say that there are three sensible ways to invest in stocks, there are only two investment methods recommended by Warren Buffet:

1. Buy and Hold low cost, diverse Index Funds (check out Vanguard‘s web-site, and others) – this is a long-term, low risk (if your holding periods are 20 – 30 years) strategy that can help you fund a normal retirement.

“By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals” W. E. Buffett – 19932.

2. Invest in a FEW stocks in companies that are (a) undervalued (b) have a large margin of safety (c) that you love and (d) are prepared to HOLD until the rest of the market decides that they love them, too (at which point you can cash out or keep holding for the long/er term). “I never attempt to make money on the stock market … Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” W. E. Buffett

Anything else is SPECULATING i.e. the process of selecting investments with higher risk in order to profit from an anticipated price movement.
Investopedia Says:
Speculation should not be considered purely a form of gambling, as speculators do make informed decisions before choosing to acquire the additional risks. Additionally, speculation cannot be categorized as a traditional investment because the acquired risk is higher than average.
Lots of people have made a ton in trading stocks and options (e.g. George Soros, but he was smart enough to know to quit gambling when you are ahead) – the key is to be able to make informed decisions …… my question to you is, how informed are youif you are merely following the herd, reading the popular press, drawing trends on a graph  using the same trends that millions of other investors are looking at, doing a rudimentary analysis of the same sets of financials that every analysts worth his salt is poring over?

In short, what is the ‘special sauce’ that you are applying that will let you buck the trend and speculate successfully, like George Soros?
 “A public-opinion poll is no substitute for thought … let blockheads read what blockheads wrote.” W. E. Buffett
And, buying most high-cost Mutual Funds or other packaged products is not investing either …
“We believe that according the name ‘investors’ to [people or] institutions that trade actively is like calling someone who repeatedly engages in one-night stands a ‘romantic.’ “ W. E. Buffett

So, take Warren’s advice: unless you have a strong reason to do otherwise, stick to one – or both – of the only two ways of investing in stocks and, over the long-term you are very likely to outperform all but the luckiest of those speculators out there …

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What is the best way for a newcomer to get started in investing in stocks?

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I just got back from Omaha, where I attended the Annual General Meeting for Berkshire Hathaway – Warren Buffett’s company – so, it’s timely that I remind you there are only a TWO sensible ways to INVEST in stocks – BOTH recommended by Warren Buffet  – plus one Speculative way:

1. Buy and Hold low cost, diverse Index Funds (check out Vanguard’s web-site, and others) – this is a long-term, low risk (if your holding periods are 30 years) strategy that can help you fund a normal retirement.

2. Invest in a FEW stocks in companies that are:

(a) undervalued,

 (b) have a large margin of safety,

(c) that you love, and

(d) are prepared to HOLD …

… until the rest of the market decides that they love them, too, at which point you cash out and go back to (a).

Anything else is SPECULATING – lots of people have made a ton in trading stocks and options (e.g. George Soros, but he was smart enough to know to quit gambling when you are ahead) – or UNDERACHIEVING such as following the herd and/or buying high-cost Mutual Funds.

You may be one of the few that can succeed in either of these alternative methods … but, please don’t offend the World’s Greatest Investor by calling it INVESTING …

We believe that according the name ‘investors’ to [people or] institutions that trade actively is like calling someone who repeatedly engages in one-night stands a ‘romantic.’ [Warren Buffett]

So, there are only two methods that Warren Buffet would recommend (and one that he clearly would not) – one for the wise and the other for the even wiser – which one would you choose?

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_______________________________________________________________________________________________

Casting Call

 

Well, the ‘news’ of my 7 Millionaires … In Training! ‘experiment’ is finally out … check out my friend, Bill’s post on Money Hacks, then click here to find out more …

The ONLY three ways to invest in stocks … and, some ways NOT to …

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So you want to invest in stocks?

And, why not be a bit of a contrarian by getting in now … when the markets are all beat up, and there is doom and gloom around, that’s when most of the money in this world is made … so, if you do want to invest, how?

Well I covered a bit about this subject in a recent post, comparing Index Funds to ETF’s … but, I want to go into it just a little bit deeper:

First of all you need to understand what type of investor you are:

1. Are you a Speculator – living on the edge, trading stocks/options (i.e. gambling) type? Nothing wrong with that – you could be the next George Soros.

If you are, then sign up for some newsletters and courses, such as the Tycoon Report (has the added advantage of being free!)

2. Or, are you a Value Investor – buying cheap, holding for the long term type? Are you the next Warren Buffet? Obviously, nothing wrong with being the world’s richest man, either.

If you are the next WB, then buy yourself a copy of Rule # 1 Investing by Phil Town. It will tell you exactly HOW to value stocks (what measures to use) and WHEN to invest (what indicators to use).

3. If you don’t have the patience for the latter (2.), or the stomach for the former (1.), then buy yourself some units in a low cost Index Fund … keep buying … and, wait!

That’s it in a nutshell …

… but, wait you say … what about:

4. Mutual Funds – too expensive and 85% of fund managers don’t even beat the market

5. Growth Stocks – if you have no special skill or knowledge, what makes you think that you can beat the Fund managers in 4.? You can’t (unless, you are lucky … then you are really just back at 1.).

Did I miss anything?

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