Strategies that bear results

Strategies that bear results 
July 18, 2012


Barbara Drury asks four fund managers where to look for stocks that offer good dividend income and growth.

Buy in gloom and sell in boom is sharemarket advice that has been proved right over and again. There is no doubt that investors are gloomy; the question is, are we gloomy enough yet?

''The problem is that no one will ring a bell and tell you it's time to get back into the market,'' the chief executive of Lincoln Indicators, Elio D'Amato, says.

''You only make money in stocks by buying low and selling high. If you want your investments to perform over the long run you need exposure to growth in up-and-coming companies.''

That's a difficult message to sell when Australian shares fell 11.1 per cent in the year to June 30. Size and quality were no defence, with only five of the top 20 stocks posting gains. After a year such as that, it is a brave investor who shifts money from the safety of a bank deposit into the uncertainty of shares.

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But the tradeoff between risk and reward is slowly shifting as the yields on term deposits fall along with official interest rates.

Where investors were able to get a guaranteed return of 6 per cent on a one-year term deposit 12 months ago, the going rate has dipped to less than 5 per cent and is expected to fall further.

Yields on 10-year government bonds are skirting 3 per cent, down from more than 5 per cent two years ago.

By comparison, the dividend yield on the local sharemarket is close to 5 per cent and it is possible to construct a quality portfolio including the banks and Telstra with a dividend yield of about 7 per cent; more including franking credits. This widening gap between the risk-free return from cash and bonds and the priced-for-risk return from shares is getting more tempting, but investors should not expect miracles.

The Australian market looks cheap at the moment at 10.8 times earnings compared with a historic price-earnings ratio of 14.5. But experts warn that growth will remain elusive while the world is deleveraging, Europe remains in crisis, US growth is anaemic and China is slowing.

''At the moment markets are so sceptical they don't believe anything people tell them and they don't believe growth till they see it. That's where the opportunities are,'' the head of Australian equities at Fidelity, Paul Taylor, says.

A dividend strategy focused on the big end of the market is a rational response to the current investment climate, but if you want a bit of growth with your income you need to cast your net wider.

ROB TUCKER, S.G. Hiscock

The SGH20 portfolio manager, Rob Tucker, says it is difficult to beat the overall market return if you only invest in the top 20 stocks. In the SGH20 fund (seeking the best 20 investment ideas from the top 300 stocks) CSL is one of only three top-20 stocks. ''We think we can add value where stocks are under-researched and undervalued,'' he says.

He says dividend growth might stall in the next 12 months, posing a trap for investors in so-called defensive sectors such as utilities. These utilities face regulatory resets - where their regulated return is lowered to match the change in the risk-free rate (10-year bond).

This means dividend payments are likely to be lower for these stocks over the next two years to three years.

''It's important not to buy shares just for yield,'' Tucker says. ''You can't have all your money in telcos, banks and utilities; you need to diversify.

''Equities are still growth assets, so we focus heavily on free cash-flow growth, which should support dividend growth on a three- to five-year view.''

Tucker looks for stocks with a strong economic moat such as the pricing power that comes from a strong brand or patent and high barriers to entry into their market. The fund currently has a bias towards healthcare stocks that are well positioned to benefit from the higher spending of an ageing population.

Tucker says Ramsay Health Care is in a good position to help the government solve the shortage of hospital beds and looks set to deliver 13 per cent compound dividend growth during the next three years. It currently sits on a dividend yield of 2.4 per cent.

Blood plasma group CSL is a solid performer with a global franchise and a pipeline of new products that should help the group grow organically. It has low debt and generates good free cash flow to fund acquisitions or share buybacks. Engineering consultancy WorleyParsons offers exposure to the mining services sector, which has been heavily sold recently. Tucker says Worley is one of the top global players in its field and is well positioned in the oil and gas sector. He expects the pipeline of capital spending in the LNG and shale oil industries will be robust during the next five years, providing longer-term growth. In the meantime, investors get a 3.8 per cent dividend yield.

