Achieve Your Financial Goals in the New Millennium Using Our Four Pillars of Wealth
An Investment U White Paper Report
By
Alexander Green, Chief Investment Strategist
, Investment U
Our philosophy of investing is this: You can’t go too far wrong if you get the big questions right.
The big questions are not “when will the economy recover?” or “where will the market go next?” True, these are the questions that most investors obsess over. But it’s a misallocation of your time.
The big question is how to build wealth with a game plan for the long haul and, more specifically, the following points that you can take action on:
- How can I secure the highest return with the least amount of risk?
- How can I protect both profits and principal?
- What can I do to build wealth and guarantee my investment portfolio will be worth more in the future?
Here’s how this philosophy can make this year – and your future ones – very prosperous.
How To Build Wealth Pillar 1: Stick to Our Asset Allocation Model
Successful investing begins by conceding that – to a degree – uncertainty will always be your companion.
You can guess what the market is going to do and be right or you can guess and be wrong. Or you can let some self-styled “expert” do the guessing for you. But no one guesses right consistently.
That’s why we follow a wealth-building investment formula that won Dr. Harold Markowitz the Nobel Prize in finance in 1990. His paper promising “portfolio optimization through means variance analysis” demonstrates how to maximize your profits and minimize your risk by properly asset allocating and rebalancing your portfolio.
Diversity Doesn’t Mean 3 Different Tech Stocks
Sometimes our readers tell us: “Oh, that means diversify. I already do that.” But that’s not what asset allocation is about. Right before the dot.com crash, you could have diversified into Microsoft, Intel, Yahoo and Amazon.com… and gone right off the cliff.
Asset allocation refers to spreading your investments among different asset classes, not just different securities or market sectors. Doing this has allowed us to survive, prosper and build our wealth, even during rough times.
High-grade bonds, real estate investment trusts (REITs), high-yield investments, inflation-adjusted treasuries, precious metals: It’s good to have at least a piece of each.
Because different asset classes are imperfectly correlated – some zig while others zag – our model allows you to boost returns while reducing your portfolio’s volatility.
In layman’s terms, proper asset allocation means you sleep better at night.
The Foundation of Our Philosophy
Asset allocation should be the foundation stone of your whole investment program. It’s critical to building your long-term financial health. To learn more about it, pick up a copy of William Bernstein’s excellent book, The Intelligent Asset Allocator.
How To Build Wealth Pillar 2: Adhere to the Oxford Safety Switch
Anyone can buy a stock or publicly traded fund. The real art of investing is knowing when to sell. Investment U does not rely on point-and-figure charts or tarot cards or Elliott Waves. Instead, we adhere to a time-tested trailing stop strategy. That means no member takes one of our stock recommendations without knowing in advance exactly where we’ll get out.
This takes the guesswork out of investing. And guarantees that both your profits and your principal are always protected. Here’s a quick review.
Let Your Winners Ride
We start all of our trading positions with a recommendation that you place a sell stop 25% below your execution price. As the stock rises, we raise the trailing stop. In other words, if you buy a stock at $20, your stop loss is at $15. When the stock hits $32, your stop loss (still trailing at 25%) will be at $24.
As long as the stock keeps trending up, we’re happy to hang on. If the stock pulls back 25% from it’s closing high, we sell. No questions asked.
And Cut Your Losses Early
You protect the profits you’ve earned on the way up and also protect your principal when things go awry. Everyone knows you should cut your losses early and let your profits run. But very few investors actually do it. The Oxford Safety Switch, championed by The Oxford Club, guarantees that you do.
During the bull market of the 1990s, many investors watched as their stock portfolios grew bigger and bigger. There was only one problem. They never took any profits. They had no sell discipline whatsoever. So when stocks started tanking, they watched many of those profits evaporate entirely. Some even turned into losses.
Other investors then bought stocks early in the ensuing bear market with high expectations. And they were crushed to see those shares drop to levels they never would have imagined.
In both cases, the fault was the same: They failed to have a sell discipline. Investors without one are flying by the seat of their pants. And that rarely ends in award-winning results. It’s simply not a practical means to build wealth.
Action to take: Use a trailing stop on all your individual stocks and have the gumption to stick with it.
How To Build Wealth Pillar 3: Size Does Matter Understand Position-Sizing
Often when the Oxford Club recommends a particular stock at a chapter meeting or seminar, someone in the audience will ask how much he or she should invest in it.
Of course, we know nothing about that individual’s net worth, investment experience, risk tolerance or time horizon. But we do have a position-sizing formula you can use to determine how much to invest in a particular stock: 3% of your equity portfolio. If you want to be conservative, invest less. If you want to be aggressive, invest more. But not too much more.
Don’t Fall in Love with an Investment
The saddest stories heard in the financial press are those of people who took a serious financial hit late in life because they were overconfident. In short, they liked an investment so much they plunked too much in it. Big mistake.
Yes, you could hit the jackpot that way and some people have. But that’s a roll of the dice and it’s not recommended.
Look at the thousands of people devastated during the recent bear market because their entire pension was tied up in their employer’s stock. More often than not, these folks had the option of putting the money into a diversified stock fund or safer alternatives.
Not spreading the risk might have felt like the right thing when the stock was rising, but it sure hurts on the way down.
