The new year and new decade is a perfect time to adopt new investment strategies. Revamp and realign your practices if necessary. Do not rely on the Street. Separate babble from substance, regardless of whether the source of the blather is Wall Street, the media, or companies. Alan Abelson’s stance is that “Selling, not analysis, has always been Wall Street’s strong suit.” And as Warren Buffett says, “Never ask the barber if you need a haircut.” The following is my investment philosophy, the essence of my entire book Full of Bull, for you to consider in the process of rethinking your own.
Do not take Wall Street literally. Put it in the proper perspective. Use its information and its research content, not its conclusions or recommendations. Use input from the Street the same way you would employ The Wall Street Journal, or a friend’s investment suggestion. View the Street as just one among many sources pertaining to potential investment strategies and opportunities. The information it offers is only a starting point—not a final conclusion. Most professional portfolio managers who run mutual funds have mediocre investment performance records. Only 48% of mutual funds outperformed their benchmark in 2009, 43% in 2008. The track record of Street analyst opinions is even worse; analysts cannot pick stocks. “In a bull market, you do not need them,” Gerald Loeb says of securities analysts. “In a bear market, you do not want them.” Research reports are never complete, forthright, balanced, or objective. They are good for background, but they are not actionable. Corporate management should be utilized in the same manner as Street analysts—for gaining an understanding of a company and industry trends, but not for investment guidance.
Conduct your own research. Observe. Read. Listen. Overhear. Ponder. Anticipate. Predict. Analyze. Question. Judge. Be skeptical. Avoid being overconfident. Be different. Be unafraid to go your own way.
Steer clear of the herd instinct, the market tendency toward imitative behavior. Invest long-term; do not trade. Look for value. Seek dividends. Do not spread yourself too thin; limit the number of stocks you own to no more than a half dozen, so that you can pay proper attention to each one. Keep it simple, nothing too exotic.
Preserve your capital. If you can avoid material shrinkage in your overall portfolio, performance will take care of itself, and you will achieve excellent long-term results. It is not what you make, it is what you keep. Investment risk (the possibility of permanent loss of capital) and price valuation are critical factors when looking at a stock, but they are usually overlooked in the pursuit of big gains from “new era” investment ideas. Consistency is more important than absolute appreciation.
High-yield value investments should constitute the bulk of a stock portfolio; growth stocks should represent no more than 20%, maybe even as little as 10%, of a portfolio. Growth stocks are risky and volatile. They might be a thrilling pursuit if you need excitement, but the rush will quickly vanish if they are decimated in a bear market or suffer even a slight negative business blip. Growth stocks such as Intel, Cisco, Google, and Goldman Sachs were sliced in half or by two-thirds during 2008. Such impact on an investment portfolio is devastating, and could take years to make up. I do not concur with the thesis that growth stocks are necessary to keep pace with the overall market and economy. Low PE multiple income stocks perform just fine in a rising market, and over long periods actually out-perform non-dividend paying, growth stocks.
Dividend and interest income should be derived from both bonds and stocks, with at least half attained from the former. I feel strongly about shielding capital. Obtain higher yield with income stocks, royalty trusts, limited partnerships (LPs), limited liability companies (LLCs), and master limited partnerships (MLPs) that are listed on the NYSE, or even preferred stocks. Income stocks can generate dividend yields above 5%, sometimes close to 10%. But be careful. Heightened risk accompanies yields in the 10% range. There is no free lunch. A few years ago, I coasted along with Calpine (a California utility) bonds that were paying more than 10%. My assumption was that electrical utility firms never go bankrupt. What a surprise when this one did! My losses far exceeded all the interest I had earned in the prior years. The conservative avenue to maximizing income is to seek quality stocks yielding around 5% that have good prospects of raising their dividends in the future. That way, based on the original purchase price, there is the potential to obtain a double digit yield down the road.
Aim for a 5% to 10% annual total return including dividends; 15% would be spectacular. Be patient and long-term oriented, and have reasonable expectations. The sobering lesson of the 2008–2009 bear market train wreck is that the primary investment objective should be protection of capital rather than maximization of capital gains. Overreaching for growth and capital gains exposes investors to excessive risk. Reduce greed and lower risk. In some years, such as 2008, no return or even a loss of 10% to 15% is a glorious victory. Take heed of the recent bear market damage and rein in your investment return target to limit risk. Perseverance must be accompanied by realistic performance goals.
As an individual investor, you are free to do the right thing. But that freedom also enables you to make foolish, elementary mistakes that professionals tend to avoid. Ray DeVoe, the market observer, contends: “Good judgment comes from experience, and experience comes from bad judgment. But bad judgment is just a polite term for stupidity.” This new decade is a perfect time to put your investment approach on the right track. Peggy Noonan, in her Wall Street Journal column, advises “maintain your equilibrium, repair, rebuild and return.” That seems appropriate in 2010.