Cardno is a professional infrastructure and environmental services company. Because it invests in professional employees it is not capital-intensive and generates good free cash flow, not to mention a dividend yield of 5.1 per cent, with an estimated 15 per cent dividend growth rate over the next two years.

Treasury Wine Estates is a turnaround story with minimal capital investment over the next three years. Tucker says the value of the company's wine inventories is not reflected in the balance sheet and is currently undervalued by the market.

He says the brand-conscious Asian market should provide a good five-year growth story for its premium Penfolds labels.

GEORGE BOUBOURAS, UBS Wealth Management

The head of investment strategy at UBS Wealth Management, George Boubouras, recommends a combination of quality cyclical stocks leveraged to growth in sectors such as mining, energy and consumer discretionary, with defensive stocks such as utilities, telcos and healthcare with cash flows that can deliver sustainable dividends. 

''Investors need to be able to sleep at night,'' he says. ''If you are not sleeping, you are in the wrong portfolio.''

Boubouras acknowledges that popular dividend stocks are expensive but says investors are prepared to pay for the certainty of dividends.

''Volatility is not going away and the market still faces challenges,'' he says. ''Earnings growth and good-quality dividends is all I'm aiming for in the current environment.''

He recommends accumulating Telstra shares on any price dips for its quality dividends from strong cash flow business models.

Westfield offers investors exposure to its quality global options and dividend-focused domestic business with a dividend yield of more than 5 per cent.

''One can search for higher yields but, as always when chasing a dividend, search for certainty of delivery,'' he says.

For a more defensive stance, AGL Energy has the largest retail customer base in the country, which Boubouras says offers the most defensive exposure to the utilities sector, plus a dividend yield of more than 4 per cent. Transurban is a quality infrastructure asset with predictable cash flows from toll roads in Sydney and Melbourne providing a dividend yield of more than 5 per cent.

Boubouras says Coca-Cola Amatil is currently expensive. However, he says the business generally trades at a premium to the overall market because of the certainty of its earnings and its reliable 4 per cent dividend yield.

PAUL TAYLOR, Fidelity Worldwide Investment

Despite the slow growth outlook, Taylor says some sectors and stocks will grow faster than others. He is investing in high-quality companies with strong balance sheets and good growth prospects and/or a high and sustainable dividend yield.

''If you can find a dividend yield of 7 per cent and earnings growth of 3 per cent, that's quite a strong position in a low-growth world,'' he says.

Taylor says companies that deliver sustainable dividends will be bid up in this market but company strategy is vital. He says Sydney Airport is a good long-term investment because of its strong and sustainable dividend yield (currently 7.2 per cent) and structural growth. ''It is one of the few China consumption plays as Chinese become more important to our tourism market'', he says.

Insurer Suncorp Group is more of a turnaround story. Not only was it hammered by natural disasters including the Queensland floods but it was caught out in the financial crisis with bad loans to property developers.

''We think its problems are cyclical, not structural,'' Taylor says. ''We think it should be a 15 per cent ROE [return on equity] business, not a 0.75 per cent ROE business, so there is a lot of upside. It was one of the only insurers to pay out on flood insurance, which was good for the brand.''

Taylor also likes Goodman Group. While retail and office property are weak, industrial property has been a beneficiary of the internet because it creates more need for distribution hubs rather than retail space.

It currently offers a dividend yield of more than 5 per cent.

One of the themes of Taylor's portfolio in the current market is to focus on the essentials of life such as supermarkets, banks and energy while consumers shun discretionary spending.

He says Origin Energy has been marked down because of uncertainty surrounding its coal seam gas to LNG project in Queensland, cost blowouts and speculation that the company may need to raise equity.

''All that is already priced into the stock and as we get more clarity it will provide price upside'', he says. In the meantime you've got a good stable business with a dividend yield of 4 per cent.