You Can Afford the Hit
That’s why position sizing is important. It’s not just about the size of your initial position; it’s also about how much of your portfolio the position becomes. Many investors refuse to diversify even when a single stock becomes a substantial percentage of their entire portfolio. They always had the same excuse: “I just can’t afford the tax hit.”
But taxes should never be the first priority in running your investment portfolio. Former blue chips like WorldCom, Enron and United Airlines have taught us that – in hindsight – the federal tax bite can look like a kiss on the cheek.
How To Build Wealth Pillar 4: Cut Investment Expenses, and Leave the IRS in the Cold
Unless you run or sit on the board of the companies you invest in, there’s nothing you can do to affect your stocks’ performance once you own them. But there is a way to guarantee that your stock-portfolio value will be worth more five, 10 and 20 years from now.
Create wealth for the short- and long-term by cutting your expenses and stiff-arming the taxman.
Let’s start with expenses…
Just Say No To High Fees
Instead of buying the nation’s largest and best-performing bond fund, the Pimco Total Return Fund, we’re recommending the Manager’s Fremont Bond Fund (Nasdaq: MBDFX). You still get the nation’s top-performing bond fund manager, Bill Gross, but you forego the high fees and expenses associated with Pimco Total Return. Fremont is a no-load fund.
Likewise, we opted for the closed-end Templeton Emerging Markets Fund (NYSE: EMF) instead of the open-end Templeton Developing Markets Fund. Both funds invest exclusively in emerging markets. Both are run by Mark Mobius, the top manager in the sector.
But the Templeton Developing Markets Fund has a 5.75% front-end load. The Templeton Emerging Markets Fund – like all closed-end funds – has none. And it sells at an 11% discount to its net asset value (NAV). (You can never buy an open-end fund for less than NAV.)
In fact, there is nothing in our Oxford Portfolio that has a front-end load, back-end load, 12b-1 fees or surrender penalties. Furthermore, you can act on any of our recommendations through a no-load fund company or a deep discount broker that charges you no more than $8 a trade.
In short, a big part of our strategy in explaining how to build wealth is cutting portfolio expenses to the bone. Lower investment costs is the one, sure-fire way to increase your net returns.
5 Tax-Managing Tips (Reducing Expenses Helps To Build Wealth)
The second way is to tax-manage your investments. That means handling your portfolio in such a way that there is simply nothing there for the IRS to take.
Here’s how to do it:
- Stick to quality. Higher quality investments mean less turnover. And less turnover means less capital gains taxes. The less you trade your core portfolio, the less tax liabilities you incur. As Warren Buffett warns, “the capital gains tax is not a tax on capital gains; it’s a tax on transactions.”
- Try to hang on 12 months. Anything sold in less than 12 months is a short-term capital gain. And short-term gains are taxed at the same level as earned income, which can be as high as 38%. But long-term gains are taxed at a maximum rate of 20%. Even better, do your short-term trading in your IRA, where the gains are tax-exempt.
- When you stop out in less than 12 months, offset your capital gains with capital losses. The IRS allows you to offset all of your realized capital gains by selling any stocks that have joined the kennel club. You can even take up to $3,000 in losses against earned income. Not selling your occasional losers is not only poor money management; it’s poor tax management.
- Avoid actively-managed funds in your non-retirement accounts. Managed funds often have high turnover and Federal law requires them to distribute at least 98% of realized capital gains each year. You can get hit with a big capital gains distribution even in a year when the fund is down. In parts of Texas, this is known as “the double whammy.”
- Own high-yield investments in your IRA, pension, 401K or other tax-deferred account. There’s no provision in the tax code to offset your dividends and interest. So do the smart thing. How to do this? Own big income-payers like bonds, utilities and real estate investment trusts (REITs) in your IRA.
| Average Portfolio | Oxford Portfolio |
| 5 years | $140,255 | $168,505 |
| 10 years | $196,715 | $283,942 |
| 15 years | $275,903 | $478,458 |
| 20 years | $386,000 | $806,231 |
Your remaining choices are simple ones like owning tax-free rather than taxable bonds if you’re “fortunate enough” to reside in the upper tax brackets.
If you reduce your annual investment expenses and tax-manage your portfolio, the effect will be dramatic. For example:
The Vanguard Group of mutual funds recently conducted a study that indicates that the average investor gives up 2.4% of his annual returns to taxes. If you trade frequently, it’s likely much higher. We can also estimate that most investors give up at least 1.9% a year in commissions, management fees, 12b-1 expenses and other costs.
How to retain an additional 4% of your portfolio’s return each year: Reduce your expenses to .3% annually and tax-manage your portfolio.
Here are some important facts on how to build wealth and improve your portfolio over time using our strategy. The differences are not subtle.
The U.S. market has returned roughly 11% a year over the past 200 years. The previous chart reflects how a $100,000 stock portfolio grows at this rate – with the drag of taxes and high expenses, and without.
In other words, after 20 years, our cost-efficient, tax-managed portfolio is worth $419,000 more. (A million dollar stock portfolio, of course, would be worth almost $4.2 million more.) This is without factoring in any superior investment performance whatsoever! It’s simply the difference achieved when watching investment costs and taxes.
Armed with our Four Pillars of Wealth, a little diligence, and the discipline to stick with the program, we can all look forward to substantially higher real-world returns in our wealth-building pursuits.
The Four Pillars of Wealth, by the way, are fundamental to the success of Investment U‘s sister business, The Oxford Club, where Investment U’s profit strategies are put into action.
Good Investing,
Alexander Green
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