Are You One of the Many Investors Wasting Your Time?

If there’s one thing investors do to waste a lot of their time, it is comparing the performance of their portfolios to the S&P 500 or the Dow Jones Industrial Average. These indexes have little in common with any well balanced and well diversified portfolio. They simply aren’t good proxies for conservative, retired or soon to be retired investors to use for their investments. In December 2004 I called the practice a big waste of time. I maintain that view today. I wrote then:

A Big Waste of Time

One of the most inane exercises carried out by professional and amateur investors alike is comparing performance against, for example, the S&P 500 or Dow 30. These things are moving targets. Investors are not comparing apples to apples. For example, the original Dow began in 1896 with 12 components. What are you comparing yourself against? American Cotton Oil or American Sugar Refining or perhaps Chicago Gas? No, all of these companies have long since disappeared from the Dow 30. In fact, only one of today’s Dow 30 companies started out in Charles Dow’s index back in 1896. The sole survivor is General Electric. The others have either gone bankrupt or merged and merged again. The Dow today is even 10% different from the Dow in 1999, as Eastman Kodak, AT&T, and International Paper have been replaced by AIG, Verizon, and Pfizer.

Both the Dow and the S&P 500 not only are moving targets, but are survivalist weighted. Losers and bankruptcies are dropped and replaced with up-and-comers. And neither index is encumbered with sales charges, expenses, or fees of any kind. And indices don’t pay taxes, which takes a giant bite out of most investors’ portfolios. No, you will do yourself no good comparing your own efforts or those of your manager’s against moving targets.

Instead, measure yourself against a set of reasonable goals based on long-term growth of the economy and normalized interest rates, both nominal and real. With a clear understanding of probable long-term growth and income characteristics, you are equipped to establish your own personal targets.

There are thousands of indexes available, including some with greater value as comparisons for investor portfolios. Those should be sought out and used in a way that takes into account all the factors I mentioned back in 2004. Don’t make the mistakes so many do by comparing your portfolio to an index that has nothing to do with your goals, risk tolerance, or desire for diversification.

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Marry Compound Interest, Divorce Market Timing

This week a long-time reader contacted me looking for some insight he could pass along to his children about the dangers of market timing. I’ve written on the topic many times over the years and wanted to share something he might find compelling. In April of 1996, I wrote about how three of Wall Street’s bright minds had completely failed while attempting to make market timing predictions about the future of the Dow Jones Industrial Index. Back then my advice was—as it is now—marry compound interest, divorce market timing. I wrote:

Market timing is a bankrupt strategy whose time has never come. The following three market predictions will alarm you. (Keep in mind, the Dow is now over 5500!) (1) On 24 February 1995, from the head of a major Wall Street investment management firm, “We won’t materially break 4000 until well into the next millennium.” (2) On the same date, from the head of institutional equities at a major brokerage firm, “Dow 5000 is not going to happen in my lifetime.” He’s still alive as far as I know. (3) On 25 May 1995, from a well-known market cycles technician, “This high (Dow) represents a gift last-chance selling opportunity (Dow 4500) before the big bear growls at the Dow. We expect the largest decline in stock prices since 1990.” Each of these forecasts was a disaster, of course, and cost followers of this advice a bundle in missed opportunity.

I have never in 32 years of investing suffered so much as one significant loss—not one. This is because I invest for the long term keyed to harnessing the awesome power of compound interest. The key to Warren Buffett’s long-term success has been buying easy-to-understand companies with unmatchable franchises and holding for the long term to allow the miracle of compound interest to do its work. If you marry compound interest and divorce market timing, you will find prosperity beyond your wildest dreams. If I can help you in only one way in your personal investing, it is to first and foremost harness the awesome power of compound interest through low-turnover, low-cost, long-term investing.

By the end of 1996 the Dow was trading well above 6400 and has never fallen below 6000 again. The market timers’ predictions were completely wrong. Building a strategy based on compound interest and regular streams of income in your portfolio was absolutely right.