ELIO D'AMATO, Lincoln Indicators

D'Amato is confident that shares will hold up in the second half-year, with companies supported by low interest rates, no inflation, falling oil prices and low wage growth. He urges investors to use this period of market weakness to weed out poor-performing companies and consider unloved stocks that are fundamentally good businesses.

Heavy share-price falls during the past few months have exposed some attractive valuations, especially in the unloved mining, energy and mining services sectors. He singles out copper and gold producer PanAust, Maverick Drilling and Exploration and global drilling and services company Boart Longyear, which all have strong forecast earnings per share growth but are trading at a discount of more than 30 per cent below Lincoln's valuation. Boart also has a forecast dividend yield of 4.89 per cent.

Similarly, iron ore heavyweight Fortescue is trading at a 27 per cent discount to Lincoln's valuation of $6.60 a share. D'Amato says the latest low inflation figure out of China adds weight to his belief that it is near the bottom of a cyclical downturn and iron ore will be leveraged to the recovery when it occurs.

''It's important to get on these trains before they leave the station,'' he says. ''Don't put all your money in at once but in three or four parcels over time.''

D'Amato says Corporate Travel Management, a global corporate travel operator, has the ability to continue to beat expectations with forecast earnings growth of 19.8 per cent a share. ''The market is always a risk/reward tradeoff. At the moment you can get a good yield investing in the banks rather than putting your money into one,'' he says.

Read more: http://www.theage.com.au/money/investing/strategies-that-bear-results-20120717-226wr.html#ixzz21VgO8T3T

Investor time horizons are increasingly measured in nanoseconds. However, long-term investing makes sense.

Warren Buffett is all the proof John Kay needs that long-term investing makes sense 

The Kay review identifies the problem, but tackling corporate and investor "hyperactivity" needs a cultural revolution.

Billionaire investor Warren Buffett Photo: AP

By Alistair Osborne, Business Editor

7:36PM BST 23 Jul 2012

8 Comments

John Kay must be an optimist.

He’s just produced a 113-page report into short-termism in UK equity markets. Who does he think’s got the concentration span to read that? Three pages would be a stretch for most of the people it’s aimed at. And that’s allowing for page 2 being intentionally blank – like the mind of any top City trader.

Luckily, you don’t have to delve too far into Kay’s critique of “hyperactive” companies and investors all seeking “immediate gratification” to spot that the economist has done an OK job of identifying the problem. Whether his recommendations will ever fix it is another thing entirely. Even Kay admits he can only offer “long-term solutions”, which sounds kind of circular.

For him, the blame for the current knee-jerk investment environment is shared pretty equally between companies and shareholders.

UK-listed companies continually lag their peers in Germany, America and France when it comes to traditional benchmarks of long-term thinking, such as business investment or R&D spend.

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And it’s not hard to see why when companies are run by bosses caught awkwardly between their next bonus or a pay-off, with the average tenure of a FTSE-100 chief executive less than five years. No wonder they tend to go for the supposed quick fixes of internal shake-ups, financial engineering or M&A rather than making decisions that might reward their successor. They do that too, as Kay shows, despite nasty history lessons from the likes of GEC, ICI and Royal Bank of Scotland.

Meanwhile, investor time horizons are increasingly measured in nanoseconds – and not only those of high-frequency traders otherwise known as computers. Quarterly targets and the bonuses that ride on them have made fund managers increasingly twitchy, while the distance between the company and the saver who wants to invest in it has been lengthened by a costly chain of middle-men each taking a cut, including investment consultants, independent financial advisers and pension trustees. What gets lost in the process is any real engagement between the company and its shareholders.

Kay’s solution for all this, as he admits, amounts more to cultural revolution than quick fix – a sort of everyday “shareholder spring”. Among his 17-point plan is the proposal to axe all cash bonuses for directors, replacing them with share-based awards that must be held “at least until after the executive has retired from the business”. He’d also like an end to mandatory quarterly reporting (wouldn’t we all) for both fund managers and companies.

Then there’s his proposal for a new stewardship code that goes beyond the current focus on corporate governance to push shareholders to ask hard questions on such things as strategy and capital allocation – though if they’re not doing that already, what are they getting paid for? He’s keen too on a new “investors forum”, so shareholders can club together to club the management or, as he ventured on Monday, to help sort out the Barclays board – even if that looks wishful thinking.

Sure, much of this, if ever implemented, might encourage a more long-term approach – though Kay could have saved himself some words by getting to the apotheosis of such investment earlier than page 56. It’s there he mentions the man who once declared “our favourite holding period is forever”, adding: “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”

As one of the richest men on the planet, Warren Buffett kind of makes Kay’s case for him.

http://www.telegraph.co.uk/finance/comment/alistair-osborne/9421860/Warren-Buffett-is-all-the-proof-John-Kay-needs-that-long-term-investing-makes-sense.html

Markets shrink: it's normal so be optimistic

July 21, 2012
Annette Sampson
Personal Finance Editor

Have we hit capitulation yet? It has been a while since we've dragged out the investor sentiment cycle, but when the head of investment strategy for AMP Capital Investors, Dr Shane Oliver, included it in his latest newsletter, it seemed time for another look.

Markets are only partly driven by fundamental considerations such as value and dividend yields.

Their real impetus comes from emotions such as fear and greed.

And while those emotions can seem erratic over the short term, in the longer term, investor psychology is highly predictable.

As the graph shows, investors go through a roller-coaster of emotions in the typical market cycle.

Rising share prices spark a sense of optimism, which fast accelerates into excitement and the thrill of watching investments grow.

The top of any boom is characterised by euphoria when we think nothing can go wrong. This is the boom that will go on forever, and while we'd be smart to run for the doors when people start talking about ''new paradigms'' and how ''this time it's different'', most of us don't want to know. We've become overconfident, believing that our success is due to our own skill, not the fact that any idiot can make money in a raging bull market. And greed has well and truly kicked in, promoting us to chase more.

Rationally, this is the most dangerous point in the investment cycle. Prices become overvalued and the average investor is blind to the early warning signs. But no one wants to know.

When the market does inevitably take a turn for the worse, emotions spiral downwards through anxiety, denial (that's where the ''I'm a long-term investor, I don't need to worry'' bit is strongest), and, eventually, fear, depression and panic.

But it's not until investors give up hope that the cycle moves back into an upswing.

The bottom of any market cycle is characterised by capitulation and despondency. Just as investors believed the bull market could go on forever at the top of the cycle, they start to believe the bad times are here to stay. That's when you start to hear people talking about getting out of the sharemarket. Permanently. Because no matter what the pundits say, things aren't going to change. And just as the most dangerous time to invest is when markets are euphoric, the best investment opportunities arise when they are despondent.

In the 1970s, the long bear market led to pronouncements that equities were dead. Oliver reckons that is where we are again now.

The only problem is that while the psychology remains the same, no two market cycles are identical. And while you can be guaranteed that we will eventually move back to hope and optimism, there are no guarantees on how long it will take.

After an initial period of denial following the global financial crisis, markets have now woken up to the fact that Europe, and indeed most Western economies, will only truly recover when they have their debt under control. That will be a long and painful process.

Preserving capital makes sense when ongoing volatility is a high probability. As the investment director at Fidelity Worldwide Investment, Tom Stevenson, recently pointed out, if you lose a third of your money, you have to grow what you have left by 50 per cent to get back to where you started.

The fact that the big stocks are now highly correlated has also made short-term stock-picking profits hard to come by. The good gets trashed along with the bad.

But as Stevenson says, there are still excellent businesses out there with fantastic prospects. While shares in those companies won't bounce back immediately, he says in 10 years you might well look back and think this was a good time to invest in these long-term winners.

Oliver argues this period of poor returns isn't new; it's just something that markets do.

And as such, giving in to despondency can mean missing out on opportunities. Yes, there are plenty of reasons to be cautious, but he says it would be dangerous to write off equities altogether.