Ken, I hope that helps, and thanks for all the years of loyalty. After over five decades I haven’t changed my investing strategy, and I hope you won’t either if you’re investing along with me.

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Investing with the Hard-Hitting NFL-style of Paul Brown

The NFL has a lot in common with investing. Both can be rough sports. You can get beaten if you’re not at the top of your game. That’s why a methodical approach is necessary to win both on the field and in the markets. Back in 2002 I wrote about the inspiration former Cleveland Brown’s football coach Paul Brown has given me during my years of investing. Read on about how Brown used a focused, methodical approach to build a football dynasty.

Former Cleveland Brown’s coach, the legendary Paul Brown, was a full professor. And Professor Brown taught his football players a systematical/methodical procedure of understanding tasks to attain successful results in the face of unforeseen variable difficulties. Paul planned for everything to the nth degree. As Cleveland Browns Hall of Famer Dante Lavelli has said, “Much of the way the game is played at the end of the century can be found in the innovative strategies and techniques that were developed and implemented by Paul Brown. Everyone for example has heard of the West Coast offense. That’s our basic (50s Browns) pass attack that Paul brought from the Browns to Cincinnati. Bill Walsh who was an assistant picked it up and took it to San Francisco.” Today, 50 years later, the West Coast Offense is bigger than ever.

Brown’s Unmatched Record

Paul Brown coached the All-American Football Conference Cleveland Browns to the championship in each of the leagues’ four seasons, including a 29-and-0 run from 19 October 1947 to 9 October 1949. Brown coached the NFL Cleveland Browns to an 88/30/2 record (win/lose/tie) in the 1950s, reaching the championship game in seven years. His methods produced winning results over and over again.

Through the years, I’ve followed Paul Brown’s career in Cleveland about as closely as anyone could, and I’ve based my investment approach and a lot of what I do in life on what I learned from Paul Brown and the Browns. The key is a systematical/methodical approach. Our new office at 500 Fifth Avenue in Naples, Florida, is dedicated to Paul Brown and the Cleveland Browns. As you enter the office, the innovations and techniques of Paul Brown are on full display.

Diversification—Patience—Value–Compound Interest

I write to you monthly of my basic investor tenet: diversification and patience built on a foundation of value and compound interest. If you apply a methodical approach, you can harness the power of my tenet to your own maximum value. Paul Brown was a fanatic on notebooks. Nothing was left to chance. Every player, even back in the 1940s, had to have one. Get yourself a yellow Sharpie marking pen (they write on the glossiest surfaces) and a shocking orange three-ring binder. I want you to circle the key points I make for you in these issues and keep each issue in your orange binder. Like Paul’s winning teams, you will quickly develop an indispensable investor playbook that will help you become a more successful, comfortable investor for the rest of your life. I can promise you success.

Investing without a plan is a recipe for disaster. Chasing the latest fad, or relying on unresearched “tips” from friends can land you in trouble. If you don’t have the time or patience to develop a real investment plan, work with an advisor who will do the heavy lifting for you.

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My Investment Plan: Easy to Understand and Easy to Implement

I couldn’t help but laugh to myself recently when I read an article in a major business publication about banks selling structured notes linked to FAANG stocks. The only thing more complicated than an explanation of the business case for some of these tech stocks is a structured note based on their performance. It’s the opposite of my small-town Vermont axiom “Simple is Sophisticated.”

Any investment plan you make should work hard to eschew the use of such exotic investment products (they’re called products because they are sold to consumers). Instead you should focus on an investment plan that is easy to understand and easy to implement.