This story was found at: http://www.theage.com.au/money/markets-shrink-its-normal-so-be-optimistic-20120720-22f3l.html

11 Investing Lessons From Peter Lynch

by Alexander Green, Investment U Chief Investment Strategist
Wednesday, July 18, 2012: Issue #1817

Sometimes I almost feel sorry for the market timers.

There’s a reason famed money manager Ken Fisher calls the stock market “The Great Humiliator.”

Nobody can know with any certainty what the stock market will do next week, next month, or next year. The sooner you recognize that, the sooner you can start making money in stocks…

I learned this lesson from three world-beaters: Warren Buffett, John Templeton and Peter Lynch.

Going Outside My Research Department…

As a young man starting out in a stock brokerage 27 years ago, I made a startling discovery. The “analysts” at my firm picking stocks for clients weren’t just bad… they were awful. I soon found myself looking for ideas outside my “research department.”

After six months of sheer frustration, I had an epiphany…

If I were going to learn from someone else, why not the best?

Instead of listening to the talking heads at my firm, why shouldn’t I listen to the greatest investors in the world?

As this was the early 80s, it was Warren Buffett, who ran Berkshire Hathaway, Peter Lynch, who managed the Fidelity Magellan Fund, and John Templeton, who headed the Templeton Growth Fund.

These men had very little in common in their investment approaches:

• Buffett was (and is) a value guy.

• Lynch was a growth analyst.

• Templeton was a global markets pioneer.

But they all started from the same premise: They didn’t have a clue what the broad stock market was going to do.

That was fine, because they knew something much more valuable: how to identify companies selling for far less than their intrinsic worth. And when the market recognized that value, they sold them.

11 Lessons From Peter Lynch

For instance, Peter Lynch taught me:

• Behind every stock is a company. Find out what it’s doing.
• Never invest in any idea you can’t illustrate with a crayon.
• Over the short term, there may be no correlation between the success of a company’s operations and the success of its stock. Over the long term, there’s a 100% correlation.
• Buying stocks without studying the companies is the same as playing poker – and never looking at your cards.
• Time is on your side when you own shares of superior companies.
• Owning stock is like having children. Don’t get involved with more than you can handle.
• When the insiders are buying, it’s a good sign.
• Unless you’re a short seller, it never pays to be pessimistic.
• A stock market decline is as predictable as a January blizzard in Colorado. If you’re prepared, it can’t hurt you.
• Everyone has the brainpower to make money in stocks. Not everyone has the stomach.
• Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.

Lynch’s advice had a profound effect on my stock market approach. He taught me that investment success isn’t the result of developing the right macro-economic view or deciding when to jump in or out of the market. Success is about researching companies to identify those that are likely to report positive surprises.

A Valuable Investment Lesson for Any Investor

I know investors who have spent a lifetime (and a fortune) in the stock market and have still not learned this lesson. Or lack the intestinal fortitude to follow it.

Worse, there are a number of gurus out there who are convinced that they have the smarts – or a system – that allows them to get in and out of the market just in the nick of time. Yet you’ll notice that system (ahem) always goes on the fritz just as soon as you start to follow it.

Count yourself a sophisticated investor the day you wake up and say, “Since no one can tell me with any consistency what the economy and the stock market will do, how should I run my portfolio?”

The answer to that question is: a well-defined, battle-tested investment approach that achieves high returns with strictly limited risk.

Of course, everyone in the industry claims that they’re beating the tar out of the market.

Our approach is based on a market-neutral investment philosophy. Our focus is on teaching investors how to seek out the most undervalued opportunities in the market.

As Buffett, Lynch and Templeton famously proved, that’s what actually works.

Good Investing,

Alex

P.S. Peter Lynch often said he found some of his best-performing investments while visiting the mall with his family. Indeed, he noted that, “If you like the store, chances are you’ll love the stock.”

http://www.investmentu.com/2012/July/peter-lynch.html

Investing in Southeast Asia

Investing in Southeast Asia: Proceed with Caution

by Carl Delfeld, Investment U Senior Analyst
Friday, July 20, 2012: Issue #1819

It’s no surprise to me that stock markets in Southeast Asia – what I call the “sweet spot” of Pacific Rim growth – are outperforming. While emerging markets are down so far this year, the Philippines is up 19%, Vietnam has bounced back 17% and Singapore has risen 13%.

Located south of China and east of India, this booming region is sometimes overlooked by even the most sophisticated investors. Yet it represents 10 countries with a population of 600 million and an economic output of $1.7 trillion.

A free trade pact between the Southeast Asian regional grouping (ASEAN) and China (ASEAN-China Free Trade Area), took effect in January 2010. By the end of that year, ASEAN exports to China had leapt 54% and overall trade between these countries jumped 47%. This free trade area has become the third largest in the world and more than 7,000 products trade at zero tariffs.

The next move is a work led by China’s prime competitors. The Trans-Pacific Partnership countries – Australia, Brunei Darussalam, Chile, Malaysia, New Zealand, Peru, Singapore, Vietnam and the United States – announced the achievement of the broad outlines of an ambitious, twenty-first century Trans-Pacific Partnership agreement that will supercharge trade and investment in the Pacific Rim.

This agreement will also boost America’s stake in this vital region. U.S. goods exports to the broader Asia-Pacific region totaled $775 billion in 2010, a 25% increase over 2009 and equal to 61% of all U.S. goods exported to the world.

Southeast Asia also sits astride the biggest trade routes in the world and the two busiest ports, Hong Kong and Singapore.

The South China Sea links the Indian Ocean with the western Pacific, but to get there ships need to move through one of several narrow straits that serve as chokepoints. To put things in perspective, the oil transported through the Malacca Strait from the Indian Ocean through the South China Sea, is triple the amount that passes through the Suez Canal and 15 times the amount that passes through the Panama Canal.

The stakes are high because roughly 65% of South Korea’s energy supplies, nearly 60% of Japan and Taiwan’s energy supplies, and about 80% of China’s oil imports come through the South China Sea. It also has proven oil reserves of seven billion barrels and an estimated 900 trillion cubic feet of natural gas.

The Probability of Conflict is Low, But Rising

But the importance of these prime trade routes and the natural resources in the area pose a risk to investors, as it makes the region a “cockpit” of rising confrontation.

China is intent on pushing its territorial claims well beyond conventional norms and Law of the Sea guidelines. Countries affected by China’s overreach, such as Malaysia, Philippines Taiwan, Brunei and especially Vietnam, aren’t rolling over, but rather pushing back hard.

Oftentimes the confrontations are sparked by fishing boats and escalate from there. This is how the recent standoff between China and the Philippines over Scarborough Shoal began.

In late May, CNOOC (NYSE: CEO), a Chinese state-owned oil company, announced it was opening nine blocks off Vietnam’s coast to international bids for oil and gas exploration. These reach to within 37 nautical miles of Vietnam’s coast, which extends 2,000 miles. Then on June 21, Vietnam’s parliament passed a maritime law that reinforced its claims to the Spratly and Paracel Islands. China shot back that this a “serious violation” of its sovereignty.

The 200 small islands and coral reefs – only about 40 of which are permanently above water -  that support territorial claims are highly contentious.

The countries that are eye to eye with China often look to America’s diplomatic and military clout to balance the scales. Japan and South Korea also have a significant stake in how the dust settles.

These simmering conflicts rarely make the front page and shouldn’t discourage you from investing in Southeast Asia. But they should prompt you to manage risks using wide diversification and 20% sell stops.

Good Investing,

Carl

http://www.investmentu.com/2012/July/investing-in-southeast-asia.html

How To Build Wealth Using Our Four Pillars of Wealth

How To Build Wealth

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:

1. 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.”
2. 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.
3. 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.
4. 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.”
5. 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

http://www.investmentu.com/research/buildwealth.html