I explained just such a plan in July 2003. This plan worked for me then, and now—fifteen years later—I am more committed to it than ever. I wrote then:

Steady Cash Flow

I do not invest in securities that do not throw off cash. I value compounding above all else. When I have cash to compound, I am content, and I wish the same contentment for you. I don’t take big loses because I don’t do stupid things. Perhaps I’m not the best investor or even one of the best. I know that by taking more risk, I might be able to improve my returns. No thanks! I sleep well and make plenty with my keep-it-simple flow of cash, low-turnover strategy. And I have succeeded with this strategy for four decades without one meaningful loss. I’d like you to come along with me on the slow, steady cash-cow track. I can help you achieve the comfort and investment success you have been looking for all of your life. But I can do this for you only if you adhere rigidly to the format I lay out for you. If instead you spend each month second-guessing me or totally disregarding my advice, we will not have much in common, will we?

Know Enough

I hope you will not think of my approach as know it all. It certainly is not. Rather my approach is know enough. My plan is straightforward—easy to understand and easy to implement. Transactions are few, requiring little of your time in executing orders. It is not rare for me to go the entire year without a sale in my portfolio. I do not follow the markets daily or weekly. And I could not tell you the price of anything I own.

Successful investing is counterintuitive. For example, don’t you think most investors choose mutual funds based on their good track records of recent years? I hear it all the time, as must you. Well, it’s jive. All funds, even the best managed (of which there are few) can have lengthy periods of wretched performance.

Don’t doubt the value of simplicity. It hasn’t failed me yet, and it won’t fail you.

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Trump’s Pro-Business American Revolution: Part II

One has to search far and wide to find a single positive headline from the mainstream press about the Trump administration. Trade-wars and foreign policy gaffes dominate the papers, but the story that isn’t being covered well is Trump’s pro-business American revolution.

After eight years of anti-business regulation and rhetoric, U.S. business finally has a spring back in its step. Small business confidence is at some of the highest levels on record, and CEO confidence, even in the face of some disruptive trade rhetoric, remains strong.

The University of Michigan Survey of Consumers shows that the percentage of respondents reporting positive changes in business conditions with respect to government and elections is off the charts. There hasn’t been anything like this on record–ever.

And it isn’t just sentiment that is booming. The manufacturing sector is on fire. Industrial production is humming, the ISM manufacturing survey is strong, and capital goods orders (a signal of business confidence) is also strong. The labor market has almost never looked better and wage growth is on the rise.

The President may not have the polish that some Americans have become accustomed to, but since when has polish ever been a reliable indicator of positive results?

Read Part I here.


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Do Old Investing Rules No Longer Apply?

Do the old rules no longer apply? Can you live on corporate earnings alone? Is ignoring your margin of safety advisable?

It turns out, unsurprisingly that the answer to all these questions is no. Back in November of 1997 I wrote the following (my emphasis added in bold):

Ben Graham’s Margin of Safety

Graham died in 1976, yet his wisdom is as fresh as if he were standing before us today. Ben Graham & Co.’s advice to investors is to evaluate a stock as if you were considering buying the entire company. Graham’s secret of sound investing can be distilled into three words—margin of safety.

Why am I focusing on Graham’s margin of safety? Because we are all happy as sin with the stock market advances of recent years, but I don’t want you to lose perspective. When I was in the institutional brokerage business with Model Roland & Co. in the early 1970s, the Dow fell by 44% in just two years. As bad a year as 1973 was—the Dow fell over 16%—it was only a warm-up for 1974. In 1974, the floor caved in. The Dow plummeted over 27%.

Sixteen Years of Falling Stock Prices

Investors tend to be a little myopic. Many investors are terrific at extrapolating the past into the future. These misguided souls are not investors at all. Rather, they are speculators. Do you know that the Dow was actually down 10% over a 16-year period from its starting point in 1965 to year-end 1981? Do you realize that the yield on the Dow today is less than 40% of its historical average? Stocks are paying an average of only 1.7%, versus the historical average of 4-1/4%. But it’s a new era, you’re thinking. Things are different today. With the Dow at 8100, the old rules no longer apply.

Well, I can tell you for sure, when you’re not getting paid to invest, you’re not getting paid. Pure and simple. Today’s common-stock investor is plunking down his hard-earned money and, in effect, saying, “I will take my gains on the come. Don’t worry about paying me anything today.” It’s the greater fool theory, not investing. I can give you lots of reasons why yield is low today. In the end, you can still say to me, reasons schmeasons, I’m not getting paid! And you would be right.

OK, it is clear that investors are not being paid, but what about corporate earning power? Don’t earnings control stock prices? As far as I know, you still can’t pay your telephone bill or mortgage payment with earnings. Dividends yes—earnings no.

I invest my own money for the long term, and I do not trade or speculate. My portfolio turnover is lower than an index fund’s. The awesome power of compound interest, along with low turnover, taxes and commissions, and a lot of time do wonders for any portfolio. It’s exactly the strategy I write about and advise for you. But even if you are faithfully committed to the long-term power of compound interest, you need to tinker and prune. You want to invest newly available money with an eye toward current market conditions and Ben Graham’s concept of a margin of safety.

All of what I wrote then applies today. Over the last few days investors have been shocked to see some of their favorite stocks getting hammered by events unrelated to earnings. Facebook is facing legal troubles. Amazon is looking down the barrel of federal regulation. Tesla has been rocked by the crash of one of its self-driving cars.

Prices of shares have dropped and could fall further in reaction to their troubles. What will investors be left with? Certainly not a steady stream of dividends.

In 1997, when I wrote the piece above on Ben Graham’s margin of safety, the P/E ratio of the Dow Industrials was 21.2, and its historical range had been from 6 to 24. It would eventually peak in 1999 at 44.2, before crashing back to earth in the dotcom bust. Today’s P/E of 24.75 is higher than the historic average for the Dow, but nothing like the dotcom era.

Higher valuations demand justification. If you can’t rely on your money ever being returned to you in the form of dividends, and instead you plan on selling shares to a greater fool in the future, that’s no justification at all. You need a margin of safety. A steady stream of dividends used to generate compound interest is that margin of safety. Invest accordingly.

Originally posted on March 30, 2018.

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Can You Outguess the Market?

Many investment gurus, panelists, and wunderkinds attempt to prove, day in and day out, that they are smarter than the market. Often they suggest that if you simply buy when they buy, and sell when they sell, you will have investment success.

But reality is that most of the time, such market timing behavior leads investors into playing a losing game of catch up. They often end up chasing the market and buying near the high, then selling near the low for the same reason. In 1992 I warned readers about the dangers of trying to outguess the market. I wrote:

How many investors are lucky enough to trade correctly to catch just 30 months out of 600 months? Come on, the odds are real poor. If you stay fully invested, however, you cannot fail to capture all of the good months. Sure, you’ll ride out some tough times. The stock market is high today based on value—no doubt about it. That was also true in 1987, when stocks got clobbered in the autumn of 1987. But the rebound from the 1987 lows was swift, and precious few investors sold pre-crash and got back into the market in a timely fashion.

Your defense against the volatility of the market is not to attempt some casino-like strategy of moving in and out. Instead, craft a diversified investment portfolio of stocks and bonds that provide comfort and confidence in bull markets as well as bear markets. Suffering massive losses in your portfolio due to a bad market timing call can be devastating.

Take a look at my chart on the Arithmetic of Portfolio losses below. You can see that after a 30% loss in your portfolio, you’d need a 42.9% gain to break even. And after a 50% loss you would need a 100% gain. Those are not easy returns to produce, and to be sure it would be best not to lose so much in the first place.

Don’t try to outguess the market. Instead, seek to craft a portfolio that will support you and your family in and out of bull markets, corrections, or even collapses.

If you need help crafting such a portfolio, please sign up for the Richard C. Young & Co., Ltd. client letter (free even for non-clients) written by my son Matt. The letter will give you an idea of the measures our family investment counsel firm puts into place for our clients’ portfolios. Hopefully those strategies will allow you to become a more successful investor.

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Is Your Investment Game Plan Ready for Action?

History has a way of repeating itself. In early 1995 I wrote about a math professor named Tom Nicely, who worked at Lynchburg College. Nicely was examining prime numbers using a group of five personal computers. While four of the computers gave Nicely the correct answer to a problem, 1.2126596294086, the fifth turned up a slightly different answer, 1.212659624891157804.

The cause of the fifth computer’s error was the Intel Pentium processor installed on it. Nicely called Intel to explain, but was given the cold shoulder. Next, he did something which at that point was still novel, he asked for help on the Internet. Others checked Nicely’s work and came back with the same results, confirming his conclusions.

Intel had already known about the problem since May when one of their own researchers had discovered it, but only after they had been backed into a corner by independent confirmation did Intel acknowledge Nicely’s research. The company even offered him a consulting job.

The bug was first reported in an industry journal known as Electronic Engineering Times, but when it was reported by the mass media on CNN on November 21, 1994, the stock dropped over 12.3% in a little less than a month. The stock only began gaining again after Intel offered a recall on December 20th.

Here We Go Again

Today Intel is in a somewhat similar, though not exact, position. A group of researchers connected by the Internet, have exposed a much larger flaw in Intel’s processors, and now the company needs to deal with the fallout.

The issues, known as Spectre and Meltdown, could potentially be used by hackers to attack computers using Intel processors. The news was again first reported in an industry journal, the Register, out of the U.K. But in today’s rapid information world, it didn’t take much time to disseminate to the market. Intel’s share price dropped over 9.2% in eight days.

Only after CEO Brian Krzanich wrote an open letter to the tech industry explaining Intel’s next steps were investors willing to climb aboard Intel once more.

Do You Have a Game Plan?

I do not relay this story to you to shame Intel. What I want you to see here, is that companies often undergo rough periods. The tech industry in particular is prone to volatility thanks to complex products and low barriers to entry. The unexpected happens, and without a game plan you may see a lot of your own money wiped off the board quickly.

My game plan for decades has been one laid out first by Ben Graham in the Intelligent Investor. Graham wrote, “One of the most persuasive tests of high quality is an uninterrupted record of dividend payments for the last 20 years or more. Indeed, the defensive investor might be justified in limiting his purchases to those meeting this test.” I would add to Graham’s astute analysis that focusing on companies dedicated to increasing dividends helps as well.

What are Your Goals?

Another factor in investing is understanding the business you are investing in. Not many investors today can honestly say they understand what the Spectre and Meltdown flaws in Intel’s chips really are. Are you prepared to invest in a company that builds a product you don’t understand and can’t explain? These shares are no doubt appropriate for some portfolios, but if risk avoidance is one of your goals, understanding the company from top to bottom is a good place to start.

I practice risk avoidance in all aspects of life, and especially in investing. If you are in or nearing retirement and are looking to relieve the burden of the work that must be done to minimize risk in your investment portfolio, I urge you to visit the website of my family run investment advisory, Richard C. Young & Co., Ltd. You can sign up for our client letter, free even for non-clients, to get a better idea of the principles used to make investment decisions.

Originally posted on January 19, 2018.

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How Pennies Can Win the War

Back in January of 1987, Ronald Reagan gave a State of the Union address in which he lamented the brutal war being waged by the Soviet Union on the people of Afghanistan. Behind the scenes though, Reagan was operating what has become popularly known as “Charlie Wilson’s War.”

Reagan and his supporters in Congress, including Charlie Wilson, were sending Stinger missiles to the Afghans fighting against the Soviets. Those missiles cost pennies on the dollar compared to the Soviet MI-24 Hind gunships they were used to target with a lethal 79% successful kill rate.

The mere pennies the U.S. was spending on the war against the Soviets really added up. The massive cost of the war was a major contributing factor to the eventual breakup of the USSR.

The same month Reagan gave his address, I was writing to subscribers to encourage them to realize the value of their hard-earned pennies.

That month I wrote:

I’ve told you about the vital importance of dividends and compound interest. At a 10% return, money doubles in only seven years. One member of the highly successful Rothschild family referred to compound interest as the eighth wonder of the world.

I’ll always remember Bob Rose’s historic note in The Wall Street Journal a while back. Bob wrote, “Early in the last century, an English astronomer, Francis Baily, figured that a British penny invested at an annual compound interest of 5% at the birth of Christ would have yielded enough gold by 1810 to fill 357 million earths.”

When put into terms of earths worth of gold, it is easy to see the value of compounding. All the mined gold in the world today would fit into a 68-foot cube. The idea of 357 million earths volume of gold is incomprehensible, but it makes the point Baily was getting at. A small investment can generate a powerful return.

At the end of his speech, Reagan told the American people “my fellow citizens, America isn’t finished. Her best days have just begun.” It was true. American went on to win the Cold War, becoming the undisputed most powerful nation on earth. It all started with an investment of what seemed like pennies in Afghanistan.

If you harvest the power of compound interest, your best investing days have just begun as well.

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The Most Important Thing in Investing

Back in 2006 I was celebrating 20 years of writing Intelligence Report. Debbie and I were in Vermont, and had just visited Vermont’s Authentic Designs to purchase lighting fixtures. The shop uses 150 year-old machines to manufacture colonial and early American lighting fixtures. There, on one of the machines for all the craftsmen to see was taped a sign that read “Simple is Sophisticated.”

After reading that taped up sign in Vermont all those years ago, I adopted “Simple is Sophisticated,” as a personal mantra to keep me focused on the essential elements of my investment strategy. The most fundamental of these, and the one I have employed to the greatest benefit to myself, and hopefully to you if you have been a subscriber or client, is compound interest. Below you will read the story of how I have employed compound interest to the benefit of my grandchildren, and how you can do the same. I wrote back in May of 2006:

Rich as Croesus

I want you to begin on your quest for sophistication through simplicity by focusing laser-like on compound interest. Here is an amazing story. I call it my grandchildren’s “rich as Croesus” strategy. (Croesus was the last king of Lydia from 560–547 B.C.)

When each of my four grandchildren was born, I opened accounts for them at Vanguard’s TaxManaged Growth & Income fund. Each year, I deposit $10,000 (and yes, I know you can now give away $11,000/year tax-free). The money is invested with little in the way of long-term tax implications. Let me show you how compound interest works its magic.

Gettin’ Rich Slowly

If you invest for a compounded rate of return of 10%, it’s easy to think that your long-term return would be twice the return gained by investing at 5%. That is not the case—not by a long shot. Let’s take a long-term look here, for that is my intention with my grandchildren. Investing $10,000 at 5% for 50 years gives them $115,000—a staggering sum, to be sure. But at 10%, $10,000 grows to a mind-boggling $1,174,000 (that’s million). Double the growth rate to 20% (admittedly unrealistic, but useful in this example), your $10,000 would become a stratospheric $91 million (over 77 times the return). And you thought you understood compound interest?

You and Counterbalancing

As noted, a 20% annual return year after year is unrealistic. But you can achieve really terrific success, most conservatively, by counterbalancing your portfolio with fixed-income and common stocks. …

In 1989, the editors of Fortune published an article headed, “A Low Risk Path to Profits” profiling Loews Corp. money manager Joseph Rosenberg. Fortune noted that J.R. believed so fervently in the awesome power of compound interest that he carried a compound interest table in his pocket at all times. Sayeth J.R., “It is the most important thing in investing.” As the article noted, it’s foolish to undermine the power of compounding by taking big risks that kick you out of the game.

As Rosenberg noted then, compound interest “is the most important thing in investing.” If you want to succeed as an investor for your family, your grandchildren, or yourself, stay focused on the simple, yet sophisticated strategies that really make a difference.

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